Lecture 2 - cash flow statement PDF

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CORPORATE FINANCE Bachelor in Commercio Estero e Turismo Ca’ Foscari University of Venice – Treviso Campus

Lecture 2 FINANCIAL ANALYSIS OF CORPORATE PERFORMANCE: HISTORICAL CASH FLOWS Watson – Head – Mantovani – Rossi, Ch. 3

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Introduction Good financial managers plan for the future: e.g. how many investments will the firm need to make over the next few years? how to finance these investments? The knowledge of where the firm stands today is the necessary pre-condition to understand where the firm might be in the future and firm future needs. The data for financial analysis (and financial planning) are available in the firm Balance Sheets (BS) and Income Statement (IS). BS shows information about company assets and the sources of money used to buy those assets. BS depicts a static situation of the company at a given moment in time: it is like a photo of the company. In BS we have Numerical Variables (e.g. Total Assets Value at the end of the year) IS shows what happened in the company over the past year. It’s not a photo but it’s more like a video. In IS we have Flow Variables (Revs: continuously created during the year) In this lecture we understand how to use the information provided by BS & IS to compute the firm FCFF.

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A recap: The business areas Computing cash flows requires to identify sets of homogeneous decisions in the BS and IS:  Operating • Operations include strategic decisions related to the corporate core business • Often split in current and non-current, according to provisioning-transformation-selling cycle

• Current assets – current liabilities = Current working capital (CWC)

 Non-operating • Investments in non-core business areas • Core businesses are extremely difficult to insulate: the perimeter of operating is quite opaque

 Finance • Financial function refers to the use of funded money inside the corporation • Split in capital management and treasury management • These decisions impact over the return-to-risk profile of the company

 Tax & Legal and extraordinary • Legal profiles are an important component of the competitive advantage of a company (e.g. corporate

governance) • The more a company is structured and internationally competing, the wider is the legal framework to • Taxation may influence strongly the free cash flows for the firm lar considerations may refer to the management of extraordinary events

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Balance Sheet • •

The balance sheet reports the corporate stocks of corporate capital. Need to understand how the management invests and sources the money for the company ASSETS Cash & Cash equivalents Trade Receivables Inventories Properties Plants Patents Goodwill Subsidiaries Non strategic investments

LIABILITIES Trade Payables

ASSETS CASH ($ & $ Eq.) CWC (Tr. Rec. + Inv. - Tr. Pay.)

Loans Long Term Fin. Debts

PCA (Prop. + Pln. + Pat. + Gdw. + Subs.)

LIABILITIES Financial Debts (Loans + Long Term Fin. Debts)

Equity

NOA (Non-Str. Inv.)

Equity

ASSETS

OIC (CWC + PCA)

LIABILITIES NFP (Fin. Debts CASH)

Equity NOA (Non-Str. Inv.)

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Income Statement Revenue - External costs = Economic added value (EAV) - Labour cost = EBITDA - Depreciation and Amortization +/- Non-operating revenue (NOR) = EBIT - Interest = EBT - Taxes = Net income for eq. Holders (NIE)

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100 40 60 30 30 10 10 30 10 20 8 12

1st measure of earnings: Revenues – External Costs = EAV 2nd measure of earnings: EBITDA – Dep. (& Amortization) +/NOR = EBIT 3rd measure of earnings: EBIT – Interests = EBT EBT is the TAXABLE INCOME

… what is left after creditors and government have been paid (NIE) can be used to payback shareholders. A portion of Net Income is paid out (Dividends), the remaining part is reinvested in the firm (Ret Earn.)

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Cash flows statement analysis Remember that: • Earning flow ≡ Δ in stocks • Δ in stocks = Δ in illiquid stocks + net cash flows • Net Cash flow = earning flow - Δ in illiquid stocks

• The two components are outputs sourcing from the results of P&L analysis and

balance sheets analysis Source/computation P&L (A)

Balance Sheet (B) Stock

Balance sheet (C=DB) D in illiquid stocks

Business Area

Earning flow

Current

D=A-C cash flow balance

EBITDA

CWC

DCWC

COCF

Strategic

- D&A

PCA

DPCA

- IPCA

Operations

EBIT (operating)

OIC

DOIC

GCFO

Non-Operating

NOR

NOA

DNOA

CFNO

Firm overall

EBIT (firm)

Invested capital

D Invested capital

GCFF

• GCFF (gross cash flow to the firm) = GCFO (gross cash flow deriving from operations)

+ CFNO (from non-operating business )

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Cash flows statement analysis FCFF (free cash flow to the firm) = GCFF – CTCF • «Free» means that its allocation depends on financial management decisions • Allocated to capital holders (FCFD or FCFE) or to the cash buffer (CASH) Source/computation P&L (A)

Balance Sheet (B)

Business Area

Earning flow Stock

Balance sheet (C=DB) D in illiquid stocks

Firm overall

EBIT (firm)

Invested capital

D Invested capital

GCFF

- Tax & Legal

TAX

CTL

DCTL

-CTCF

Net firm overall

D=A-C cash flow balance

= FCFF

-Debt Capital

INT

DEBT

DDEBT

-FCFD

-Equity Capital

NIE

EQUITY

DEQUITY

-FCFE

CASH BUFFER

DCASH

= DTREASURY

Treasury mgmt

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FCFO – Free Cash Flow from Operations (Operating) Unlevered Free Cash Flow  FCFO: Asset-side Valuation [PV(FCFOs) = Market Value of Operating Assets (i.e. OIC) = EV]

     

1. (+) Incremental Revenues 2. (-) Incremental Costs (External Costs & Labour Costs) 3. = EBITDA (Gross Profit Margin) 4. (-) Incremental Depreciation & Amortization (+/- Non-operating Revenue) 5. = EBIT (asset-side valuation Taxable Income) 6. (-) Taxes (= EBIT x Corporate Taxation Rate) 7. = NOPAT 8. (+) Incremental Depreciation & Amortization 9. (-/+) ∆± Working Capital (CWC) 10. (-/+) Capital Expenditure (CapEx = Investments) 11. = FCFO = NOPAT + Depreciation –ΔCWC – CapEx FCFO is the amount of money in the company generated by operating activities only That’s why: PV(FCFOs @ wacc) = Market Value Total Assets = EV then E = EV – NFP FCFO is indeed estimated without paying Negative Interests on Debt and therefore Taxes are (somehow) THEORETICAL (as calculated upon EBIT, only) In real corporations Taxes are paid on EBT, after interest deductions. This provides tax shields FCFF is the Cash Flow (available) to the (entire) Firm (FCFF = FCFO + TaxShield) FCFF = GCFF - CTCF is used to pay shareholders (FCFE) & debtholders (FCFD),

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FCFF – Free Cash Flow to the Firm (Operating) Unlevered Free Cash Flow  FCFF: Asset-side Valuation [PV(FCFFs) = Market Value Total Assets = EV]

  



1. (+) Incremental Revenues 2. (-) Incremental Costs (External Costs & Labour Costs) 3. = EBITDA (Gross Profit Margin) 4. (-) Incremental Depreciation & Amortization (+/- Non-operating Revenue) 5. = EBIT (asset-side valuation Taxable Income) 6. (-) Taxes (= EBIT x Corporate Taxation Rate) 7. = NOPAT 8. (+) Incremental Depreciation & Amortization 9. (-/+) ∆± Working Capital (CWC) 10. (-/+) Capital Expenditure (CapEx = Investments) 11. = FCFF = NOPAT + Depreciation –ΔCWC – CapEx FCFF is the amount of money in the company available to shareholders & debt holders, that is the Free Cash Flow (available) to the (entire) Firm That’s why: PV(FCFFs) = Market Value Total Assets = EV then E = EV – NFP FCFF is indeed estimated without paying Negative Interests on Debt and therefore Taxes are (somehow) THEORETICAL as calculated upon EBIT (in practice Taxes are paid after, on EBT). FCFF are Unlevered FCF: FCFF are calculated assuming Debt = 0!

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FCFE – Free Cash Flow to the Equity Levered Free Cash Flow  FCFE: Equity-side Valuation [PV(FCFEs) = Market Value Equity = E]

1. (+) Incremental Revenues 2. (-) Incremental Costs (External Costs & Labour Costs) 3. = EBITDA (Gross Profit Margin) 4. (-) Incremental depreciation & amortization (+/- Non-operating Revenue) 5. = EBIT (asset-side valuation Taxable Income) a. (-) Interests on Debt b. = EBT (the actual Taxable Income) 6. (-) Taxes (= EBT x Corporate Taxation Rate) 7. = NIE 8. (+) Incremental depreciation & amortization 9. (-/+) ∆± Working Capital (CWC) 10. (-/+) Capital Expenditure (CapEx = Investments) 11. = FCFE = NIE + Depreciation –ΔCWC – CapEx • FCFE is the amount of money in the company available to shareholders solely, that is the Free Cash Flow

(available) to the Equity (only) • That’s why: PV(FCFEs) = Equity Market Value = E then EV = E + NFP • FCFE is estimated after Interests on Debt have been paid out (at a.). Taxes are (somehow more)

EFFECTIVE and calculated upon EBT. • FCFE are Levered FCF: FCFE are calculated taking into account Debt = Leverage!

Keywords     

Balance Sheet Income Statement FCFF: Free Cash Flow to the Firm FCFE: Free Cash Flow to the Equity Incremental Flows...