11/20/2021

Ignacio Lezaun

English edition
2021

Fundamentals of Finance

1
 2

Contents of the course

1. The role of the Chief Financial Officer

2. Statement of cash flows
3. Working capital management I
4. Working capital management II
5. Short-term finance instruments
6. The time value of money
7. Conclusions
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UNIT
2

Unit 2:
Statement of cash flows

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OBJECTIVES UNIT
2

2.1 Understand differences between net income and cash flow:

a. Revenue and collections
b. Expenses and payments

2.2 Calculating cash flow

c. Direct versus indirect method
d. Calculating cash flow activities
e. Cash flow statement
f. Exercise

2.3 Cash flow metrics and calculations

g. EBIDTA as a proxy
h. Operating cash flow
i. Free Cash Flow (FCF)
j. Free Cash Flow to Firm (FCFF)
k. Free Cash Flow to Equity (FCFE)
l. Exercise
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 UNIT
2

Exercise

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Class exercise: Laserlus company

GROSS ASSETS
31/12/20
150,000.00 €
31/12/21
150,000.00 € CAPITAL
31/12/20
120,000.00 €
UNIT
31/12/21
120,000.00 €
DEPRECIATION
NON-CURRENT
-30,000.00 € -35,000.00 € RESERVES 18,000.00 € 2 21,600.00 €
ASSETS 120,000.00 € 115,000.00 € NET INCOME 6,000.00 € 7,500.00 €
INVENTORIES 18,500.00 € 5,000.00 € NET EQUITY 144,000.00 € 149,100.00 €
CUSTOMERS 38,000.00 € 20,000.00 € NON-CURRENT LIABILITIES -€ -€
CASH 24,900.00 € 33,975.00 € SUPPLIERS 15,000.00 € 4,125.00 €
CURRENT ASSETS 81,400.00 € 58,975.00 € TAXES PAYABLE 2,400.00 € € 750.00
OTHER DEBTS 40,000.00 € 20,000.00 €
CURRENT LIABILITIES 57,400.00 € € 24,875.00
TOTAL ASSETS 201,400.00 € 173,975.00 € TOTAL EQUITY + LIABILITIES 201,400.00 € 173,975.00 €

INCOME STATEMENT 2021

Sales 120,000.00 €
Cost of materials 30,000.00 €
Direct labor cost 37,500.00 €
Indirect costs 35,000.00 €
Depreciation 5,000.00 €
Gross margin 12,500.00 €
General expenses 2,000.00 €
EBIT 10,500.00 €
Interests € 500.00
EBT 10,000.00 €
Tax 2,500.00 €
Net Income 7,500.00 €

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Answer

Cash Flow Statement Net Income EBT Corp Tax payments 2021:
UNIT
2021
Cash flows from operating activities:
Net income / EBT 7.500,00 € 10.000,00 €
2020 Corp Tax
70% 21 22,400.00 €
1.750,00 €
Adjustents to reconcile net income to net cash from operating activities Total 4.150,00 €
+ Depreciation 5.000,00 € 5.000,00 €
+ Interests 500,00 € 500,00 € Corp Tax Exp-Cash Reconciliation
Corp Tax -2.500,00 €
+ Var Customers 18.000,00 € 18.000,00 €
+ Var. Inventories 13.500,00 € 13.500,00 € Var Tax Payable -1.650,00 €
- Var Suppliers -10.875,00 € -10.875,00 € Total -4.150,00 €
- Var Tax payable -1.650,00 € -

- Interest paid -500,00 € -500,00 €

- Corp Tax payments - -4.150,00 €
Net cash from operating activities 31.475,00 € 31.475,00 €

Cash flows from investing activities

Proceeds from sale of investments 0,00 €
Purchase of assets 0,00 €

Net cash from investing activities 0,00 € 0,00 €

Cash flows from financing activities:

Repayment fin debt (-) -20.000,00 € -20.000,00 €
Dividend (-) -2.400,00 € -2.400,00 €
Net cash used by financing activities -22.400,00 € -22.400,00 €

Net increase in cash during the year 9.075,00 € 9.075,00 €

Cash and cash equivalents on January 1, 2021 24.900,00 € 24.900,00 €
33.975,00
Cash and cash equivalents on December 31, 2021 € 33.975,00 €

Check: 0,00 € 0,00 €

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UNIT
2

2.3 Cash flow metrics and calculations

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EBITDA (as a proxy) 9

UNIT
2

“EARNINGS BEFORE INTEREST, TAX, DEPRECIATION,

AMORTIZATION”

• Not a cash flow metric but a proxy

• Good for mature companies with little capital expenditure
Capital expenditure refers to funds that are used by a company for the purchase, improvement, or
maintenance of long-term assets to improve the efficiency or capacity of the company
• Useful for comparison across companies
• Useful for a couple of years, not for long run comparison

Source: Corporate Finance Institute 11/20/2021

 EBIDTA: Example 10

UNIT
INCOME STATEMENT      
Year ended December 31,
    2
(in millions) 2018 2017 2016 2015 2014

Revenue $22,000 $20,000 $18,000 $15,000 $10,000

COGS -3,200 -3,200 -3,000 -3,000 -2,500
Gross Profit 18,800 16,800 15,000 12,000 7,500

Depreciation -500 -500 -500 -450 -400

SG&A -300 -300 -300 -300 -300
Interest -50 -50 -50 -50 -50
Earnings Before Tax 17,950 15,950 14,150 11,200 6,750

Tax -3,590 -3,190 -2,830 -2,240 -1,350

Net Earnings 14,360 12,760 11,320 8,960 5,400

EBITDA $18,500

Source: Corporate Finance Institute 11/20/2021

 Free Cash Flow (FCF) 11

UNIT
2
▪ FCF is equal to Cash from Operations minus Capital Expenditures

▪ Calculation for operating cash flow already seen in cash flow by

activities

▪ It represents the amount of cash generated by a business, after accounting

for re/investment in non-current capital assets by the company

▪ Can be calculated a) from directly the company cash records or b) indirect

method

(*) Before interest

Source: Corporate Finance Institute
11/20/2021
Indirect method for FCF
UNIT
(+) Operating profit (EBIT) Income statement 2
(-) Payments for income tax IS+BSL
(+) Depreciations and amortizations Income statement
(+) Provisions Income statement
(-/+) Increase/decrease in customers Balance sheet assets
(-/+) Increase/decrease in inventories Balance sheet assets
(+/-) Increase/decrease of suppliers Balance sheet liabilities
(+/-) Increase/decrease other accounts payable (*) Balance sheet liabilities
(-) Investment in non-current assets Balance sheet assets
(+) Divestment of non-current assets Balance sheet assets
(+) Increase in anticipated income Balance sheet liabilities
(-) Increase in anticipated expenses Balance sheet assets
(=) Free cash flow

(*) Excluding Corporation Tax debt variation (as payments for income tax have directly been added above)

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Free Cash Flow to Equity (FCFE) UNIT
2

• FCFE is derived from the statement of cash flows by taking operating cash
flow, deducting capital expenditures, and adding net debt issued (or subtracting
net debt repayment)
• FCFE includes interest expense paid on debt and net debt issued or repaid, so it
only represents the cash flow available to equity investors (interest to debt
holders has already been paid).
• A positive FCFE means a company has operating cash flows available after
payments have been made for capital expenditure and debt repayment

• This excess belongs to common shareholders

FCFE
TO EQUITY = FCF +/- DEBT
(*) Before interest
FLOWS
Source: Corporate Finance Institute 11/20/2021
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Linking FCF to FCFE
UNIT
2

FCFE = FCF +/- DEBT FLOWS

CALCULATION OF DEBT OUTFLOWS- direct method

(-) Entry of financial debt Balance sheet liabilities
(+) Repayment of financial debt Balance sheet liabilities
(+) Payment of interest Income statement
(=) Debt outflows

Note: Interest tax shield represents the taxes saved by the

company due to the existence of interest expense, It is calculated
as interest x% tax rate. In certain cases, interest tax shield is
considered as part of the debt flows, in which case the FCF is
calculated considering EBIT, x% tax rate instead of payments for
income tax.

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 FCFE Example 17

CASH FLOW STATEMENT          UNIT

Year ended December 31,
(in millions) 2018 2017 2016 2015 2014 2
Cash from Operations
Net Income $14,360 $12,760 $11,320 $8,960 $5,400
Adjusted for:
Depreciation 500 500 500 450 400
Stock based compensation 0 0 0 0 0
Change in accounts receivable -200 500 900 -1,500 -1,000
Change in inventory 1,000 -3,000 1,300 2,000 -14,000
Change in accounts payable 500 -500 -500 500 1,000
Cash from Operations $16,160 $10,260 $13,520 $10,410 ($8,200)
Cash from Investing
Purchase of PP&E ($500) ($5,500) ($1,200) ($5,450) ($40,400)
Acquisition of businesses 0 0 0 0 0
Cash from Investing ($500) ($5,500) ($1,200) ($5,450) ($40,400)
Cash from Financing
Issuance (repayment) of debt 0 6,000 5,000 3,500 18,500
Issuance (repayment) of equity 0 0 0 0 30,000
Dividends 0 0 0 0 0
Cash from Financing 0 6,000 5,000 3,500 48,500

Net Change in Cash $15,660 $10,760 $17,320 $8,460 ($100)

Cash at beginning of period 49,190 38,430 21,110 12,650 12,750
Cash at end of period $64,850 $49,190 $38,430 $21,110 $12,650
Free Cash Flow to Equity (FCFE) $15,660 $10,760 $17,320 $8,460 ($30,100)

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FCFE using indirect method
UNIT
2

CALCULATION OF FCFE- indirect method

(+) Net profit Income statement
(+) Depreciation and amortizations Income statement
(+) Provisions Income statement
(- / +) Increase / decrease in customers Balance sheet assets
(- / +) Increase / decrease in inventories Balance sheet assets
(+/-) Increase / decrease of suppliers Balance sheet liabilities
(+/-) Increase / decrease other accounts payable (*) Balance sheet liabilities
(-) Investment in non-current assets Balance sheet assets
(+) Divestment of non-current assets Balance sheet assets
(+) Increase in anticipated income Balance sheet liabilities
(-) Increase in anticipated expenses Balance sheet assets
(+) Entry of financial debt Balance sheet liabilities
(-) Repayment of financial debt Balance sheet liabilities
(=) FCFE

(*) Including Corporation Tax debt variation (as income tax expense is already included in Net profit above)

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Free Cash Flow to Firm (FCFF) UNIT
2

▪ FCFF is a hypothetical figure, an estimate of what it would be if the firm was

to have no debt
▪ Requires a multi-step calculation and is used in to arrive at the total firm value
▪ Calculation:
▪ Start with Earnings Before Interest and Tax (EBIT)
▪ Calculate the hypothetical tax bill the company would have if they didn’t
have the benefit of a tax shield
▪ Deduct the hypothetical tax bill from EBIT to arrive at Net Income
▪ Add back depreciation and amortization
▪ Deduct any increase in non-cash working capital
▪ Deduct any capital expenditures

(on EBIT)

Source: Corporate Finance Institute 11/20/2021

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Summary of differences UNIT
2

Source: Corporate Finance Institute 11/20/2021

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UNIT
2

Next week: Exercise

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Class exercise: Laserlus company
◼ The following information about the company Laserlus SL is provided: UNIT
◼ Balance sheet for the years 2020 and 2021
2
◼ Income statement for the year 2021

◼ The following information is also available:

◼ The Corporation tax rate is 25%
◼ In March 2021, a dividend is paid to shareholders (40% of the previous year’s profit)
◼ During 2021, 70% of the Corporation Tax for the current year is paid
◼ Half of the loan is returned

◼ For the year 2021, calculate:

1. FCF (considering operating taxes as tax % on earnings)
2. Debt flows (tax shield included)
3. FCFE
4. Cash Flow Statement
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Class exercise: Laserlus company

GROSS ASSETS
31/12/20
150,000.00 €
31/12/21
150,000.00 € CAPITAL
31/12/20
120,000.00 €
UNIT
31/12/21
120,000.00 €
DEPRECIATION
NON-CURRENT
-30,000.00 € -35,000.00 € RESERVES 18,000.00 € 2 21,600.00 €
ASSETS 120,000.00 € 115,000.00 € NET INCOME 6,000.00 € 7,500.00 €
INVENTORIES 18,500.00 € 5,000.00 € NET EQUITY 144,000.00 € 149,100.00 €
CUSTOMERS 38,000.00 € 20,000.00 € NON-CURRENT LIABILITIES -€ -€
CASH 24,900.00 € 33,975.00 € SUPPLIERS 15,000.00 € 4,125.00 €
CURRENT ASSETS 81,400.00 € 58,975.00 € TAXES PAYABLE 2,400.00 € € 750.00
OTHER DEBTS 40,000.00 € 20,000.00 €
CURRENT LIABILITIES 57,400.00 € € 24,875.00
TOTAL ASSETS 201,400.00 € 173,975.00 € TOTAL EQUITY + LIABILITIES 201,400.00 € 173,975.00 €

INCOME STATEMENT 2021

Sales 120,000.00 €
Cost of materials 30,000.00 €
Direct labor cost 37,500.00 €
Indirect costs 35,000.00 €
Depreciation 5,000.00 €
Gross margin 12,500.00 €
General expenses 2,000.00 €
EBIT 10,500.00 €
Interests € 500.00
EBT 10,000.00 €
Tax 2,500.00 €
Net Income 7,500.00 €

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Working Capital Management I UNIT 3

OBJECTIVES
1. Background
2. Managing and Measuring Liquidity
3. Managing Accounts Receivable
4. Managing Accounts Payable
5. Managing Inventory
6. Working Capital Management
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UNIT 3

3.1 Background

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All activities require resources UNIT 3
For example …

• An industrial company requires a supply of raw

materials, and to store the finished product before
distributing it

• In a commercial enterprise, merchandise must be

purchased, stored, and shipped

• In a service provision company, structural expenses

must be borne until the service provision is
completed
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