Using of cash flow

Using of cash flow • for the financial stability and causes for changes in the amount of financial means, • for the short-term planning of incomes and expenses, • to plan long-term financial prognosis , • for the valuation of financial effectiveness of investments, • a form for finding market price of the enterprise (discounted CF).

Investment activities From the economic theory: Capital assets, which are not determined for the immediate consumption, but for the usage in the manufacture of other capital assets. It is a postponement of current consumption on purpose to gain higher future benefits. From the business administration point of view: Single expended sources, which will bring financial incomes during future periods (longer than one year).

Which form of investments do you know?

Clasification of investments 1) Tangible (material, capital) investments – make or spread production capacity of the enterprise, building of new properties, routes, buying of land, machines etc. 2) Intangible (non-material) investments – buying of technical knowledge, licenses, software 3) Financial investment – purchase of long-term equities, borrowing of money to gain interests, dividends or profit.

Forms of tangible investments 1) Recovery investments. 2) Changes of machines on purpose to decrease costs. 3) Expansion of current production and market enlargement. 4) Investments based on law requirements (safety at work, ecology), 5) Other investment projects.

Forms of procurement of investment assets • purchase (machines, land, equities), • investment construction, • supplier (building of shop floor), • own overheadscost (smaller construction changes), • financial leasing, • donation.

Participants of investment activities • Investors – organization, which is the customer of investment and who pays it. • 2) Draftsmen– prepare project including budget. • 3) Suppliers – realize construction.

Which sources for investments do you know?

Sources for financial investments • 1) Own sources: • depreciation, • profit, • benifits form the sale or liquidation of tangible assets, • new issue of shares or contributions of co-partners. 2) External sources: • loan for fixed assets, • issued bonds (obligace), • leasing, • subsidies from state or regional budgets.

Valuation of efectivness of investments • Comparing of input of capital invested (expenses on investment) with benefits (incomes), which the investment brings. • Crucial criteria for investment valuation: • profitability (rate of return)– relationship between profit (cash flow) and costs for its procurement and working, • risk – degree of danger, that we will not receive expected benefits, • liquidity (payback period) – period of transformation of investment back to cash form.Ideal investment – high rate of return, without risk and liquidity.

Procedure of investment valuation 1) Find out the capital expenses for the investment, 2) Estimation of future net cash flow, which will bring the investment and also risk, with which are these investments connected, 3) Selection of suitable criteria for valuation of effectiveness of investment.

Capital expences for investment • Investment costs • expences for the procerument of land, buildings, machines and equipment. • Expences connected with sale and liquidation of fixed assets, • expenses for project documentation, • expences for research and development connected with the investment, • Expenses for the training of employees, • Increase of net working capital.

Expected cash incomes • Expectation of income flow from suggested investment is more difficult than finding out of costs, because on icome act many factors like inflation, changed conditions in the market) and their influence is very difficult to say and expect. • Total cash income structure is: • net profit, • depreciation, • income from the sale of equipement after its finished period of service.

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Methods of valuation of investment • 1) Static methods – they not include factor of time: • payback period, • return on investment, • accounting rate of return. 2) Dynamic methods – přihlížejí k působení faktoru času: • net present value, • internal rate of return, • discounted payback period, • index of profitability.

Payback period Period, in which the cumulated incomes cover totol capital expenses on this investment. If the incomes are each year equal, the payback period is: If the incomes are different, the payback period is a summ of the expected incomes in each year till time when it is equal to invested costs. Rule of investments: The investment is profitable when the payback period is shorter than the life-cycle (time of service) of this investment.

Return on investment ROI measures how effectively the firm uses its capital to generate profit; the higher the ROI, the better. More generally, the income that an investment provides in a year. Rule for investment: The investment is profitable, when the return on investment is higher than the rate of return expected by the investor.

Accounting rate of return Similar to ROI, but instead of profit uses money (cash) income (profit + depreciation). Rule for investment: The investment is profitable, whenARR is higher than the rate of return expected by the investor.

Dynamic methods of valuation of investment They suppose, that the value of money changes during the time, e.g. Current capital 1 000 000 CZK with the interest rate 10 % p.a. will have in one year value 1 100 000 CZK, but one year ago had the value 909 091 CZK. All the cash flow (possitive or negative) have to be hold out to a suitable dat (present time) and converted (discounted) to a present value.

Time value of money Methods to find out curent value or future value of money.

Net present value Sum of discounted net cash flows for the during the whole life-cycle of the investment. Ct cash flow from the givin date for the period t období, i discounted rate as a decimal number (e.g. the rate of return of an alternative investment) n life-cycle of the investment.

Rule for investing using NPV NPV > 0 accept the investment, NPV = 0 we achieved just expected rate of return, NPV < 0 refuse the investment.

Internal rate of return Finding of discount rate, with which the NPV is equal to zero, it means NPV of expected incomes is equal to present value of expences on investment.

Rule for investing using IRR If IRR is higher than discount rate (expected rate of return including the risk), it investment project is possible to accept. If the investment is financed by the loan, it means, that the IIR should be higher than the intrest rate of this loan.

Relationship between NPV and IRR NPV IRR Discount rate %

Discounted payback period The period, when cumulated discounted incomes from the investment are paid back by the discounted capital expenses. Rule for investment: Investment is profitable, if the discounted payback period is shorter than the expected life time of the investment.

Index of profitability Proportion between discounted net incomes and discounted invested invested costs of the project. Relationship between NPV and index of rate of return: NPV = 0 ↔ IP = 1 NPV > 0 ↔ IP > 1 NPV < 0 ↔ IP < 1 Rule for investment: Investment is profitable, if IP is higher than 1.

Comparing of investment options • If there are more than 2 possibilities for investment of capital: • there is enough capital just for one investment – it is necessary to choose the most profitable option. • there is enough capital for more projects – it is necessary to decide about the sequence of projects according to their profitability.

For each investment we will find out NPV, IRR, IP. • 2) According to IRR etc. we decide about the rank . • Disadvantages: • we do not include time, • during the time the value of capital changes.

Using of cash flow