1. Théorie Financière 2004-2005 3. Tableau de financement et planning financier Professeur André Farber

2. August 23, 2004 Tfin 2004 03 Cash flows |2 Financial statements and cash flows Objectives for this session

3. August 23, 2004 Tfin 2004 03 Cash flows |3 Levers of Performance Return on Equity Return on Invested Capital Profit MarginAsset Turnover Leverage

4. August 23, 2004 Tfin 2004 03 Cash flows |4 Summarized (managerial) balance sheet Assets Fixed assets (FA) Working capital requirement (WCR) Cash (Cash) Liabilities Stockholders' equity (SE) Interest-bearing debt (D) FA + WCR + Cash = SE + D Working capital requirement : definition + Accounts receivable + Inventories + Prepaid expenses - Account payable - Accrued payroll and other expenses Interest-bearing debt: definition + Long-term debt + Current maturities of long term debt + Notes payable to banks

5. August 23, 2004 Tfin 2004 03 Cash flows |5 Net Working Capital Net working capital can be understood in two ways: as an investment to be funded: Current Assets - Current Liabilities as a source of financing=Stockholders' equity + LT debt - Fixed Assets Fixed Assets Current Assets Stockholder’s equity Long term debt Current liabilities Net Working Capital Current ratio: a measure of NWC Current ratio = Current assets / Current liabilites Net working capital = Current assets - Current liabilites Current ratio > 1  NWC > 0

6. August 23, 2004 Tfin 2004 03 Cash flows |6 Net Working Capital vs Working Capital Requirement Summarized balance sheet identity: FA + WCR + CASH = SE + LTD + STD can be written as: WCR + (CASH - STD) = (SE + LTD - FA) WCR + NLB = NWC Working Capital Requirement Net Liquid Balance Net Working Capital

7. August 23, 2004 Tfin 2004 03 Cash flows |7 Return on invested capital Return on assets (net)= Net income / Total assets Advantage: fits with DuPont system ROE = ROA x Equity multiplier Limitation: Net income = EBIT - Interest expense - Taxes –Depends on capital structure: 1. Interest expense: function of interest-bearing debt 2. Interest expense : tax deductible Preferred measure: Return on Invested Capital (ROIC) NB: ROIC = ROA (gross) (1 - Tax rate) = ROE of a all equity financed firm

8. August 23, 2004 Tfin 2004 03 Cash flows |8 Financial leverage Financial leverage magnifies ROE only when ROA (gross) is greater than the interest rate on debt. Balance sheet: TA = SE + D Income statement: NI = EBIT - INT- TAX Interest expense INT = r D (Interest expense = Interest rate x Interest-bearing debt) TaxesTAX = (EBIT - r D) T c ( Taxes = Taxable income x Tax rate) Remember : ROIC = ROAgross (1 - Tc) ROE = ROIC + (ROAgross - r) (1-Tc) (D/SE)

9. August 23, 2004 Tfin 2004 03 Cash flows |9 Sources of Cash Inflow and Cash Outflow Operating Activities Sales of goods and services Investing Activities Sale of fixed assets Sales of LT financial assets Financing Activities Issuance of stocks and bonds LT and ST borrowing Operating Activities Purchase of supplies Selling, general and administrative expenses Tax expenses Investing Activities Capital expenditures and acquisitions LT financial investments Financing Activities Repurchage of stocks and bonds Repayment of debt Dividend payment CASH CF from operating activities CF from investing activities CF from financing activities

10. August 23, 2004 Tfin 2004 03 Cash flows |10 Farber.com: a fable Starting a local version of Amazon.com Initial balance sheet t = 0 Cash100Book Equity100 Operations year 1:  Sell 2 books @ €100 each  Buy 2 books @ € 50 each Income statement year 1: Revenue200 Expenses100 Net Income100 But….cash account = 0 What happened?

11. August 23, 2004 Tfin 2004 03 Cash flows |11 Farber.com: what happened…. Final balance sheet t = 1 Cash 0Book Equity200 Account Receivable200 Statement of cash flows: reconciles the two views –Direct method:+ Cash collected from customers 0 - Cash payment to suppliers+ 100 = Cash flow from operations- 100 –Indirect method: Net Income+100 -  Working Capital Requirement+ 200 = Cash flow from operations-100 No payment from clientsInitial Capital + Retained Earnings

12. August 23, 2004 Tfin 2004 03 Cash flows |12 Farber.com: additional complications Initial balance sheet t = 0 Cash100Book Equity100 Operations year 1:  Borrow and buy 2d hand computer @ €200  Sell 1 books @ €100 each  Buy 2 books @ € 50 each Income statement year 1: Revenue100 Cost of goods sold50 Depreciation100 Interest10 Net Income-60 Final cash account -10 Straight-line depreciation 2 years

13. August 23, 2004 Tfin 2004 03 Cash flows |13 Farber.com: details Final balance sheet t = 1 Cash-10Book Equity40 Account Receivable100Debt200 Inventories 50 Fixed Assets100 Total240Total240 Statement of cash flows: direct method Cash collection from customers0(=REV -  AR) -Cash payment to suppliers100(=CGS+  INV) -Cash paid for interest10 Cash flow from operating activities-110 Cash flow from investing activities-200(=  FA+Dep) Cash flow from financing activities+200 Change in cash-110

14. August 23, 2004 Tfin 2004 03 Cash flows |14 Farber.com: statement of cash flows - indirect method Statement of cash flows Net Income-60 +Depreciation+100 -  Working Capital Requirement+ 150 = Cash flow from operations-110 Cash flow from investing activities-200  Debt+200 Cash flow from financing activities+200 Change in cash-110

15. August 23, 2004 Tfin 2004 03 Cash flows |15 Notations Income statement REVRevenue CGSCost of goods sold SGASelling, general and administrative expenses DepDepreciation EBITEarnings before interest and taxes IntInterest expenses TAXTaxes T c Tax rate NINet income Balance sheet FAFixed assets, net ARAccounts receivable INVInventories CASHCash & cash equivalents SEEquity capital LTDLong term debt APAccounts payable STDShort-term borrowing Statement of retained income DIVDividendes

16. August 23, 2004 Tfin 2004 03 Cash flows |16 Income statement and balance sheet Income statement EBIT = REV - CGS - SGA - Dep TAX = T c (EBIT - Int) NI = EBIT - Int - TAX Balance sheet equation FA + AR + INV + CASH = SE + LTD + AP + STD Working capital requirement: WCR  AR + INV - AP =(Current assets - CASH) - (Current liabilities - STD) Summarised balance sheet: FA + WCR + CASH = SE + D (D = LTD + STD)

17. August 23, 2004 Tfin 2004 03 Cash flows |17 Cash flow statement : indirect method  FA +  WCR +  CASH =  SE +  D  FA = AQ - Dep AQ = Acquisitions - Disposals (investing & divesting)  SE = NI - DIV +  K  K = New issuance of capital (NI + Dep -  WCR) - (AQ) + (  K +  D -DIV) =  CASH Cash flow from operating activities Cash flow from investing activities Cash flow from financing activities ++ =

18. August 23, 2004 Tfin 2004 03 Cash flows |18 Statement of cash flows: direct method + Cash collection from customers - Cash payment to suppliers and employees - Cash paid for interest - Cash paid for taxes = Cash flow from operating activities + Cash flow from investing activities + Cash flow from financing activity =  CASH REV -  AR CGS +  INV + SGA -  AP Int TAX (REV-CGS-SGA-Int-TAX)-  WCR -AQ  K +  D - DIV NI+Dep-  WCR (NI + Dep -  WCR) + (-AQ) + (  K +  D - DIV) =  CASH

19. August 23, 2004 Tfin 2004 03 Cash flows |19 Free Cash Flow Free Cash Flow = Cash flow from operating activities + Cash flow from investing activities Calculating free cash flows of all equity firm: Free Cash Flow = EBIT(1-T C ) + Dep -  WCR - AQ Statement of cash flows for all-equity firm: Free Cash Flow = DIV -  K +  Cash

20. August 23, 2004 Tfin 2004 03 Cash flows |20 Financial Forecasting EBITDA -Depreciation =EBIT -Taxes +Net Income Income Statement Statement of Cash Flows CF from operating activities Update Balance Sheet CF from investing activities CF from financing activities

21. August 23, 2004 Tfin 2004 03 Cash flows |21 Financial Planning Based on ∆Revenues Assumptions on key ratios relating  Revenues to: Gross margin: m = EBITDA /Revenues Working capital requirement: w =  WCR /  Revenues Net fixed assets: a =  NFA /  Revenues Financial policy: Payout ratio p = DIV/Net Income Depreciation d = Depreciation / Fixed Assets -1 Environment: Tax rate T C Cost of debt i

22. August 23, 2004 Tfin 2004 03 Cash flows |22 Data Revenues year 0: 2,000 Growth rate year 1: 25% Balance sheet end year 0 Net Fixed Assets600 Working Capital Requirement400 Cash0 Total Assets1,000 Book Equity600 Debt (financial)400 Total Liabilities + Stockholders’ equity 1,000 Gross margin: m = 30% WCR: w = 20% Net fixed assets: a = 30% Payout ratio p = 50% Depreciation d = 10% Tax rate T C = 40% Cost of debt i = 10%

23. August 23, 2004 Tfin 2004 03 Cash flows |23 Step 1: Income statement Year 0Year 1 Sales2,0002,500Rev -1 (1+g) EBITDA750m × Rev Depreciation60d × NFA -1 EBIT690 Interests40i × D -1 Taxes260 Net Income390

24. August 23, 2004 Tfin 2004 03 Cash flows |24 Step 2: Statement of Cash Flows Year 0Year 1 Net Income390From Income Stat. Depreciation60From Income Stat. ∆WCR100 w ×  Revenues CF from operations350 ∆NFA150 a ×  Revenues Depreciation60 CF from investing-210 Div195p × Net Income Stock Issues/buy back0Assumption ∆Debt55Plug CF from financing-140 ∆Cash0

25. August 23, 2004 Tfin 2004 03 Cash flows |25 Step 3: Update balance sheet Year 0Year 1 Net Fixed Assets600750NFA -1 + Inv – Dep Working Capital400500 WCR -1 +  WCR Cash00 Cash -1 +  Cash 1,0001,250 Book Equity600795BEq -1 +SI + NI – DIV Debt400455 D -1 +  D 1,0001,250

26. August 23, 2004 Tfin 2004 03 Cash flows |26 The Full Model

27. August 23, 2004 Tfin 2004 03 Cash flows |27 Sustainable growth What growth rate can a company achieve without requirement additional external equity?  Assets = (a+w)  Revenues  Assets =  Book Equity +  Debt =  Book Equity +  Book Equity = Net Income (1 – Payout)(1 + ) = (Revenues) (Profit Margin)(1-Payout)(1+ ) g =  Revenues / Revenues = (Profit Margin)(1 – Payout)(1+ ) / (a+w)

28. August 23, 2004 Tfin 2004 03 Cash flows |28 Sustainable Growth: example Back to previous example: –a+w = 0.30 –Net Profit margin = 15% –Payout ratio = 50% – =  Debt /  Book Equity = 2/3 –g = [15% (1 - 0.50) (1+2/3) ] / 0.30 = 41.67%