Cash Flow Analysis

Cash Flow
Ind AS 7
GLIM
Dr. Manaswee K Samal
Analysing cash flows
Framework
Statement of cash Cash from Cash flow analysis
flows: operations: Reporting limitations
Relevance of cash Indirect method Cash flows and
Reporting by Direct method accruals
activities Alternative measure
Constructing the Business conditions
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
• Operating cash flows are adequate for dividend payment or not
• How did the firm repay the loans
• 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
What does cash flow validate?
• Prediction of operating results on the basis of
acquired and planned productive capacity
• Assessment of future expansion capacity,
capital requirements
• Current obligations
• Connection between income statement and
balance sheet
Cont…
• Capex feasibility
• Cash source of expansion
• Future dividend policies
• Debt servicing
• Quality of earnings
• Financial flexibility in adversity
CFS ANALYSIS
Cash Realisation Ratio
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+ Tax] / Interest
Why tax is added with CFO?

Asset efficiency ratio
• CFO/Total operating assets
Any other ratio?
• Sales/Total Assets
(or, Sales / Operating assets?)
• ROA = EAT / Total Assets
• ROOA = NOPAT / Operating Assets

Capital Asset ratio
[CFO + Cash inflows from asset disposal] / Cash
outflow for asset acquisition
Credit worthiness ratio
• Cash generated by operations /[Short-term &
Long-term debt]
For highest credit rating, it should be 1:1
Cash flow adequacy ratio
Cash reinvestment ratio
Measure of the percentage of investment in
assets representing operating cash retained
and reinvested in the company for both
replacing assets and growth in operations
= CFO / (investment in gross plant, investment ,

other assets, working capital)
Current liability coverage ratio
= CFO / CL
Long term debt coverage ratio
• = CFO / LTD
Cash generating power
• CFO / [CFO + CFI + CFF]
• What should you take in the denominator?

External financing ratio
• CFF/CFO
• A larger ratio is undesirable

Operating cash margin
• CFO/Sales
• EBIT/Sales
• EBITDA/Sales
Cash flow per share
= CFO / No. of equity shares
Ignore preference dividend as it does not exist

in most of companies…if exists, a little
Preference shares:
Not a tax friendly instrument, hence not popular
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

Question: Should you learn
everything from a single course?
Answer: MBA in three months?

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Cash Flow

Ind AS 7 does not give this option

• Investing activities- expenditure made in

• Financing activities- predicting future claims

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

Where claim was reduced, etc.

• Disposition of earnings and investment of discretionary

• Judging stability: Increase in cash flow due to

A higher ratio means higher quality ratio.

[CFO+ Tax] / Interest

Why tax is added with CFO?

• ROA = EAT / Total Assets

• ROOA = NOPAT / Operating Assets

= CFO / (investment in gross plant, investment ,

• What should you take in the denominator?

• A larger ratio is undesirable

Ignore preference dividend as it does not exist

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

• CFO – Tax shield on Interest - CAPEX

Answer: MBA in three months?

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