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FINANCE 2. Cash flows + financial planning

Learn about sources of cash inflow and outflow, cash flow statement methods, and financial planning strategies through MBA case studies.

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FINANCE 2. Cash flows + financial planning

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  1. FINANCE2. Cash flows + financial planning Solvay Business School Université Libre de Bruxelles Fall 2006

  2. Sources of Cash Inflow and Cash Outflow Operating ActivitiesSales of goods and services Investing ActivitiesSale of fixed assetsSales of LT financial assets Financing ActivitiesIssuance of stocks and bondsLT and ST borrowing CASH Operating ActivitiesPurchase of suppliesSelling, general and administrative expensesTax expenses Investing ActivitiesCapital expenditures and acquisitionsLT financial investments Financing ActivitiesRepurchage of stocks and bondsRepayment of debtDividend payment CF from financing activities CF from operating activities CF from investing activities MBA 2006 Cash flows + financial planning

  3. Farber.com: a fable • Starting a local version of Amazon.com • Initial balance sheet t = 0 Cash 100 Book Equity 100 • Operations year 1: • Sell 2 books @ €100 each • Buy 2 books @ € 50 each • Income statement year 1: Revenue 200 Expenses 100 Net Income 100 • But….cash account = 0 What happened? MBA 2006 Cash flows + financial planning

  4. Farber.com: what happened…. • Final balance sheet t = 1 Cash 0 Book Equity 200 Account Receivable 200 • 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 clients Initial Capital + Retained Earnings MBA 2006 Cash flows + financial planning

  5. Farber.com: additional complications • Initial balance sheet t = 0 Cash 100 Book Equity 100 • Operations year 1: • Borrow and buy 2d hand computer @ €200 • Sell 1 books @ €100 each • Buy 2 books @ € 50 each • Income statement year 1: Revenue 100 Cost of goods sold 50 Depreciation 100 Interest 10 Net Income -60 • Final cash account -10 Straight-line depreciation 2 years MBA 2006 Cash flows + financial planning

  6. Farber.com: details • Final balance sheet t = 1 • Cash -10 Book Equity 40 • Account Receiv. 100 Debt 200 • Inventories 50 • Fixed Assets 100 • Total 240 Total 240 • Statement of cash flows: direct method Cash collection from customers 0 (=REV - AR) -Cash payment to suppliers 100 (=CGS+ INV) -Cash paid for interest 10 Cash flow from operating activities -110 Cash flow from investing activities -200 (= FA+Dep) Cash flow from financing activities +200 Change in cash -110 MBA 2006 Cash flows + financial planning

  7. 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 MBA 2006 Cash flows + financial planning

  8. Income statement REV Revenue CGS Cost of goods sold SGA Selling, general and administrative expenses Dep Depreciation EBIT Earnings before interest and taxes Int Interest expenses TAX Taxes Tc Tax rate NI Net income Balance sheet FA Fixed assets, net AR Accounts receivable INV Inventories CASH Cash & cash equivalents SE Equity capital LTD Long term debt AP Accounts payable STD Short-term borrowing Statement of retained income DIV Dividendes Notations MBA 2006 Cash flows + financial planning

  9. Income statement and balance sheet • Income statement • EBIT = REV - CGS - SGA - Dep • TAX = Tc (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) MBA 2006 Cash flows + financial planning

  10. Cash flow statement : indirect method FA + WCR + CASH = SE + D FA = CAPEX - Dep CAPEX = Acquisitions - Disposals (investing & divesting) SE = NI - DIV + K K = New issuance of capital (NI + Dep - WCR) - (CAPEX) + (K + D -DIV) = CASH Cash flow from operating activities Cash flow from investing activities Cash flow from financing activities = + + MBA 2006 Cash flows + financial planning

  11. + 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 -CAPEX K + D - DIV Statement of cash flows: direct method =NI+Dep-WCR (NI + Dep - WCR) + (-CAPEX) + (K + D - DIV) = CASH MBA 2006 Cash flows + financial planning

  12. Free Cash Flow • Free Cash Flow = Cash flow from operating activities + Cash flow from investing activities Free Cash Flow = DIV - K - D + Cash • Calculating free cash flows of all equity firm: Free Cash Flow = EBIT(1-TC) + Dep - WCR - CAPEX • Statement of cash flows for all-equity firm: Free Cash Flow = DIV - K + Cash MBA 2006 Cash flows + financial planning

  13. Financial Forecasting EBITDA-Depreciation=EBIT -Taxes +Net Income Income Statement Statement ofCash Flows CF from operating activities CF from investing activities CF from financing activities UpdateBalance Sheet MBA 2006 Cash flows + financial planning

  14. 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 TC • Cost of debt i MBA 2006 Cash flows + financial planning

  15. Data Gross margin: m = 30% WCR: w = 20% Net fixed assets: a = 30% Payout ratio p = 50% Depreciation d = 10% Tax rate TC = 40% Cost of debt i = 10% • Revenues year 0: 2,000 • Growth rate year 1: 25% • Balance sheet end year 0 MBA 2006 Cash flows + financial planning

  16. Step 1: Income statement MBA 2006 Cash flows + financial planning

  17. Step 2: Statement of Cash Flows MBA 2006 Cash flows + financial planning

  18. Step 3: Update balance sheet MBA 2006 Cash flows + financial planning

  19. The Full Model MBA 2006 Cash flows + financial planning

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