1. Cash Flow Analysis Lindsay Dastrup

2. Overview Direct method Indirect method Cash flow patterns Cash flow ratios Free cash flow

3. Categories of Cash Flow Operating Activities –transactions that affect the determination of net income Investing Activities –sale and purchase of property, buildings, and equipment Financing Activities –transactions whereby cash is obtained from or repaid to owners

4. Cash Flow from Operations Direct method –the reporting of the cash received or disbursed of each income statement item Indirect method –the adjustment of the net income for items that do not affect cash flow TWO METHODS

5. Orchard Blossom Company

6. Direct Method Sales and cash collected from customers Beginning accounts receivables$ 40 +sales 150 =cash available for collection$ 190 -ending accounts receivable 60 =cash collected from customers $ 130

7. Direct Method Cost of goods sold and cash paid for inventory Ending inventory$ 75 +cost of goods sold 80 =required inventory$ 155 -beginning inventory 100 =inventory purchased$ 55

8. Direct Method Wages expense and cash paid for wages Beginning wages payable$ 7 +wage expense 25 =total wages payable$ 32 -ending wages payable 10 =cash paid for wages$ 22

9. Cash from Operating Activities: Direct Method Cash collected from customers$ 130 Cash paid for inventory -55 Cash paid for wages -22 Cash paid for depreciation 0 Net cash from operating activities$ 53

10. Indirect method Net income$ 15 +depreciation 30 -increase in accounts receivables -20 +decrease in inventory 25 +increase in wages payable 3 = net cash from operating activities $ 53

11. Cash from Investing Long-term investments Book value of long term investments sold +gain (loss) on sale =cash proceeds

12. Cash from Investing Buildings and Equipment Beginning buildings and equipment balance -original cost of buildings and equipment sold =ending balance

13. Cash from Financing Dividends paid Beginning balance of retained earnings -dividends declared +net income =ending balance of retained earnings

14. Cash from Financing Dividends paid Dividends declared -increase in dividends payable =cash paid for dividends

15. Cash from Financing Issued common stock +borrowed short term debt +borrowed long term debt -dividends paid -treasury stock purchases =cash from financing activities

16. Analysis of Cash flows Cash flow patterns Cash flow ratios

17. Cash Flow Patterns Start-up, high growth company Large cash inflows from financing pays for capital expansion subsidized negative cash flow from operations

18. Cash flow patterns Steady-state company Cash flow from operation is sufficient to replenish long term assets pay dividends

19. Cash flow pattern Cash cow Large cash inflow from operations capital expansion repay loans pay cash dividends repurchase of company stock

20. Cash flow ratios Cash flow–to-net income Cash from operations Net income Measure of earnings quality Tends to be greater than 1 Should remain fairly stable for the years for a specific company

21. Cash flow ratios Cash flow adequacy Cash from operations Cash required for investing activities Measures relationship between investment spending and cash generated by operations Indicate a company’s attitude towards reinvestment in long-lived production assets When ratio is small it indicates that cash flows from operations fall short of funding growth

22. Cash flow ratios Cash times interest earned (Cash from operations + Interest paid + Taxes paid) Interest expense Measures ability to service debt Generally, a higher ratio indicates more solvency

23. Free cash flow Profit after tax +depreciation +investment in fixed assets +investment in working capital =free cash flow

24. Tire City Corporation 1. Given the income statement and balance sheet, determine the operating cash flows, the investment cash flows, and the financing cash flows 2. Determine the value of the firm using the following assumptions: WACC (discount rate)= 15.06% Growth rate= 5.0% 1998 FCF= $759.24

25. Tire City Corporation

29. Summary Operating –Income statement and current assets and liabilities Investing –Long-term assets Financing –Long-term liabilities and owner’s equity

30. Summary Ratios –Cash flow to net income –Cash flow adequacy –Cash times interest earned

31. Reading List Intermediate Accounting by Stice, Stice, Skousen; 15 th edition Principles of Corporate Finance by Brealey, Myers, Allen; 8 th edition