Cash Flow
(Actually part of: Understanding Accounts.)
For a company to survive, the cash flow from operations needs to be enough to cover all financial needs in the medium/long term. The cash flow statement shows the uses and sources of cash during a financial period. If it is not published, it can be calculated from the other statements.
The calculation of a cash flow statment serves three purposes:
\- finding the sources and uses of cash
\- separating core operations and unusual events
\- comparing cash generation with cash need
There are several fields needed in a cash flow statement. These are calculated as follows.
To start with, we can look at the operating profit, which already has depreciation deducted though, which is a non-cash charge. Therefor we do:
Net operating profit + Depreciation = EBITDA (Earnings before interest, taxes, depreciation and amortisation). If there are other non-cash charges, you need to add them back in too. The good thing with EBITDA is, that it kind of looks at the core business, factoring out the other stuff, which are more political items than business ones.
If trade receivables from the beginning of the period to the end have shrunk, this is an additional source of cash as the company must have collected some of the previous year’s receivables and all of this years. Similarly an increase in an operating liability presents a source of cash. In short:
\- Increase in asset = decrease in liability = cash inflow
\- Decrease in asset = increase in liability = cash outflow
Adjusting EBITDA with these working capital items, gives the Operating Cash Flow (OCF). This is the cash generated by the operating activities of a company before any financing and long-term investment decisions.
The next item is tax payment, which is often done a lot later than the fiscal year tax payment that is included in the income statement. We start by calculating the corporation tax payable at the start plus during the reporting period, substracting the amount payable at the end of the period. This is the corporation tax paid during the period. You then do the same with the deferred tax payable and prepayments.
The next item is relating to dept, and normally interest and lease expenses can be taken from the income statement. In the previous year balance sheet you can normally find a “current portion of long-term dept”, which is the amount that the company would have needed to repay this year.
This brings us to the _discretionary cash flow_ , which is the cash flow available after current operations and metting obligatory payments. The come some things the company can do.
First up on the list are dividends, where you again use those payable at the start of the period, plus declared during the period and still payable at the end.
With the rest of the money the company can choose to do many things. Buy property, plant or aqeuipment for example. To find out what they spent here, you take: PPE at the start of the period + depreciation — PPE at the end of the period + revaluation + foreign exchange gain or losses on PPE + capitalised interest + book value of items sold or bought = expenditure on PPE.
Cash proceeds must be added to the cash flow. Next up are investments. Here you look for any changes, excluding changes in valuation or exchange rates. Also take into account any provisions or other out of the ordinary items that might become due soon (or later) to not be surprised later.
Then you look at how the company financed it’s cash shortfalls, with equity, long-term or short-term dept.
Table 8.1. on page 87 holds a good summary of the entire calculation.
When forecasting you should take into account three different cash flows:
\- Operating free cash flow: this is after taxes
\- Free cash flow: after additional interest
\- Residual free cash flow: after dividends
If there isn’t enough information available, you take Operating Profit and substract taxation to get NOPAT, which is also used a lot in replacement of free operating cash flow.
**cash flow ratios
These are used to look at the ratios between cash inflows and obligations. (NOPAT / interest paid) shows how well the interest payment was covered. You can then also add in other stuff lke current portion of long-term dept and leases (CPLTD&L) and/or dividends. It really depends on what you want to calculate.**