863 billion, then decreased it in 2007 by $603 million. Last year, with the stronger flows from operations and decreased stock retirement, they increased their cash position by $4.288 billion.
As with Microsoft, Sony has seen a strong increase in cash flows from operations over the past three years. They have increased 89.4% from ¥399 billion to ¥757 billion. This improvement is only partly attributable to top line improvement, as Sony's starting line hardly improved at all in 2007. Instead, that year saw a significant shift in the change in working capital. With regards to investing activities, Sony has not increased its capital expenditures over this time period. Also unlike Microsoft, Sony has seen significant capital outflows in all three years from its investments. They have enjoyed inflows from other activities, but not enough to offset the increasing losses. Sony has consistently been able to increase its cash flows from financing activities. 2008, however, saw a strong spike in cash flows from financing activities, from ¥172 billion to ¥510 billion. Overall, the strength of Sony's improvement in cash flows from operations, in particular with respect to its starting line, has resulted in a steady increase in cash flows over the past three…… [Read More]
The different authors use a number of quantitative approaches to understanding firm performance. Paunovic (2013) discusses the pricing and valuation of swaps. The author seeks to "demystify the structure of these financial derivatives (swaps) by presenting their valuation methods and by showing how they are used in practice." Thus, the author is presenting textbook explanations of swaps to her audience. Swaps are priced at par at the present time. The counterparties are swapping fixed rate obligations for floating rate, and make differential payments. Neither party would enter into the agreement at an unfavorable rate, but over time the changes in interest rates will mean that one party or the other will pay more. The floating rate is often based on LIBOR, or other common floating rate. Since banks are almost always intermediaries in swaps, they might seek to take a spread on the rate. Thus, a company setting up a swap agreement is likely paying fair value on the day for the swap, plus the bank's spread. The company might choose to do this because it needs to exchange its floating rate obligation for a fixed rate, or vice versa. This is usually based on operational or financial needs, as companies would seldom enter a swap agreement simply on a gamble about the direction of future interest rate changes. The author provides basic, accurate information about the nature of swaps and how they are used.
The second paper is Wang and Hwang (2011), where they discuss the use of options to control corruption and counterfeiting of drugs in emerging markets. Their quantitative work is weakened by a fundamental misunderstanding of options markets. They propose options as a means of helping firms to hedge pharmaceutical prices. While they understand how options work and how they are priced, they miss out on a fundamental difference between pharmaceuticals and products where options currently exist. Options are used for stocks and commodities, where prices fluctuate and future price movements are generally unpredictable.…… [Read More]
Cash Flow Analysis
Discuss Cash Flow And Its Analysis
Financial leverage refers to the use of a company's assets and liabilities targeting to earn profits upon balancing the risks associated. Financial leverage follows the argument in physics of lever where little force is used to lift heavy objects. Financial leverage uses debts and stock (Preferred stock) to increase earning. Leverage is a significant measure that financial institutions use to increase benefits though it comes with risks.
Benefits and risks of financial leverage
Use of financial leverage increases the earning and thus, higher profits for a financial institution. In cases where a company successfully uses leverage their credit rating increases since it a demonstration of how well they can tackle risks related to debt. Other benefits include efficiencies in scale of operations and higher cash flows.
Use of financial leverage puts an institution in risk of insufficient operation income. The leverage incurred is always a liability so is the small amount used to acquire the leverage. The institution runs the risk of inability to meet its short-term obligation to customers and shareholders. This likely to be the case in times of low economic performance that implies lower turnovers. It is generally accepted should the amount leveraged fail to yield positive income then the company will have decreased returns to shareholders.
Banks ROA and ROE compared to other industries
Return on Assets (ROA) is a measure of a company's profitability given the total asset invested. Return on equity (ROE) measures earning on funds held by a company for its shareholders or customers. It is appreciated that banks choose to operate on the funds…… [Read More]
A second challenge organizations face with cash flow management is being realistic with the amount of time it will take for them to receive revenues. This negatively affects cash flow projections that Sprague illustrates as being very important to a company's success. Companies are become slower and slower to pay their vendors, with 45 to 60 days becoming more the norm than the traditional 30 days, according to Feldman, as cited by Spargue. The third and final challenge to cash flow management is the lag in time between when payment to suppliers and employees comes due and the time in which revenues are received from customers.
Sprague (2008) gives a fairly comprehensive overview of cash flow, with this article. The author begins with the history of cash flow reporting and the cash flow statement. Sprague describes how cash flow reporting has transformed from being an option that had begun to catch on as effective in the 1960s to today's now mandatory requirement, as issued in FASB No. 95, stating that cash flow statements must be included with the income statement and balance sheet, in an organization's annual report to shareholders. FASB No. 95 is covered briefly, with a discussion of the required cash flow measurements. The two types of reporting -- direct and indirect -- are discussed; however there are questions that the author raises in their statement of facts, yet doesn't address.
Sprague (2008) comments that an overwhelming majority utilize the indirect method of reporting cash flow. Yet, this method, according to Sprague, "provides the least useful information for investment decisions" (p. 3). The author fails to describe specifically why the indirect method yields such useless information. Nor does she give a reason why so many organizations choose this method of reporting or why, if it doesn't effectively provide information, is it an option at all. An explanation of why the indirect method is preferable in some instances, despite the drawbacks, would have added another dimension to this section. Despite this interesting historical background, the remainder of the article brought the author's point home, regarding the importance of proper cash flow management.
The challenges corporations face in managing cash flow are briefly detailed and the sections that caused the most concern. Sprague (2008) highlights the most common areas where organizations often have issues. One of the challenges…… [Read More]
Walgreens' cash flow using its 2011 annual report. Currently ranked as the largest drugstore chain in the U.S., Walgreens had its beginnings in 1901 when Charles R. Walgreen bought the Chicago drugstore where he worked as a pharmacist. Over the next two decades, Walgreen bought 20 additional stores, adding such features as soda fountains with luncheon service, as well as his own line of drug products. The company added its first photofinishing studio in 1919 and introduced the malted milkshake at its fountain counters in 1922. By 1925, Walgreens had 65 stores with total annual revenue of $1.2 million. Walgreens' sales passed the $1 billion mark in 1975, and the company continued its growth and innovation to its current position of leadership in the retail pharmacy industry (Funding Universe, n.d.). With record profits of $2.7 billion in fiscal year 2011, Walgreens filled 819 million prescriptions, a figure that equates to one in five retail prescriptions in the U.S. The company is headquartered in Deerfield, IL and has over 247,000 employees (Walgreens, 2011).
Analysis of Cash Flow Statements
Analyzing Walgreens' cash flow statement provides indications of the company's performance in 2011. Net earnings increased by $623 million over 2010, continuing a positive trend from 2009 as well, although the increase of $85 million was not as large. While this earnings increase was positive, it was not sufficient to offset Walgreens' negative cash outflows over the same period.
Walgreens' cash flow statement shows the company reported net cash provided by operating activities amounting to $3.64 billion. A decrease from the previous year of $3.74 billion represented an increase in working capital. With 2011 net earnings of $2.7 billion, Walgreens' net earnings increased by 29.8% over 2010. Walgreens attributed the sizable increase to higher gross margins, as well as to the sale of its pharmacy benefit management business and a lower effective tax rate (Walgreens, 2011).
Walgreens cash flow from operations (CFO) showed non-cash expenses that included $1.09 billion in depreciation and amortization. Walgreens' CFO also showed an adjustment of $434 million for the sale of its pharmacy benefit management business, which is a cash flow not normally generated by its regular business operations. Walgreens' uses of cash included…… [Read More]
accounting income and cash flow? Which do we need to use when making decisions by using NPV? Explain in short.
Accounting income takes in consideration total profits; which is usually some form of total revenues minus total expenses. Cash flow is a totally different concept because it doesn't necessarily account for total income, rather it just accounts for cash out flows and in flows. For example, it may not account for various administrative costs or wages that are paid to employees and it may not account for the total income of the organization but just for one specific project.
A positive NPV is a good start -- now we need to take a closer look
Forecasting risk: How sensitive is our NPV to changes in the cash flow estimates; the more sensitive, the greater the forecasting risk (explain which conditions we accept the risk for both investors and company point view).
Investors generally make decisions about risk based on their own personal situation. For example, an investor close to retirement may be risk adverse while a younger investor may be more receptive to risk. The company's will also have a unique risk profile based on their current circumstances. However, both the company as well as the individual investor will have to incorporate their risk tolerance into their required rate of return for their NPV calculation. By adjusting the risk premium in the NPV calculation, both the investor and the company can also adjust
3)… [Read More]
Based on a large sample of firms from different countries after adopting IASB cash flow accounting, firms evidenced "less earnings management, more timely loss recognition and more value relevance of accounting data" than firms without IASB standards (Morais & Curto 2008). The drive towards greater homogenization of international standards has lead the United States FASB (Financial Accounting Standards Board) to consider the IASB's call for a shift to cash flow methods for all organizations. The justification for this is that accruals are more subject to dishonest practices "since every accrual requires certain assumptions and estimates… when a firm completes a sale on credit, it must estimate the likelihood that the cash will be received, when the receipt will take place, and if full payment is uncertain, how much should be reflected on the income statement. None of these issues arise when the sale is for cash" and a firm cannot use assumptions and estimates to inflate profits ("Will global accounting rules help or hinder accuracy," Knowledge @ Emory, 2007).
However, cash flow accounting is not without its critics. Because "accrual account recognizes revenue and expenses in the period they occur, regardless of whether cash changes hands" it may be a better long-term picture of the state of the firm ("Will global accounting rules help or hinder accuracy," Knowledge @ Emory, 2007). Cash flow accounting can more easily be subject to shifts in the flow of receipts and payments, and a firm can choose to 'pack' its cash transactions into a particular period of time when it needs to maximize its impression of profitability. "If managers wish to distort results, they can boost cash inflows by simply delaying the purchase of supplies, or of interest-bearing, short-term securities, and can also delay paying whom they owe" ("Will global accounting rules help or hinder accuracy," Knowledge @ Emory, 2007). .
Neither system is perfect. Thus, a shift to cash flow accounting, although it seems likely, given the drive to adopt towards international accounting standards, is only an imperfect solution: a combined approach is likely the most accurate portrayal. "The value of information from financial statements arises from a combination of cash basis and accrual basis measures" ("Will global accounting rules help or hinder accuracy," Knowledge @ Emory, 2007). Although having international standardized accounting rules may make it easier to define accepted best practices within the profession,…… [Read More]
The cash flow statement is a critical tool for financial planners and analysts interested in assessing the health and wellness of a company from a financial and operational perspective. The statement of cash flows provides information about the cash payments received by a company during a defined period; the amount that should be received from cash receipts is also reported (Kieso, Weygandt, & Warfield, 2007). This is critical information a company needs to determine how well their products and services are doing. The cash flow information assesses whether products and services are bringing in revenues for the company. Cash flow does not includes revenues coming in as interest or credit however, for the month the receipt is issued say for the charge incurred, or when the loan is given. There is a system of checks and balances. The system in place is highly organized to capture a big picture sense of how well a company is doing. Cash flows generally reflect an upward trend in cash flows, provided a company does well as one expects; many business however, take some times before they realize a positive cash flow. This is normal.
Other information a company can gather from cash flows includes the "operating, investing, and financing activities" during a defined period; allowing a company to reconcile the amount of cash it receives from the beginning of the period an accountant calculates cash to the end of the period (Kieso, Weygandt, & Warfield, 2007). Having this information is valuable for many reasons. It allows a company to determine how much cash it will have available in the future; the company can estimate how much cash it may have and predict when that cash may be available. Most companies project what their cash flow will be from the time they begin offering a product or service, for defined periods of time. For example, a company may project how much their cash flow will be for five-year intervals starting…… [Read More]
, 2009). Similar adjustments are made for items, such as expenses, taxes etc. (Stickney et al., 2009).
The second section shows the cash inflows and outflows from investing. The figures shown are the changes that have occurred on the previous year. For example, if the firm makes a capital investment, the cost of that investment will be an outflow. If there is revenue created by an investment, such as the sale of the asset, this will be a cash inflow (Stickney et al., 2009).
The third section is the financing. The main components are the changes in debt; increased debt creates a cash inflow, whereas paying off debt creates an outflow. Any capital that comes into the firm or leaves the firm is included in this section. If dividends are paid, they will be a cash outflow in the financing section. The cash flow statement will end with a net total of the cash flow from all areas and a calculation of the difference between the current and the previous period.
By understanding what the cash flow statement shows and why it is created the importance may be appreciated. The statement shows important information that is valuable to a range of stakeholders, including investors, creditors and management. The statement accounts for the actual cash flow and shows the sources of that cash flow, an important element of assessing the financial health of a firm. For example, a firm that appears to make a loss following heavy investments may be making positive cash flows. It may be argued that whatever view is taken of a firm, one of the most important issues will be the cash it generates and how money is spent to support the operations. However, just as with any other financial statement, the interpretation of the results should not be read in isolation, the results may reflect different strategies and only show the position of the firm at a single point in time, negative cash flow is not always bad, just as a positive cash flow may indicate a…… [Read More]
After considering the material provided by both the FSO Technologies
and Bank of America tutorials, it becomes increasingly clear that the key
to long term financial viability is projection and planning. In the case
of the childcare center, the tutorial advised that once one has clearly
mapped out a cash budget which compares expected cash inflows and outflows,
one can begin to make meaningful incremental and longterm changes in
spending and pricing. As the childcare center director, I would be in a
unique position of insight to administrate a consideration of all the
utilities, employees, facilities, marketing and petty expenses which
constitute our overall budget. This would also allow me to detect places
where expenses can be reduced or where more is needed.
By combining this with a projection of future cash needs, I would be
in a position to assess the true nature of our overall cash flow situation.
This would allow me to make management decisions according to a lucid and
empirical understanding of what is feasible and what is not.
3. Critically analyze how the cash flow tutorial and record keeping
forms that you completed can benefit a center director.
The tutorials on cash flow and record keeping were useful in their
provision of a practical and concrete set of steps through which one can
plan and project costs and opportunities. To this extent, perhaps the most
compelling point to emerge is the notion that it is important to make
projections regarding not just cash on the books, but actual cash flow. As
the tutorial at Bank of America denotes, a cash crunch can be created when
an organization fails to project the difference between these theoretical
and realistic parameters. (VA, 2) Another message of crucial importance
which is offered by the tutorials is their shared resolution that one
should never attempt simply to book opportunities for revenue. One must be
prepared to project and meet the actual costs of execution.
Works… [Read More]
Free Cash Flow
In order to make a capital budgeting decision, the company must identify the incremental free cash flows associated with the project, particular for long-term projects that require the cash flows to be treated to account for the time value of money (NetMBA, 2010). A free cash flow is defined as "the cash that a company is able to generate after…" the initial expenditure (Investopedia, 2012). The first step is to eliminate the obvious non-incremental flows such as pre-existing overhead, sunk costs and non-cash flows like depreciation.
Within these issues, the process is not always simple. For example, many managers find overhead determinations to be difficult. The underlying principle is that the overhead the manager needs to take into account is the overhead that is incremental to the project, for example if new support staff are added. Diversion is an area that is tricky, however. Resources diverted from other areas of the company can be difficult to treat (Keown, 2012). For example, it is clear that the cost component of such flows is not incremental, because that money would be spent elsewhere anyway. However, the revenues might be different between the two uses of the resources. So to find the incremental cash flow of the new project, the difference between the revenue of the new project relating to the diverted assets must be compared with the revenue those assets would generate in their existing uses.
Peavler (2012) notes that there are significant challenges in estimating cash flows far into the future. For the most part, any future cash flows are inherently speculative. The farther into the future the flows are, the most speculative they are. The company can only truly derive rough estimates of the future cash flows that it is using to make the capital budgeting decision. Some of the risk inherent in using such projections can…… [Read More]
Walgreens Liquidity and Cash Flow
The Management's Discussion and Analysis, together with the Consolidated Statement of Cash Flows and Notes, provide insight into the company's sources and uses of cash.
Over the two-year period for the years ending August 31, 2009 thru 2011, the company has seen large cash outflows which affected its cash position and its liquidity. Net cash provided by operations declined from $4.1 billion in 2009 to $3.6 billion in 2011. Cash provided by operations was the principal source of funds for the Duane Read acquisition, for expansion, remodeling programs, shareholder dividends and stock repurchases (Walgreens, 2011).
Walgreens management attributes the decrease in net cash provided by operations to higher working capital. In part the cash flow decrease in working capital was offset by higher earnings, which increased by $708 million over the two-year period (Walgreens, 2011).
Walgreens' cash and cash equivalents have trended down from $2.1 billion in 2009 to $1.9 billion in 2010 to $1.6 billion in 2011 for a total decrease of $531 million. Included in the company's cash and cash equivalents is cash on hand and all highly liquid investments having an original maturity of three months or less (Walgreens, 2011).
Cash provided by operations funded Walgreens investment in additions to property and equipment for $1.2 billion in fiscal year 2011. Walgreens added a total of 297 locations, a net addition of 164, which included the acquisition of 258 Duane Reade locations. Walgreens' expansion included 62 owned locations added during the year, with 44 under construction at fiscal year end. In addition to the Duane Reade chain, business acquisitions included the purchase of drugstore.com, Inc. (Walgreens, 2011).
The company used $2.0 billion for their stock repurchase program in 2011; in the previous year, Walgreens…… [Read More]
Equity, Cash Flow, And Notes Analysis for the General Electric Company
Regarding the specific components of the Statement of Changes in Owner's Equity and Statements of Cash Flows, from line items to balances
General Electric still stands tall in the public's estimation and in its international reputation as a pioneer of Six Sigma management policies regarding internal quality control. (Six Sigma, 2004) According to its annual report, GE Share owners' equity increased $8.9 billion, $4.3 billion and $7.9 billion in 2002, 2001 and 2000. Thus, the performance of the General Electric company in sheer dollar terms continues to improve, not simply as a statistical blip between the current financial year and the financial year of the past, but steadily, and over time. The increases were largely attributable to net earnings of $14.1 billion, $13.7 billion and $12.7 billion. These increases were only partially offset by dividends declared of $7.3 billion, $6.6 billion and $5.6 billion in 2002, 2001 and 2000, respectively.
But by and large, GE's profit as a company thus overall increased in terms of its net worth, and also in terms of its ability to pay dividends to its stockholders and shareholders. It was also able to maintain generous stock options packages and retirement packages to its employees, domestically and internationally, and increased its net worth in both its manufacturing and service sectors.
Part B: Analysis of the changes in those balances from the prior year, possible specific explanations for any changes from the previous year, and how management can use that information in helping the business to achieve its http://www.ge.com/images/en/ar2002/space.gif
It should be noted that GE's international financial statements were affected by currency translation adjustments. These translations increased the recorded equity by $1.0 billion in 2002, compared with reductions of $0.6 billion and $1.2 billion in 2001 and 2000, respectively. "Changes in the currency translation adjustment reflect the effects of changes in currency exchange rates on our net investment in non-U.S. subsidiaries that have functional currencies other than the U.S. dollar," stated the GE Management Statement and Analysis regarding Cash Flow and Liquidity of the company. Thus, in addition to specific corporate policies, the currency exchange rate also affected the reporting of the company's profits to a considerable degree, because…… [Read More]
Each ***** will whelp an average of 5 pups per year and that the sale of these pups will average $4,000 each. Breeding stock imported from Europe typically averages $10,000 U.S. per dog after import expenses and other costs.
These assumptions based on the experience and past knowledge of the staff as well as industry averages. It is felt that they represent realistic estimates. It is difficult to predict certain aspects of the financial data, such as the number of small dogs that will need grooming vs. some of the large dogs that will come in. Conservative estimates give room for error. This was the method chosen for the estimation of proforma statements.
Initial capital will come from $50,000 total form the partners. A small business loan of $495,000.00 will be used to finance the remainder of capital start up costs, plus one year's operating expenses. The term of the loan will be 10 years at an annual rate of 4.5%.
Pro-Forma Balance Sheet
Net accounts receivable
Total Current Assets $316,691 $402,262 $424,276
Buildings (net of depreciation)
Plant & equipment (net)
Furniture & fixtures (net)
Total Net Fixed Assets $2,270 $2,323 $2,420
Current portion of long-term notes
Accruals & other payables
Total Current Liabilities $298 $305 $312
Other long-term liabilities
Total Long-term Liabilities $1,340 $1,416 $1,505
Total Shareholders' Equity $317,323 $402,864 $424,879
TOTAL LIABILITIES & EQUITY
Proforma Income Statement
Less sales returns and allowances
COST OF SALES
Plus goods purchased / manufactured
Total Goods Available
Less ending inventory
Total Cost of Goods Sold
Gross Profit (Loss)
Salaries and wages
Total Selling Expenses
Salaries and wages
Payroll…… [Read More]
How does net cash flow differ from net income and why is that difference relevant to financial decision making?
Net cash flow takes in consideration the changes in short-term assets of an organization. Whenever a cash receipt is made then net cash flow is raised or when a bill or expense is paid then the net cash flow decreases. It is basically a measure of how much cash, or cash equivalents, that the organization has at any given time. Net cash flow can also be forecasted so that the organization can have an idea of how much cash it will hold, or need to hold, in the future.
Net cash flow, although it is indirectly related, is not necessarily directly related to any measure of profitability. For example, if a company receives a check for a hundred thousand dollars then it would increase net cash flow; even if the receipt was for a project in which they were losing money on. Therefore you can have a positive net cash flow but still have…… [Read More]
The role of the firm in the economy is to maximize shareholder wealth (Friedman 1970), owing to the agency role that managers play, where they safeguard the wealth of the investors. Given this reality, managers are obligate to seek out ways to increase the profits of their companies. There are as many ways to earn profits as there are companies, but this paper is going to focus on a particular approach, which is cash management. For a business, cash is the ultimate goal, as the fungible store of wealth that the shareholders seek. Yet for the business, cash is also a source of inefficiency. Unused cash on the balance sheet earns nothing, and cash sitting in short-term investments is unlikely to have a positive real return either. Apple shareholders recently demanded that the company return some of its excess cash to the shareholders as dividends, because of how inefficient excess cash is for a company (Popelka 2013).
Thus, the manager is responsible for striking the right balance between spending money to earn returns, and returning that wealth to the shareholder. The company must acquire cash and then quickly use that cash to either generate more, via retaining the earnings and reinvesting in the company, or by returning the cash to the shareholders. For the manager, then, it is imperative to manage the organization's cash closely. This mandate is reflected in the concept of the cash conversion cycle. The cash conversion cycle reflects the degree to inventory is converted to cash, and how fast that cash is converted back into other goods and services. Richards and Laughlin argued in 1980 that managing the organization's cash "receives less attention in the literature than long-term investment and finance decisions, but occupies the major portion of the financial manager's time and attention." They tied the concept of cash conversion cycle to liquidity -- and this approach remains relevant today -- but even in companies where the overall liquidity position is not in doubt, there is need to manage cash effectively, to increase profits and returns for the shareholders.
How Cash Affects Profits
The case of Apple makes a good starting point for understanding how cash affects profits, because of its extreme nature. For most companies, cash is a lifeblood, and the…… [Read More]
The IRR is also known as yield method, and IRR of a project is the rate of discount at which the present value of cash flow is equal to the present value of cash inflow. While IRR base the value on rate of return, the ARR ignores the time value of money and it is not accounting based of return. Under ARR, depreciation is calculated in different methods such as accelerate or straight line, and the technique ignores the salvage value of the initial investment.
5. "Explain the relative significance of the unadjusted payback period in this decision situation."
Payback period assists in determining payback period in the life cycle of the project. Typically, it would be more than 8 years before NPV would become negative. However, the payback may not be useful in determining acceptance of a project because it ignores cash flow and does not consider time value for money after the payback in the life of a project.
Payback period is the time duration that is required to recoup the initial costs that has been committed in a project. The pay back period is the number of years that it will take cash flows from project to recover initial investment put in the project.
The relative significant of the unadjusted payback period in this situation is that payback period helps to determine the payback period in the project lifecycle. In the project, it would be more than 8 years before the Net Present Value (NPV) would be negative. Application of pay back is easy and it is easy to understand. Another significant of unadjusted pay back period is that it stress the period of recouping the investment put in the project.
The significant shortcoming of pay back period is that it ignores that cash inflows received after the payback period. Since payback period emphasizes on early recovery, it does not lay emphasis on the cash inflow after the payback period.
6. "Explain how the weighted average cost of capital should be used in capital budgeting analysis when utilizing the NPV method."
Weighted average cost of capital (WACC) should be used as discount rate in the project life cycle as well as to discount all cash flows. To determine the Net Present Value of a project, it is essential to discount the cash flows at weighted average cost of capital using…… [Read More]
Investors prefer cash flow over earning but the article points out that there are many shortfall is in using standard cash flow measures. There are various definitions of cash flow, some quite incoherent. GAAP does not help either since the whole subject of cash flow itself is so vast, varies from country to country, and possesses complexities and unpredictability that even GAAP with its laws and definitions has just left us with more confusion, inconsistency, and miscategorization.
In response to this complexity of cash flows, many investors resort to EBITDA (earnings before interest, taxes, depreciation, and amortization) and cash earnings (typically defined as net income plus depreciation and amortization). These existed before the GAAP measures, but they have their own major shortcomings.
The question then is: what is the best measure of free cash flow? And the way to answer this is to ask how free cash flow metric will be used.
The article distinguished between four possible uses of cash flow metrics and focuses on the two most popular uses of cash flow in valuations:
a. As the main variable in DCF models
b. In price-to-free cash flow (P/FCF) multiples.
The article focuses on cash flows in multiples-based valuations (b) because this is where the problems are…… [Read More]
Dell's Waning Cash Flow, Signs of Concern" attempts to elucidate the reasons behind the purported deal of Dell -- a computer company -- to go private after existing for years as a company with publicly traded stock. As such, the author explores a number of scenarios that may have influenced Dell founder Michael S. Dell's decision to go private. He discusses both the benefits and the negatives associated with a private company, and attempts to offer the reader insight into the financial prowess -- or lack thereof -- of this particular organization.
The premise that the article is based on is that Dell and Silver Lake (an investment firm) are considering a $24 billion deal to go private due to inefficient marketplace performance and declining interest in stock investors. However, one of the chief tenets that Eavis contends that is spurring this deal is the fact that Dell allegedly has a shrinking cash flow. The author states that during the most recent fiscal year, the company's free cash flow was 2 billion dollars less than it was during the previous fiscal year. He simultaneously alludes to the fact that Dell is fortunate to have closed out the current fiscal year with a free cash flow at $2.77 billion, while alluding to the fact that it may have other cash flows (such as its "large pool of overseas cash" (Eavis, 2013) to justify a purchase well over $24 billion.
Another central premise of Eavis' article is that Dell is on the brink of desperation due to it waning (free) cash flow, and that going private could either make or break the company. In the event of the former, he emphasizes that going private can significantly reduce an organization's costs. In the event of the former, he propounds the notion that the additional interest Dell will incur as a private entity could drain its free cash flow even more, leaving it in considerable financial jeopardy.
In reading this article, it was fairly clear that the author was privy to a host of inside information about Dell and its financial standing. Also, it is desirable of most articles and of journalism in general to present a balanced view of their subject. However, the primary drawback of this article is that the author makes too many contradictions, and leaves the reader with little understanding as to where in fact Dell…… [Read More]
Cash flow and balance sheet tests
The cash flow test very simply put is the ability of a company to pay off their debts as they are liable to pay them; i.e. As soon as they are indebted they already have generated the money to pay it off immediately. A company will prove to be insolvent if and when the futuristic calculations prove it to be incapable of paying their debts. In case, a company is able to pay off their debts or bills for the first two months and after those, it is still considered insolvent. Hence, the cash flow insolvency test will be a futuristic calculation of debts and cash inflows based on the current trends of both e.g. If a company is earning $100,000 and has debts of $50,000 going out every month, the debts will increase to $60,000 in a month's time making the company insolvent (Arner et al., 2006).
The balance sheet test is somewhat similar to the cash flow test but instead of calculating futuristic cash inflows, it focuses on probabilities of increase or decrease in liabilities and cash flows. Hence, the entire balance sheet test is based on the perspective inflows and outflows of a company. If and when the difference between the cash inflows and cash outflows is negative, then the company is considered to be insolvent. It is important to note here that only a handful of companies will measure up to being solvent after the balance sheet insolvency tests are complete (Arner et al., 2006).
Between the cash flow and balance sheet test, the cash flow test is a lot more accurate to measure a company's insolvency as it considers the tangible inflows and outflows to determine a company's financial standing i.e. The cash flows that the company is already recording and will continue to record in the future as well. The balance sheet test on the other hand considers the perspective cash flows, i.e. those cash flows that might possibly occur in the future, which leaves a sense of unpredictability to the company's financial strength. Hence, the cash flow test is better and much…… [Read More]