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Cash Flow Module

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Cash Flow Module. Calculates and distributes cash generated by firm Excess cash: When liabilities exceed assets Either increase assets Decrease liabilities Another way to balance the model Adjust left side of balance sheet (Cash, Marketable Securities) Adjust right side of balance sheet

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Cash Flow Module

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  1. Cash Flow Module • Calculates and distributes cash generated by firm • Excess cash: When liabilities exceed assets • Either increase assets • Decrease liabilities • Another way to balance the model • Adjust left side of balance sheet • (Cash, Marketable Securities) • Adjust right side of balance sheet • Pay dividend in excess of minimum • Decrease retained earnings • Link between income statement and balance sheet

  2. Cash flow module • Start with operating cash flow • NI + Depreciation • Adjust for all changes in balance sheet items • Redundancy (fail safe) system • Picks up changes in financing • End result • Cash Available for Dividends • Sometimes will equal NI*payout • Can be more (residual) • Feeds to Dividends line in Income Statement

  3. Representative EquationsCash flow sector, cont.

  4. Cash must flow somewhere • Not into a financial black hole • Above equations direct specified amount to Cash Balance • Residual directed to dividends • Could have gone into Marketable Securities or used to retire debt • The key • Residual flow must be directed somewhere

  5. A financial black hole • The $200 must be directed somewhere • Marketable securities (or cash) • Larger Dividend • Retire debt • Repurchase stock

  6. EquilibriumTwo ways to achieve • Equilibrate stock balances (adjust right side) • Financing Module • Total Assetst = Total Liabilitiest • Total Assetst = Total Liabilitiest-1 + New Financingt • Balance flow of funds (adjust left side) • Cash Flow Module • Total Uses of Fundst = Total Sourcest • Net Change in Cash Balancet = Net Cash Inflowt • Either or both methods can be used • Use elements of both for checks

  7. Model must be told how to balance • Simulation model • Can • Determine how much new financing is necessary • Cannot • Make decisions • User specifies plug • Force equality between sources and uses of cash • Adjust cash balance • “Cash-balancing” model OR • Force equality between assets and liabilities • Adjust debt and common stock balances • “Stock-balancing” model

  8. EquilibriumExample: Stock balancing • Investment module • Calculates additional investment in fixed assets of $100 million • Financing module • $25 million to come from spontaneous and internal sources • Left-hand side exceeds right-hand side of balance sheet • Assets exceed liabilities and stockholders' equity by $75 million • Difference: the amount necessary to balance • Required External Financing • The plug • $75 million • User determines the source • Debt or equity • Forces the model into balance

  9. EquilibriumExample: Flow balancing • Investment module • Calculates additional investment in fixed assets of $100 million • Financing module • $125 million to come from spontaneous and internal sources • Right-hand side exceeds left-hand side of balance sheet • Difference: the amount necessary to balance • Excess cash • The plug • $25 million • User determines the allocation • Increase cash or marketable securities • Increases assets • Increase dividend • Decreases liabilities (retained earnings) • Decrease debt • Buyback shares • Forces the model into balance

  10. Perverse EffectsDividends: Problems • Paying dividends without sufficient cash flow • Paying negative dividend when firm experiences a loss • Distributing excess cash

  11. Perverse EffectsDividends: Solutions • Calculate Minimum Dividend in Financing Module • Assures dividend will be financed • Prevent from going negative when NI < 0 • Use =MAX(.) • Calculate Cash Available for Dividends in Cash Flow Sector • Includes external financing for minimum dividend • Reference CAfD in income statement

  12. Perverse EffectsDividends: Excel code

  13. Four equilibrium checks • Balance Sheet • Total Assets less Total Liabilities and Shareholder Equity • Have all the financing needs been met? • Must equal 0 • Cash Flow module • Net Cash Flow less Increase in Cash less Dividends • Is all free cash flow allocated? • Must equal 0 • Else some cash is flowing into a financial black hole • Statement of Cash Flows • Net increase in cash less uses of cash • Does what’s left after all uses for cash equal net increase in cash? • Must equal 0 • Master check • Sum of the three above • Must equal 0

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