Author: Collins Qian
Contributor: Chris Nelson
bc
Cash Flow
March 1998
Copyright© 1998 Bain & Company, Inc.
1CU7030298IMB
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BOS
Copyright© 1998 Bain & Company, Inc.
Cash Flow
Agenda
•The importance of cash flow
•Types of cash flow
•Applications
•Cash flow steps
•Exercise
•Key takeaways
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BOS
Copyright© 1998 Bain & Company, Inc.
Cash Flow
Agenda
•The importance of cash flow
•Types of cash flow
•Applications
•Cash flow steps
•Exercise
•Key takeaways
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BOS
Copyright© 1998 Bain & Company, Inc.
Cash Flow
What is Cash Flow?
Cash flow describes the movement of cash into
(sources) and out of (uses) a company.
Sources of cash Company Uses of cash$
$ $
$
$
$ $ $
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BOS
Copyright© 1998 Bain & Company, Inc.
Cash Flow
Why Do We Care About Cash?
•The market value of a company is equal to the present value of its
expected future cash flows
•Various stakeholders demand cash
– investors demand CASH returns
–suppliers and employees require CASH compensation
–debtholders demand CASH payments
•Accounting methods can be used to “manage” earnings; CASH is
harder to manipulate
Cash is King!
Cash flow is the measure of a company’s strategic
value.
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BOS
Copyright© 1998 Bain & Company, Inc.
Cash Flow
Earnings vs. Cash Flow*
•Some accounting decisions impact earnings, but not cash
– In 1988, General Motors made at least four decisions that
impacted earnings but not cash
Earnings do not equal cash flow.
*Earnings are also called after tax profits or net income
•Successful high growth companies tend to have high earnings, but low cash
flow; successful low growth companies tend to have low earnings, but high
cash flow
Accounting Decision
•Extended useful plant life from 35
to 45 year schedule
•Changed the way it accounted for its
pension plan
•Adjusted its inventory
valuation policy
•Changed the residual value
assumption for cars it leased
Earnings Impact
$790MM
$480MM
$217MM
$270MM
Cash Impact
None
None
None
None
Total: $1,757MM None
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BOS
Copyright© 1998 Bain & Company, Inc.
Cash Flow
Agenda
•The importance of cash flow
•Types of cash flow
•Applications
•Cash flow steps
•Exercise
•Key takeaways
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BOS
Copyright© 1998 Bain & Company, Inc.
Cash Flow
Types of Cash Flow
Net cash flow is equal to the sum of the cash flows
from operating, investing, and financing activities.
Operating cash flow Investing cash flow Financing cash flow
•Ability of a company’s
recurring operations to
generate cash
•Ability of a company’s
investment decisions to
generate cash
•How a company
funds its operations
•Operating profits
•Decrease in
working capital
•Sale of fixed
assets
•Long-term issuance
of shares
Examples
of sources:
•Operating losses
• Increase in working
capital
•Purchase of fixed
assets
•Repayment of loans
•Payment of
dividends
Examples
of uses:
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BOS
Copyright© 1998 Bain & Company, Inc.
Cash Flow
Operating Cash Flow
*Investing activities not related to ongoing operations (such as the purchase or sale of divisions or companies, or
investments in unrelated businesses) are not included in investing cash flow. They are included in financing cash flow.
•Operating cash flow excludes all cash flows related to a firm’s
capital structure
–cash generation ability is independent of how a firm is financed
• It excludes one-time events
– these are not related to a firm’s recurring operations
•Operating cash flow is used to measure the strategic value of a
business
– for company valuations, operating and investing cash flows are
used, not financing cash flow
•Bain is usually more interested in operating and investing* cash
flow than in financing cash flow
Operating cash flow measures the ability of a business’s
recurring operations to generate cash.
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BOS
Copyright© 1998 Bain & Company, Inc.
Cash Flow
Investing Cash Flow
• Investments in ongoing operations - property, plant and equipment - are
included in investing cash flow
–cash is used to replace assets as they wear out
– if a business is to grow, additional assets must be acquired
– in some cases, the cash used to acquire these assets is generated from
the sale of existing noncurrent assets
–such cash inflows, however, seldom cover the entire cost of asset
acquisitions. Often times cash flow from operations is used to finance
acquisitions, or, failing a positive operating cash flow, external financing is
used
•Pure financing activities are not included in investing cash flow. They are
included in financing cash flow
–purchase or sale of divisions or companies
– investments in unrelated businesses
• Investing cash flows relating to ongoing operations are used as a measure of
the strategic value of a business. Those that are purely financing/investment
mechanisms are used to evaluate the financial strategy of the business
Investing cash flow measures the use of a business’s
cash for the acquisition of non-current assets.
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Copyright© 1998 Bain & Company, Inc.
Cash Flow
Financing Cash Flow
•Major types of financing cash flow include:
–debt-related transactions
8changes in long-term debt
8interest income and expense
–equity-related transactions
8changes in common and preferred stock
8dividends
8short-term investments
– long-term asset and liability transactions
8purchase or sale of a division or company
8changes in long-term liabilities
Financing cash flow captures all the non-operating cash
changes experienced during the year, and it provides
information on how a company is funding its operations.
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Copyright© 1998 Bain & Company, Inc.
Cash Flow
Statement of Cash Flows
•The SCF is divided into three sections: operating, investing, and
financing
•Each section shows sources and uses of funds for the accounting
period
•The SCF shows the amounts for
–depreciation and amortization
–capital expenditures
– taxes paid
–dividends paid
• It does not show sources and uses by business unit
• It does not provide much detail
– for example, it does not show capital expenditures by project,
nor individual equipment purchases
The SCF is not a substitute for cash flow analysis
The statement of cash flows (SCF) found in annual reports is a good source
of data for constructing cash flows, but sometimes it does not have the
detail required for the analysis being done.
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BOS
Copyright© 1998 Bain & Company, Inc.
Cash Flow
Agenda
•The importance of cash flow
•Types of cash flow
•Applications
•Cash flow steps
•Exercise
•Key takeaways
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BOS
Copyright© 1998 Bain & Company, Inc.
Cash Flow
Applications
Bain case teams use cash flow (CF) analysis to value
investments/acquisitions, to improve the health of business units,
and to help companies manage their portfolios.
Valuation
(mergers,
acquisitions)
Business unit
analysis
Portfolio
management
• What is the cash
generation potential of
an investment/
acquisition?
• What are we willing to
pay (in cash) for that
investment/acquisition?
• How healthy is a
business unit?
• What factors have
effected the business
unit’s ability to generate
cash/value over time?
• How can the business
unit’s cash
management be
improved?
• What is the overall
balance of cash
users/cash generators
in a client’s portfolio of
businesses?
• How does this effect
the client’s overall
cash position/outlook?
• What restructuring
can be done to
improve this profile?
CF = common denominator CF = measuring stick CF = portfolio tool
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BOS
Copyright© 1998 Bain & Company, Inc.
Cash Flow
Agenda
•The importance of cash flow
•Types of cash flow
•Applications
•Cash flow steps
•Exercise
•Key takeaways
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BOS
Copyright© 1998 Bain & Company, Inc.
Cash Flow
Cash Flow Cookbook
*Cash is defined as cash plus marketable securities minus short-term notes
**I/S = income statement, SCF = statement of cash flows, B/S = balance sheet
+
+/ -
+/ -
-
+/ -
=
1. Profit before interest and tax (PBIT)
2. Depreciation
3. Other non-cash expenses/income
4. Decrease/increase in working capital (excluding cash)
5. Taxes paid
6. Tax impact of interest income/expense
Operating cash flow
Bain case teams use the following cash flow cookbook:
-
=
7. Capital expenditures
Investing cash flow
+/ -
+/ -
+/ -
+/ -
-
+/ -
=
8. Interest income/expense
9. Tax impact of interest expense/income
10. Increase/decrease in long-term debt
11. Increase in outstanding stocks/shares
12. Dividends
13. Changes in other accounts
Financing cash flow
14. Reconcile with change in cash* from Balance Sheet
Net cash flow
Source**
I/S
SCF, B/S and Notes
Notes
B/S
I/S, B/S
I/S
SCF, B/S and Notes
I/S
I/S
B/S
B/S
SCF, B/S, and Notes
B/S, I/S
B/S
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BOS
Copyright© 1998 Bain & Company, Inc.
Cash Flow
Agenda
•The importance of cash flow
•Types of cash flow
•Applications
•Cash flow steps
•Exercise
•Key takeaways
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BOS
Copyright© 1998 Bain & Company, Inc.
Cash Flow
Exercise - Background (p. 1)
*This exercise is based on The Gillette Company’s financial statements in 1996. Since several modifications
have been made to the financial statements, the information provided hereafter should not be used to
analyze Gillette’s financial performance.
•Net Sales
•Cost of Sales
•Gross Profit
•SG&A
•Profit from Operations
• Interest Expense
• Income before taxes
• Income Taxes
•Net Income
1996
$9,
($3,)
$6,
($4,)
$1,
($)
$1,
($)
$
Income Statement: The New England Razor Company*
Use the following data to calculate the cash flow for
The New England Razor Company:
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Copyright© 1998 Bain & Company, Inc.
Cash Flow
*Deferred taxes can be a liability account, an asset account, or both (as is the case here).
Assets
Current Assets
• Cash
• Marketable securities
• Receivables
• Inventories
• Deferred income taxes*
• Prepaid expenses
Total Current Assets
Property, Plant & Equipment
Liabilities and Stockholders’ Equity
Current Liabilities
• Loans payable
• Current portion of Long-Term debt
• Accounts payable and accrued expenses
• Income taxes payable
Total Current Liabilities
Long-Term Debt
Deferred Income Taxes*
Other Long-Term Liabilities
Dividends Payable
Stockholders’ Equity
• Common stock
• Additional Paid-in Capital
• Retained Earnings
• Treasury stock
Total Stockholder’s Equity
$
$
$2,
$1,
$
$
$4,
$5,
$9,
$
$
$1,
$
$2,
$1,
$
$
$
$
$
$4,
($1,)
$4,
1995
$
$
$2,
$1,
$
$
$4,
$4,
$8,
$
$
$1,
$
$2,
$1,
$
$
$
$
$
$3,
($1,)
$3,
$9, $8,
Balance Sheet
December 31, 1996 and 1995 (in $MM)
1996
Exercise - Background (p. 2)
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Copyright© 1998 Bain & Company, Inc.
Cash Flow
•Property, Plant and Equipment
•Less accumulated depreciation
•Net Property, Plant, and Equipment
1996 (in $MM)
$7,
$2,
$5,
1995 (in $MM)
$6,
$2,
$4,
Note 1: Property, Plant and Equipment
Note 2: Dividends
The company declared dividends of
$ in 1996
Note 3: Sale of assets
A loss of $22MM was incurred on equipment sold during the year
The equipment had an original cost of $ and was sold for $
Exercise - Background (p. 3)
Notes to the financial statements are a critical source of information.
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BOS
Copyright© 1998 Bain & Company, Inc.
Cash Flow
Operating Cash Flow
*Cash is defined as cash plus marketable securities minus short-term notes
**I/S = income statement, SCF = statement of cash flows, B/S = balance sheet
+
+/ -
+/ -
-
+/ -
=
1. Profit before interest and tax (PBIT)
2. Depreciation
3. Other non-cash expenses/income
4. Decrease/increase in working capital (excluding cash)
5. Taxes paid
6. Tax impact of interest income/expense
Operating cash flow
-
=
7. Capital expenditures
Investing cash flow
+/ -
+/ -
+/ -
+/ -
-
+/ -
=
8. Interest income/expense
9. Tax impact of interest expense/income
10. Increase/decrease in long-term debt
11. Increase in outstanding stocks/shares
12. Dividends
13. Changes in other accounts
Financing cash flow
14. Reconcile with change in cash* from Balance Sheet
Net cash flow
Source**
I/S
SCF, B/S and Notes
Notes
B/S
I/S, B/S
I/S
I/S
I/S
B/S
B/S
B/S, I/S
B/S
SCF, B/S and Notes
SCF, B/S and Notes
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BOS
Copyright© 1998 Bain & Company, Inc.
Cash Flow
Step 1 - Profit Before Interest and Tax
Where to find:
Process:
Comments:
• Income statement
• It can be labeled in many different ways, including profit
before interest and tax, profit from operations, operating
profit, and earnings before interest and tax
• If income statement is provided, pick number from
income statement
• If income statement is not provided, calculate profit
before interest and tax:
Profit before taxes
- Interest income and other income (earned)
+ Interest expense and other expenses (incurred)
- Any one-time gains included in profit before taxes
+ Any one-time losses included in profit before taxes
= Profit before interest and tax (PBIT)
•The goal is to get profit before interest payments, tax
payments, and extraordinary items
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BOS
Copyright© 1998 Bain & Company, Inc.
Cash Flow
Step 1 - Profit Before Interest and Tax - Answer
Profit before interest and tax*: $1,
1996
Operating cash flow begins with profit before interest
and tax.
*Shown as profit from operations on The New England Razor Company’s income statement 23CU7010598KRA
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BOS
Copyright© 1998 Bain & Company, Inc.
Cash Flow
Steps 2 and 3 - Depreciation and Other Non-Cash Income/Expenses
Where to find:
Process:
•Depreciation - statement of cash flows, or
calculate from Balance Sheet and Notes
•Other Non-Cash Income/Expenses - Notes
•Review assets and liabilities that are not taken into account in
working capital (elements of working capital include current assets
and liabilities with the exception of cash, tax items, and financing
assets and liabilities (., interest and dividends payable))
•Ask two questions:
–was the item non-cash?
–was the item included in profit before interest and tax?
• If the answer to both is yes, adjust profit before interest and tax
–., depreciation - add back to profit before interest and tax
–., loss on sale of asset - add back to profit before interest and
tax
• If answer to either question is no, make no adjustments
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BOS
Copyright© 1998 Bain & Company, Inc.
Cash Flow
Step 2 - Depreciation
Where to find:
Process:
•Statement of cash flows, or calculate from
Balance Sheet and Notes
• If depreciation is provided in the statement of cash
flows, pick number from there
• If not, calculate depreciation:
Accumulated depreciation at year end
- Accumulated depreciation at year beginning
+ Depreciation from sale of asset
= Depreciation expense for the year
•Depreciation from sale of asset:
Original cost of asset
- Proceeds from sale of asset
- Losses incurred
= Depreciation from sale of asset
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BOS
Copyright© 1998 Bain & Company, Inc.
Step 2 - Depreciation - Answer (p. 1)
Depreciation from sale of asset
= The original cost of asset - proceeds from sale of asset - losses incurred
= $ - $ - $ = $
Depreciation expense for 1996
= Accumulated depreciation at year end - accumulated depreciation at year beginning +
depreciation from sale of asset
= $2, - $2, + $ = $
Cash Flow
Depreciation is a non-cash expense. Therefore, it is added to profit
before interest and tax in the operating cash flow.
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BOS
Copyright© 1998 Bain & Company, Inc.
Cash Flow
Step 2 - Depreciation - Answer (p. 2)
The depreciation expense for the year can be calculated
from the balance sheet and notes.
- + =
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BOS
Copyright© 1998 Bain & Company, Inc.
Cash Flow
Step 3 - Other Non-Cash Expenses - Answer
Loss on equipment sold during the year: $ (from Note 3)
1996
Other non-cash expenses are added to profit before
interest and tax in the operating cash flow.
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BOS
Copyright© 1998 Bain & Company, Inc.
Cash Flow
Step 4 - Change in Working Capital (Excluding Cash)
Where to find:
Process:
•Balance sheet
•Working capital = current assets - current liabilities
•Review each current asset and current liability
Include:
Exclude: •Cash and cash equivalents
•Tax items
– include in taxes paid calculation (Step 5)
•Financing assets and liabilities, such as:
– interest payable
–dividends payable
–current portion of long-term debt
•Operating assets and liabilities
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BOS
Copyright© 1998 Bain & Company, Inc.
Cash Flow
Working Capital
Current Assets and Liabilities Included in Change in Working Capital Calculation
• Current assets
– cash
– marketable securities
– inventory
– accounts receivable
– pre-paid expenses
– deferred income taxes
• Current liabilities
– accounts payable
– accrued expenses
– loans payable
– income taxes payable
– current portion of long-
term debt
– interest payable
– dividends payable
Included in cash, not working capital
Included in cash, not working capital
Included in operating cash flow, but not in working capital
Included in financing cash flow
Not all current assets and liabilities are included in working capital.
Included in operating cash flow, but not in working capital
Included in financing cash flow
Included in financing cash flow
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BOS
Copyright© 1998 Bain & Company, Inc.
Cash Flow
Current Assets
Changes in working capital asset items have cash flow impacts.
…means cash is being used to
fund the business
…means cash is being generated by the
business
Increase in non-cash working capital Decrease in non-cash working capital
Decreases in current assets...Increases in current assets...
• Increase in inventories
–cash spent to buy inventories
• Increase in pre-paid expenses
–cash used to pre-pay bills
•Reduction in inventories
–cash generated by selling inventories
•Reduction in accounts receivable
–cash received from customers
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Copyright© 1998 Bain & Company, Inc.
Cash Flow
Current Liabilities
Changes in working capital liability items have cash flow impacts.
…means cash is being retained
by the business
…means cash is being used to
fund the business
Decrease in non-cash working capital Increase in non-cash working capital
Decrease in current liabilities...Increases in current liabilities...
• Increase in accounts payable
–cash saved by delaying
payment to suppliers
• Increase in deferred tax liability
–cash saved by delaying
payment of taxes
•Decrease in accounts payable
–cash paid to suppliers
•Decrease in accrued expenses
–cash used to reduce
accrued expenses
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BOS
Copyright© 1998 Bain & Company, Inc.
Cash Flow
Step 4 - Change in Working Capital - Answer
Loans payable:
Receivables:
Inventories:
Prepaid expenses:
1995 ($MM)
$2,
$1,
$
$1,
$
1996 ($MM)
$2,
$1,
$
$1,
$
Asset or
Liability
Asset
Asset
Asset
Liability
Liability
Change
Increase
Increase
Increase
Increase
Increase
Impact on
Working Capital
Increase
Increase
Increase
Decrease
Decrease
Impact on Working
Capital ($MM)
$
$
$
($)
Change in Working Capital
$
$
Accounts payable &
accrued expenses: ($)
An increase in working capital has a negative impact on operating cash flow.
Increase
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BOS
Copyright© 1998 Bain & Company, Inc.
Cash Flow
Step 5 - Taxes Paid
Where to find:
Process:
Deferred taxes:
•Provision for income taxes - Income Statement
•Change in deferred income taxes - Balance Sheet
•Current tax expense - Notes or calculate from Income
Statement and Balance Sheet
• Income taxes payable - Balance Sheet
+ Income taxes payable (beginning of period)
- Income taxes payable (end of period)
•Deferred taxes arise when pre-tax income reported on
the income statement differs from that shown on the
tax return
•Deferred taxes are sometimes shown on the balance
sheet as an asset and sometimes as a liability
= Taxes paid
Provision for income taxes
+ Increase in deferred income taxes asset account
+ Decrease in deferred income taxes liability account
= Current tax expense
Current tax expense
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BOS
Copyright© 1998 Bain & Company, Inc.
Cash Flow
Step 5 - Taxes Paid - Deferred Taxes
•Deferred taxes can be shown either as an asset or as a liability, or
even as both (as in this exercise)
•When deferred taxes are shown as an asset, an increase increases
taxes paid and is therefore a use of cash (negative impact on cash
flow). When deferred taxes are shown as a liability, an increase
decreases taxes paid and is therefore a source of cash (positive
impact on cash flow)
Deferred taxes are a complication to look out for in the
cash flow analysis.
Deferred income taxes (asset):
Deferred income taxes (liability):
1995 ($MM) 1996 ($MM)
Asset or
Liability Change
Cash Flow
Impact Result ($MM)
$
$
$
$
Asset
Liability
Increase
Decrease
Decrease
Decrease
($)
($)
Net result ($)MM
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BOS
Copyright© 1998 Bain & Company, Inc.
Cash Flow
Step 5 - Taxes Paid - Answer (p. 1)
Taxes paid is a use of cash, therefore it should be
deducted from operating cash flow.
Provision for income tax
+ Increase in deferred income taxes asset account
= Current tax expense
Current tax expense
+ Income taxes payable (beginning of year)
- Income taxes payable (end of year)
=
$
$
$
$
$
($)MM
$ paid
+ Decrease in deferred income taxes liability account $
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BOS
Copyright© 1998 Bain & Company, Inc.
Cash Flow
Step 5 - Taxes Paid - Answer (p. 2)
Incr. In def.
tax asset
$
Provision
for income
tax
$
Taxes paid can be calculated from the income statement and the balance sheet.
+ = + - =
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BOS
Copyright© 1998 Bain & Company, Inc.
Step 6 - Tax Impact of Interest Income/Expense
Where to find:
Process:
Comment:
Calculate from income statement
Interest income/expense
x Effective tax rate
= Tax impact of interest income/expense
Cash Flow
• Since interest income/expense is a result of financing
decisions, the tax impact of interest income/expense must be
removed from the operating cash flow and included in the
financing cash flow
• The effective tax rate =
• The tax impact of interest income/expense will be offset by
Step 9 of the financing cash flow
Provision for income taxes
Income before taxes
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BOS
Copyright© 1998 Bain & Company, Inc.
Cash Flow
Step 6 - Tax Impact of Interest Income/Expense - Answer
Effective tax rate = Provision for income taxes
Income before taxes
$
$1, = %=
Interest expense
X Effective tax rate
= Tax impact of interest expense
$
X %
$
The tax impact of interest expense is subtracted from operating cash flow
because interest expense results from financing decisions, not operating ones.
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BOS
Copyright© 1998 Bain & Company, Inc.
Cash Flow
Operating Cash Flow Calculation
Profit before interest and tax
$
$
($)
($)
($)
$1,
$1,
The New England Razor Company’s cash flow from
operations is $1,.
= Cash Flow from Operations
+ Depreciation expense for the year
+ Other non-cash expenses
- Increase in working capital
- Taxes paid
- Tax impact of interest expense
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BOS
Copyright© 1998 Bain & Company, Inc.
Cash Flow
Investing Cash Flow
*Cash is defined as cash plus marketable securities minus short-term notes
**I/S = income statement, SCF = statement of cash flows, B/S = balance sheet
+
+/ -
+/ -
-
+/ -
=
1. Profit before interest and tax (PBIT)
2. Depreciation
3. Other non-cash expenses/income
4. Decrease/increase in working capital (excluding cash)
5. Taxes paid
6. Tax impact of interest income/expense
Operating cash flow
-
=
7. Capital expenditures
Investing cash flow
+/ -
+/ -
+/ -
+/ -
-
+/ -
=
8. Interest income/expense
9. Tax impact of interest expense/income
10. Increase/decrease in long-term debt
11. Increase in outstanding stocks/shares
12. Dividends
13. Changes in other accounts
Financing cash flow
14. Reconcile with change in cash* from Balance Sheet
Net cash flow
Source**
I/S
SCF, B/S and Notes
Notes
B/S
I/S, B/S
I/S
I/S
I/S
B/S
B/S
B/S, I/S
B/S
SCF, B/S and Notes
SCF, B/S and Notes
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BOS
Copyright© 1998 Bain & Company, Inc.
Cash Flow
Step 7 - Capital Expenditures
Where to find: • Statement of cash flows or calculate from balance sheet and notes
• If SCF is unavailable, use one of the following two methods to
calculate capital expenditures:
PPE, at cost, at end of year
- PPE, at cost, at start of year
+ Original cost of PPE sold during year
- Proceeds from sale of PPE
= Capital expenditures
Net PPE at end of year
- Net PPE at start of year
+ Depreciation expense
+ Loss from sale of assets
= Capital expenditures
Process: • Obtain capital expenditures number from SCF
• Balance sheet alone is insufficient to determine capital
expenditures due to complications caused by asset sales
• Purchase and sale of assets
– if assets are directly related to recurring operations, .,
PPE, include in capital expenditures
– if assets are not directly related to recurring operations,
include in financing cash flow
Comments:
Method 1:
Method 2:
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BOS
Copyright© 1998 Bain & Company, Inc.
Cash Flow
Step 7 - Capital Expenditures - Answer (p. 1)
-
+
-
=
PPE, at cost, at end of year
PPE, at cost, at start of year
Original cost of PPE sold during year
Proceeds from sale of PPE
Capital expenditures
($6,)MM
($)MM
$1,
$7,
(from Note 3)
(from Note 1)
(from Note 3)
(from Note 1)
Capital expenditures decrease investing cash flow.
-
+
+
=
Net PPE at end of year
Net PPE at start of year
Depreciation expense
Loss from sale of assets
Capital expenditures
($4,)MM
$
$
$1,
$5,
(from B/S)
(from Step 2)
(from Note 3)
(from B/S)
$
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BOS
Copyright© 1998 Bain & Company, Inc.
Cash Flow
Step 7 - Capital Expenditures - Answer (p. 2)
Capital expenditures can be calculated from the Balance Sheet and Notes.
+ - = -
44CU7010598KRA
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BOS
Copyright© 1998 Bain & Company, Inc.
Cash Flow
Investing Cash Flow Calculation
Cash flow from investing ($1,)MM
Capital expenditures ($1,)MM
The New England Razor Company has a cash flow from
investing of ($1,)MM.
45CU7010598KRA
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BOS
Copyright© 1998 Bain & Company, Inc.
Cash Flow
Financing Cash Flow
*Cash is defined as cash plus marketable securities minus short-term notes
**I/S = income statement, SCF = statement of cash flows, B/S = balance sheet
+
+/ -
+/ -
-
+/ -
=
1. Profit before interest and tax (PBIT)
2. Depreciation
3. Other non-cash expenses/income
4. Decrease/increase in working capital (excluding cash)
5. Taxes paid
6. Tax impact of interest income/expense
Operating cash flow
-
=
7. Capital expenditures
Investing cash flow
+/ -
+/ -
+/ -
+/ -
-
+/ -
=
8. Interest income/expense
9. Tax impact of interest expense/income
10. Increase/decrease in long-term debt
11. Increase in outstanding stocks/shares
12. Dividends
13. Changes in other accounts
Financing cash flow
14. Reconcile with change in cash* from Balance Sheet
Net cash flow
Source**
I/S
SCF, B/S and Notes
Notes
B/S
I/S, B/S
I/S
I/S
I/S
B/S
B/S
B/S, I/S
B/S
SCF, B/S and Notes
SCF, B/S and Notes
46CU7010598KRA
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BOS
Copyright© 1998 Bain & Company, Inc.
Cash Flow
Step 8 - Interest Income/Expense
Where to find: • Income statement
Process: •Find interest income/expense on income statement
– interest income is added to financing cash flow
– interest expense is subtracted from financing cash
flow
47CU7010598KRA
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BOS
Copyright© 1998 Bain & Company, Inc.
Step 8 - Interest Income/Expense - Answer
1996
Interest expense $
Cash Flow
Interest expense decreases financing cash flow.
48CU7010598KRA
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BOS
Copyright© 1998 Bain & Company, Inc.
Cash Flow
Step 9 - Tax Impact of Interest Income/Expense
Where to find: •Calculate from income statement
Process: Interest income/expense
x Effective tax rate
= Tax impact of interest income/expenses
The effective tax rate = Provision for income taxes
Income before taxes
Comments: •This item simply offsets the impact of Step 6. The
purpose of these two items is to correctly allocate
the tax impact of interest to financing cash flow, not
operating cash flow.
• Interest expense reduces taxes, and so the amount
of the reduction needs to be added to financing cash
flow
– the benefit of the interest tax shield is effectively a
source of cash due to financing decisions (not
operating ones)
• Interest income has the opposite effect
49CU7010598KRA
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BOS
Copyright© 1998 Bain & Company, Inc.
Cash Flow
Step 9 - Tax Impact of Interest Income/Expense - Answer
Effective tax rate = Provision for income taxes
Income before taxes
$
$1,
= %=
Interest expense
x Effective tax rate
= Tax impact of interest
$
X %
$ MM
Interest expense reduces taxes and, therefore, the tax impact of
interest expense has a positive effect on financing cash flow.
50CU7010598KRA
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BOS
Copyright© 1998 Bain & Company, Inc.
Cash Flow
Step 10 - Change in Long-Term Debt
Where to find: •Balance Sheet
Process: •The change (from the start to the end of the period)
is the sum of the following two items:
–current portion of long-term debt (a current
liability)
– long-term debt (a long-term liability)
•An increase in the sum of these items means debt
has increased, which is a source of cash and is
added to financing cash flow
•A decrease has the opposite impact
Comments:
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BOS
Copyright© 1998 Bain & Company, Inc.
Cash Flow
Step 10 - Change in Long-Term Debt - Answer
Current portion of
long-term debt:
+/ - Change in
long-term debt:
1995 ($MM)
$
$1,
1996 ($MM)
$
$1,
Asset or
Liability
Liability
Liability
Change
Decrease
Increase
Impact on
Cash Flow
Decrease
Increase
Result ($MM)
($)
$
Change in long-term debt $ MMIncrease
An increase in long-term debt increases financing cash flow.
Increase
52CU7010598KRA
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BOS
Copyright© 1998 Bain & Company, Inc.
Cash Flow
Step 11 - Change in Outstanding Stocks and Shares
Where to find: •Balance Sheet
Process: • Identify changes in the equity accounts which were
sources or uses of cash, such as:
–new share issues (source of cash)
–share re-purchases (use of cash)
Comments: •Changes in retained earnings should be ignored.
They reflect the profit generated by the business
during the year, which has already been accounted
for by using operating profit as the starting point for
our cash flow calculation.
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BOS
Copyright© 1998 Bain & Company, Inc.
Cash Flow
Step 11 - Change in Outstanding Stocks and Shares - Answer
Common stock:
Additional paid-in
capital:
1995 ($MM)
$
$
1996 ($MM)
$
$
Asset or
Liability
Liability
Liability
Change
Increase
Increase
Impact on
Cash Flow
Increase
Increase
Result ($MM)
$
$
Change in outstanding stocks and shares $
Treasury stock: ($1,) ($1,) Liability Decrease Decrease ($)
The increase in outstanding stocks and shares has a positive impact on
financing cash flow.
54CU7010598KRA
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BOS
Copyright© 1998 Bain & Company, Inc.
Cash Flow
Step 12 - Dividends
Where to find: •Statement of Cash Flows or
calculate from Balance Sheet
and Notes
Process: •Obtain the dividends from the Statement of Cash Flows
•Subtract any dividends paid from financing cash flow
• If a Statement of Cash Flow is not available, use the
following calculation:
Dividends payable at start of year (from B/S)
- Dividends payable at end of year (from B/S)
+ Dividend declared during year (from Notes)
= Dividends
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BOS
Copyright© 1998 Bain & Company, Inc.
Cash Flow
Step 12 - Dividends - Answer
1996
Dividends payable at start of year $
- Dividends payable at end of year ($)
+ Dividend declared during year $
= Dividends $
Dividends decrease financing cash flow.
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BOS
Copyright© 1998 Bain & Company, Inc.
Cash Flow
Step 13 - Changes in Other Accounts
Where to find: • Income Statement, Balance Sheet
Process
(income statement
accounts):
• Examine each item between operating profit and profit before taxes
If non-cash If cash
Ignore If related B/S account
exists, include the I/S
amount, plus the change
in the B/S account
If no related B/S
account, include
in financing cash
flow as is
Gain/loss on
sale of division
Dividends
(as shown in Step 12)
Interest income
(as shown in Step 8)
Example:
Process
(balance sheet
accounts):
• Review any B/S accounts not already considered (usually just long-term
assets and liabilities); add changes in their balance to financing cash flow
– ignore changes in PPE; their cash impact has been addressed through
the “capital expenditure” and “depreciation” items in operating cash flow
– ignore changes in deferred taxes; their cash impact has been addressed
by the “taxes paid” item in operating cash flow
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BOS
Copyright© 1998 Bain & Company, Inc.
Cash Flow
Step 13 - Changes in Other Accounts - Answer
Other long-term liabilities:
1995 ($MM)
$
1996 ($MM)
$
Change
Decrease
Impact on
Cash Flow
Decrease
Result ($MM)
($)
A decrease in other long-term liabilities decreases financing cash flow.
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BOS
Copyright© 1998 Bain & Company, Inc.
Cash Flow
Financing Cash Flow Calculation
-
+
+
+
-
-
Interest expense
Tax impact of interest expense
Increase in long-term debt
Increase in outstanding stocks and shares
Dividends
Decrease in other long-term liabilities
Financing cash flow
$
$
$
($)MM
$
($)MM
($)MM
Financing is a source of $ in cash for The New
England Razor Company.
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BOS
Copyright© 1998 Bain & Company, Inc.
Cash Flow
Cash Flow Summary
1. Profit Before Interest and Taxes (PBIT)
2. + Depreciation
3. + Other non-cash expenses
4. - Increase in working capital
5. - Taxes paid
6. - Tax impact of interest expense
7. - Capital expenditures
8. - Interest expense
9. + Tax impact of interest expense
10. + Increase in long-term debt
11. + Increase in outstanding stocks and shares
12. - Dividends
13. - Decrease in other long-term liabilities
14. Change in cash
$1,
$
$
($)MM
($)MM
($)MM
($1,)MM
($)MM
$
$
$
($)MM
($)MM
$
$1,
$
Operating cash flow
Financing cash flow
The New England Razor Company has a net change in cash of $.
($1,)MM Investing cash flow
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BOS
Copyright© 1998 Bain & Company, Inc.
Cash Flow
Step 14 - Cash Reconciliation
Balance SheetWhere to find:
Process:
The cash flow should reconcile with the change in cash
and cash equivalents on the balance sheet.
Change in cash
+ Change in marketable securities
= Change in cash
Comment: Cash equivalents are combined with cash to
give an accurate picture of cash position
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BOS
Copyright© 1998 Bain & Company, Inc.
Cash Flow
Step 14 - Cash Reconciliation - Answer
Cash:
Marketable Securities:
1996 ($MM)1995 ($MM) Change ($MM)
$
$
$
$
($)
$
Change in cash position $
The Balance Sheet for the New England Razor Company shows a net change in
cash of $.
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BOS
Copyright© 1998 Bain & Company, Inc.
Cash Flow
Agenda
•The importance of cash flow
•Types of cash flow
•Applications
•Cash flow steps
•Exercise
•Key takeaways
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BOS
Copyright© 1998 Bain & Company, Inc.
Cash Flow
Key Takeaways
• “Cash is King”
– cash flow is a very useful measure of a company’s performance
– earnings can be very different from cash flow
• Operating cash flow + investing cash flow + financing cash flow =
net cash flow
• The major components of operating cash flow are:
– profit before income and tax
– non-cash expenses/income (mainly depreciation)
– change in non-cash working capital
• The major component of investing cash flow is:
– capital expenditures
• The major components of financing cash flow are:
– debt-related transactions
– equity-related transactions
– long-term asset and liability transactions
• Financial statements often have some unusual features, but
95% of the cash flow can usually be understood by looking at
the items listed above
The value of cash flow analysis is in understanding
the components or drivers of cash flow
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BOS
Copyright© 1998 Bain & Company, Inc.
Takeaway Slides (p. 1)
Cash Flow
Cash is King Cash Flow Cookbook
+
+/ -
+/ -
-
+/ -
1. Profit before interest and tax (PBIT)
2. Depreciation
3. Other non-cash expenses/income
4. Decrease/increase in working capital (excluding cash)
5. Taxes paid
6. Tax impact of interest income/expense
-
=
7. Capital expenditures
Investing cash flow
+/ -
+/ -
+/ -
+/ -
-
+/ -
8. Interest income/expense
9. Tax impact of interest expense/income
10. Increase/decrease in long-term debt
11. Increase in outstanding stocks/shares
12. Dividends
13. Changes in other accounts
Net cash flow
Source
I/S
SCF, B/S and Notes
Notes
B/S
I/S, B/S
I/S
I/S
I/S
B/S
B/S
B/S, I/S
B/S14. Reconcile with change in cash from Balance Sheet6
Balance SheetWhere to find:
Process: Change in cash
+ Change in marketable securities
= Change in cash
Comment: Cash equivalents are combined with
cash to give an accurate picture of
cash position
Cash Position Applications
• The market value of a company is equal to the present value of
its expected future cash flows
• Various stakeholders demand cash
– investors demand CASH returns
– suppliers and employees require CASH compensation
– debtholders demand CASH payments
• Accounting methods can be used to “manage” earnings; CASH
is harder to manipulate
Cash is King!
Valuation
(mergers, acquisitions)
Business unit analysis Portfolio management
• What is the cash
generation potential of
an investment/
acquisition?
• What are we willing to
pay (in cash) for that
investment/acquisition?
• How healthy is a
business unit?
• What factors have
effected the business
unit’s ability to generate
cash/value over time?
• How can the business
unit’s cash
management be
improved?
• What is the overall
balance of cash
users/cash generators
in a client’s portfolio of
businesses?
• How does this effect
the client’s overall
cash position/outlook?
• What restructuring
can be done to
improve this profile?
CF = common denominator CF = measuring stick CF = portfolio tool
SCF, B/S and Notes
SCF, B/S and Notes
Operating cash flow
Financing cash flow=
=
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BOS
Copyright© 1998 Bain & Company, Inc.
Takeaway Slides (p. 2)
Cash Flow
Types of Cash Flow Operating Cash Flow
Investing Cash Flow Financing Cash Flow
Operating cash flow Investing cash flow Financing cash flow
• Ability of a
company’s
recurring
operations to
generate cash
• Ability of a
company’s
investment
decisions to
generate cash
• How a
company funds
its operations
• Operating
profits
• Decrease in
working capital
• Sale of fixed
assets
• Long-term
issuance of
shares
Examples of
sources:
• Operating
losses
• Increase in
working capital
• Purchase of
fixed assets
• Repayment of
loans
• Payment of
dividends
Examples
of uses:
• Investments in ongoing operations - property, plant and equipment - are
included in investing cash flow
– cash is used to replace assets as they wear out
– if a business is to grow, additional assets must be acquired
– in some cases, the cash used to acquire these assets is generated from
the sale of existing noncurrent assets
– such cash inflows, however, seldom cover the entire cost of asset
acquisitions. Often times, cash flow from operations is used to finance
acquisitions, or, failing a positive operating cash flow, external financing
is used
• Pure financing activities are not included in investing cash flow. They are
included in financing cash flow
– purchase or sale of divisions or companies
– investments in unrelated businesses
• Investing cash flows relating to ongoing operations are used as a measure of
the strategic value of a business. Those that are purely financing/investment
mechanisms are used to evaluate the financial strategy of the business
• Operating cash flow excludes all cash flows related to a firm’s capital
structure
– cash generation ability is independent of how a firm is financed
• It excludes one-time events
– these are not related to a firm’s recurring operations
• Operating cash flow is used to measure the strategic value of a
business
– for company valuations, operating and investing cash flows are
used, not financing cash flow
• Bain is usually more interested in operating and investing cash flow
than in financing cash flow
• Major types of financing cash flow include:
– debt-related transactions
8 changes in long-term debt
8 interest income and expense
– equity-related transactions
8 changes in common and preferred stock
8 dividends
8 short-term investments
– long-term asset and liability transactions
8 purchase or sale of a division or company
8 changes in long-term liabilities
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