Cash Flow Analysis

Cash Flow Analysis

What is Cash flow analysis? • Cash flow analysis deals with the timing and amount of cash inflows/outflows from a firm or an investment

Where do we start? • General Overview • Types of Analysis • Cash Flows in Capital Budgeting • Comprehensive Example

Why Cash Flow Analysis? • Profits and cash flows are very different things • Profits under the accounting system are calculated on accrual basis rather than cash basis Overview Analysis Budgeting Example

Why Cash Flow Analysis? • As an investor much better to look at both Income Statement and the Statement of Cash Flows • As management, very important to analyze the different types of inflows/outflows for capital budgeting decisions Overview Analysis Budgeting Example

Types of Analysis • Statement of CF Analysis • Free Cash Flows • Payback Period • Net Present Value • Internal Rate of Return Overview Analysis Budgeting Example

Statement of CF Analysis • Cash Flow from Operating Activities • Cash Flow from Investing Activities • Cash Flow from Financing Activities Overview Analysis Budgeting Example

Free Cash Flows Overview Analysis Budgeting Example

Payback Period • A criteria used in capital budgeting. Defined as the number of years required to recover initial cash investment Overview Analysis Budgeting Example

Payback Period: Example Overview Analysis Budgeting Example

Net Present Value • In simple terms NPV is the sum of discounted cash inflows from a project- the projects initial outlay • If NPV is > 0 accept else reject Overview Analysis Budgeting Example

NPV: Example Overview Analysis Budgeting Example

Internal Rate of Return • Discount rate that equates the present value of inflows with the present value of outflows. In simple terms it reflects the rate of return for a project Overview Analysis Budgeting Example

IRR: Example Overview Analysis Budgeting Example

What is Capital Budgeting? • Capital budgeting is the decision making process through which firms decide which projects get the funding • Financial plans for most firms are based on the capital budgeting analysis using cash flows Overview Analysis Budgeting Example

CF Guidelines in Capital Budgeting • Use Free Cash Flows Rather than accounting Profits • Only worry about incremental Cash Flows • Cash Flow diversion from other Product Categories Overview Analysis Budgeting Example

Capital Budgeting Guidelines • Look for Incidental or Synergistic Effects • Working-Capital Requirements • Incremental Expenses • Opportunity Costs Overview Analysis Budgeting Example

Comprehensive Example Overview Analysis Budgeting Example

Practice Problem Using this data solve for the Free Cash Flows and then NPV and IRR. This problem is very similar to the example solved previously. Click here for answer

Summary • Cash flow analysis is crucial for the success of a project and the firm • The most common type of analysis is Free Cash Flows analysis • Free Cash Flows can help with further analysis as they can be used in NPV and IRR calculations

Reading List • Kewon, Martin, Petty and Scott Jr. Financial Management: Principles and Applications. New Jersey: Prentice Hall, 2000. • Ross−Westerfield−Jaffe .Corporate Finance, Seventh Edition. New York: McGraw−Hill Primis, 2005. • CFA Institute. Corporate Finance Readings. Charlottesville, CFA Institute, 2005. • http://en.wikipedia.org/wiki/Cash_flows

Bibliography • Kewon, Martin, Petty and Scott Jr. Financial Management: Principles and Applications. New Jersey: Prentice Hall, 2000.(This book was heavily drawn upon. The comprehensive example format is very similar to what the author uses in the book.) • Ross−Westerfield−Jaffe .Corporate Finance, Seventh Edition. New York: McGraw−Hill Primis, 2005. • CFA Institute. Corporate Finance Readings. Charlottesville, CFA Institute, 2005. • http://en.wikipedia.org/wiki/Cash_flows

Cash Flow Analysis