Cash Flow

Ind AS 7
 Analysing cash flows
Framework
Statement of cash Cash from Cash flow analysis
flows: operations: Reporting limitations
Relevance of Indirect method Cash flows and
cash accruals
Direct method
Reporting by Alternative measure
activities
Business conditions
Constructing the
statement Free cash flow
 Why CFS?
• Assessment of firm’s ability to generate cash
• Use of cash
• Certainty of cash flow generation with
changing business environment
 Relevance of CFS
• Helps in assessing change in liquidity, solvency and financial
flexibility [ability to adjust]
• Judging how much cash is generated from or used in
operations
• What percentage of total expense is met in cash
• CFO is adequate for dividend payment or not
• Source of loan repayment
• How is increase in investments financed?
• What is the source of asset acquisition for expansion or
diversification or even capacity maintenance?
• Relation between income and cash
• Use of cash received from new financing by way of share
capital or loans
 Three activities
Operating Activities Investing activities Financing activities
Principal revenue Acquisition or disposal of Related to transactions
generating activities and long term assets and with shareholders and
activities other than investments other than lenders
investing or financing cash equivalents
activities
 Reporting by activities
- Operating activities: effect of working capital
items and income statement items (except
non-operating items)
- Investing activities: assets expected to
generate income and investments
- Financing activities: contributing, withdrawing
and servicing funds (dividend, interest
payment, repayment of loan, raising equity,
etc.)
 Which cash flows are operating
cash flows
• Payment to suppliers
• Cash received from customer
• Payment towards operating expenses
• Interest payment by Tata Motors to lenders
• Interest payment on deposits by SBI
• Interest received on bonds purchased by
Infosys
• Interest on loan given by Bank of India
• Tax paid
Cash flow from Investing Activities
• Cash paid to acquire PPE, intangibles, other long
term assets
• Cash received from sale of above assets
• Investments in equity/ bonds of other enterprises
except those for trading (HFT) or instruments
considered as cash equivalents
• Loans and advances made to others (not being an
FI/bank)
• cash paid/ received on derivatives except on those
held for trading or classified as financing activity
Cash flow from Financing Activities
• Cash from issue of shares or bonds
• Cash paid as dividend or on share repurchase
• Interest paid on loans and repayment of loans
• Finance lease payments by lessee
Can cash flows be reported on net
basis?
• Cash flows on behalf of customers
representing cash flows of the customer
rather than the reporting entity
Demand deposit acceptance and repayment by
banks
Rent collected on behalf another party
Cash of customer held by investment entity
 continued
• Cash payments or receipts when turnover of
those items is quick, amounts are large and
maturities are short
Credit card principal outstanding
Purchase and sale of investments
Short term borrowings with short maturity like
three months
 Convergence with IFRS (IAS 7)
IAS 7 gives option to nonfinancial entities to
show interest & dividend paid, interest &
dividend received as operating cash flows
Ind AS 7 does not give this option
 Why disclose under three heads?
• Operating activities: useful in forecasting
future operating cash flows

• Investing activities: expenditure made in

resources to generate future income

• Financing activities: predicting future claims

on future cash flows by providers of funds
Preparation of statement of cash flows
• Indirect method: net income is adjusted for non-cash
income (expense) items and accruals – helps in
relating income to cash; helps in predicting income
then relating income to cash (most commonly used
method)
• Direct method: each item is adjusted for its accruals
Under both the methods, cash flow from financing
and investing activities computed in the same
method.
Only cash from operations is computed in different
manner.
 Net cash from operations
Net Income
+ Depreciation & amortisation
+/- Increase (Decrease in DTL)
- Gains on sale of assets/investments
+ Loss on sale of assets/investments
+/- Cash generated by current assets and
liabilities
 Limitations
No uniformity
Discontinued operations- separate disclosure
Income tax is reported as operating cash flow
(should relate to all three activities)
 Analysis
• Source of assets replacement
• Source of expansion and business acquisition
• Degree of dependence on external financing
• Investing demands and opportunities
• Requirements and types of financing
• Sensitiveness of managerial policies like
dividend to cash flow
 Inferences
• Quality of management’s decisions:
Business acquisitions/expansions/ time lag of cash
flow

Asset sale/acquisition: impact on cash flow; where it

committed resources, where it reduced investments,

Where claim was reduced, etc.

• Disposition of earnings and investment of

discretionary cash flow
 Cont..
• Size, composition, pattern and stability of cash
flow

• Judging stability: Increase in cash flow due to

securitisation, reduction in inventory, increase
in payables (represents deferred cash outflow)
may not be sustainable
 Company and Economic Conditions
• Both successful and unsuccessful companies
experience cash problems- nature is different
How?
Increase in receivables
Increase in inventories
Profit
More equity and debt
 Analysis of cash flow
• Cash realisation ratio= CFO/Net income

A higher ratio means higher quality ratio.

CRR > I: what if by stretching accounts payable?

 Coverage ratios
• DSCR and Interest coverage ratio: if numerator
can be cash from operations

[CFO+ Cash payment for interest* + Tax] /

Interest

* If CFO has been computed after interest payment for nonfinancial

companies (not under Ind AS 7)
 Asset efficiency ratio
• CFO/Total operating assets
 Capital Asset ratio
[CFO + Cash inflows from asset disposal –
Dividend paid] / Cash outflow for asset
acquisition
 Creditworthiness ratio
• CFO /[Short-term & Long-term debt]

For highest credit rating, it should be 1:1

 Cash flow adequacy ratio
Measures ability to generate sufficient cash from
operations to cover capex, investment in inventories,
dividend
= 3-yr sum of cash from operations / 3-yr. sum of capex,
inventory addition, dividend

 3-year period is taken to weed out cyclical fluctuation

 Other current assets are excluded as they are financed

primarily by short-term credit

 Reveals cash financing of growth

 Cash reinvestment ratio
Measures percentage of investment in assets
representing operating cash retained and
reinvested in the company for both replacing
assets and growth in operations

= (CFO – dividend) / (Investments in Capex +

investments+ other assets + working capital)
 Current liability coverage ratio
= [CFO – Cash dividend paid] / CL
 Long term debt coverage ratio
• = [CFO – Cash dividend paid] / LTD
 Cash generating power
• CFO / [CFO + CFI + CFF]

• Take the inflows part of CFI and CFF

 External financing ratio
• CFF/CFO

 A larger ratio is undesirable

Take the CFF related inflows

 Operating cash margin
• CFO/Sales

• EBITDA/Sales

• Is EBIDTA a cash figure?

 Cash flow per share
• [CFO – Preference dividend] / No. of equity
shares
 FCFF
• Not a GAAP number

• Represents cash for unlevered firms

• Used for valuing a firm (DCF technique)

• Can be calculated taking EAT or EBIT or CFO

 Four ways to get FCFF
• EAT + DEP + I (1-t) – Change in WC other than cash-CAPEX

• EBIT – tax on EBIT + DEP – Change in WC other than cash –

CAPEX
• EBITDA(1-t) + DEP(tax rate) - Change in WC other than cash
– CAPEX

• CFO – Tax shield on Interest - CAPEX

 DCF: Let us revisit the numerator
• What about leased assets?
• What about acquisitions through issue of
securities?

Consider ‘as if cash flows’:

PV of MLPs from Lessee’s point of view
FV of securities issued
 Which tax rate to use for projections?

• Effective tax rate?

• Marginal tax rate?

Scenarios:
 Effective tax rate for ever
 Marginal tax rate from the start
 Gradual scaling up of effective tax rate to approach
marginal tax rate
 Depreciation and Tax (for forecasted figures)

• EBITDA = 1000 million

• Tax deductible depreciation = 200 million
• Depreciation not deductible = 100 miilion

How to calculate tax?

Calculate tax on 800 million and add back 100 million.
 How do we calculate CV?
• Multiple of earnings or revenue in the terminal
year?
• Liquidation value?
• CV based on a growth rate?

o Liquidation value is often taken as book value

o Private company: Liquidation value makes sense
 Discussions on the denominator
How do we calculate cost of debt?
What is debt?

•Include all lease obligations (operating as well

as finance leases)

•Include all interest bearing debt (short term or

long term)
 Cost of debt continued…
• Bonds are traded: Use YTM
• If the firm has rated bonds: use risk-free rate
plus default spread for that rating
• If no rating:
Use latest borrowing rates if recently loan has
been taken
Or, use synthetic rating (like use Interest coverage
ratio)
Market Value of equity of unlisted
company

• Take multiples of comps

 Do weights, Ke & Kd change?
• Can move towards median structure of the
industry
• As firm gets matured, risk might come down
as compared to a start phase
 Market beta or Total Beta
• Private company investors are no diversified.
• Use total beta
• Total beta = Market beta / Correlation with
market
 What next?
• You will continue to learn…….