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AFM 182 > Chapter 8: Cash Flow Analysis & Planning > Flashcards

Chapter 8: Cash Flow Analysis & Planning Flashcards

1
Q

who cares about cash flows

A

Internal and external stakeholders

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2
Q

why are cash flows important to a business

A
  • Business can’t operate when there’s no more cash
  • Business can’t meet expectations of external stakeholders without sufficient cash to operate and grow the business
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3
Q

what do internal stakeholders do related to cash flows

A
  • monitor cash flow to understand if and when a company needs to get more cash from investors (by issuing new shares) or banks (get loans)
  • Management teams monitor cash flows from operating activities and assesses if these cash flows are enough to:
    • Make investments required for continued growth
    • Cover financing activities like loan repayments and/or dividend payments
  • If there aren’t enough cash from operating activities, financing activities like borrowing from a bank or raising equity from private/public investors are done
  • also need to understand cash to budget future cash flows
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4
Q

what do external stakeholders look at cash flows for

A
  • Private and public investors look at cash flows to determine company’s ability to pay dividends and assess if company is investing enough cash to fund future growth
  • Bank analyze cash flows to assess if a company can make interest payments and repay its debt
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5
Q

what are the 3 categories of the cash flow statement

A
  • operating activities
  • investing activities
  • financing activities
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6
Q

what is the cash flow equation

A

Net Cash Flow From/For Operating Activities + Net Cash Flow From/For Investing Activities + Net Cash Flow From/For Financing Activities = Net Increase (or Decrease) in Cash for the Period + Cash Balance at Beginning of Period = Cash Balance At End of Period

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6
Q

what do management care about specifically in terms of cash

A

care about “liquidity”; having cash available to run the day-today operations

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7
Q

what are operating activities & examples

A
  • Activities related to operating the core business
  • Examples:
    • Cash received from customers for selling goods/delivering a service during a period
    • Cash used to pay suppliers and employees
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8
Q

what is the equation for the operating activities section of the cash flow statement

A

Net Income +/- Non-Cash Items +/- Changes in Current Assets +/- Current Liabilities

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9
Q

what are non-cash items and are they added/removed

A
  • Depreciation/Amortization
    • added to net income
  • Gain/Loss on Long-Term Asset Disposal
    • Losses are added to net income
    • Gains are removed from net income
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10
Q

what are current liabilities and are they added/removed

A
  • Accounts Payable, Accrued Liabilities, Unearned Revenue
  • Period-over-period increases are added
  • Period-over-period decreases are removed
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11
Q

what are current assets and are they added/removed

A
  • Accounts Receivable, Inventory, Prepaids
  • Period-over-period increases are removed
  • Period-over-period decreases are added
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12
Q

what are investing activities

A
  • Business activities related to purchasing or disposing of long-term assets and investments that are not cash equivalents or held for trading
  • Also include activities related to making cash advances and loans to other parties
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13
Q

what are examples of cash inflows from investing activities

A

Cash received from:
- Disposing a long-term asset
- Sale of investments (excluding cash equivalents or investments held for trading)
- Collection of advances and loans
- Cash used to buy new equipment or intangible assets

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14
Q

what are examples of cash outflows from investing activities

A

Cash received for:
- Purchasing new equipment or intangible asset
- Purchasing a new store
- Purchasing Investments (excluding cash equivalents or investments held for trading)
- Advances and loans made to other parties

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15
Q

what is the cash treatment for investing cash inflows and outflows (what is added, what is removed)

A
  • Cash inflows are added
  • Cash outflows are subtracted
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16
Q

what are financing activities

A

Business activities related to raising capital

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17
Q

what are examples of financing cash inflows

A

Cash received from:
- Borrowing (ex. bonds, loans)
- Issuing equity (ex. selling common shares)

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18
Q

what are examples of financing cash outflows

A

Cash received for:
- Repaying (ex. Bonds, loans)
- Repurchasing equity (ex. buying back shares)
- Paying dividends to shareholders

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19
Q

what is the cash treatment for financing cash inflows and outflows (what is added, what is removed)

A
  • Cash inflows are added
  • Cash outflows are subtracted
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20
Q

what is the IFRS approach 1 for categorizing interest paid, interest received, dividends paid, and dividends received

A

all operating cash flow

21
Q

what is the IFRS approach 2 for categorizing interest paid, interest received, dividends paid, and dividends received (the one 182 uses)

A
  • interest paid: financing
  • interest received: investing
  • dividends paid: financing
  • dividends received: investing
22
Q

what are the 4 questions used to analyze the cash flow statement

A
  1. What was the net change in cash during the period?
  2. What were the major SOURCES of cash (ex. Big inflows, positive numbers)?
  3. What were the major USES of cash (ex. Big outflows, negative numbers)?
  4. What overall strengths and/or weaknesses do you see?
23
Q

what is liquidity

A
  • A company’s ability to convert assets to cash
  • Indicates if a company has enough current assets that can be converted to cash to pay off current liabilities
  • Liquidity is short-term focused
24
Q

how is liquidity assessed

A

by looking at a company’s working capital

25
Q

what is net working capital

A
  • The difference between a company’s current assets and current liabilities
  • Measures the liquidity of the company
  • Also indicates the company’s operating efficiency and short-term financial health
26
Q

what are 2 basic liquidity ratios

A
  • current ratio
  • quick (acid-test) ratio
27
Q

what is current ratio

A
  • Measures the company’s ability to pay current obligations (those payable in one year)
  • Answers the question, “does the company have enough resources to meet its short-term obligations?
28
Q

how do you analyze a current ratio

A
  • Expressed as a #
  • Ratio >= 1.0 is considered satisfactory as it means the company has enough current assets to cover all of its current obligations in the short term
  • Ratio < 1.0 indicates the company would have problems if they needed to repay all of its current liabilities immediately
28
Q

what is quick (acid-test) ratio

A
  • Measures company’s ability to pay current obligations without selling or liquidating its inventory
  • The company’s ability to pay off its current liabilities with just cash & A/R
  • Means that in an immediately critical situation, the company should be able to pay all its short-term liabilities without relying on the sale of inventory, which usually takes longer to turn into cash compared to other current assets
29
Q

how do you analyze a quick (acid-test) ratio

A
  • Expressed as a #
  • If quick ratio is much lower than current ratio, it means the company’s current assets are heavily comprised of inventory
  • Would then need to do further analysis to confirm the company’s financial health
  • Ratio > 1.0 means the company can pay off all its current liabilities without needing to sell inventory
30
Q

what questions do liquidity ratios help answer

A
  • Does the company turnover (sell) its inventory without having it for long periods of time? (relevant for companies with inventory)
  • Does the company collect credit sales (A/R) in a timely manner?
  • Does the company pay its suppliers (A/P) within credit terms?
30
Q

what is the point of liquidity ratios

A

ratios that track a company’s ability to be efficient with its working capital

30
Q

what is the cash conversion cycle

A
  • The number of days it takes for a company to convert inventory and sales into cash
  • Assessment of the cash conversion cycle can answer the above questions and the results of the associated ratios
30
Q

what does it mean when companies have higher debt ratios

A

they are associated with higher credit risk because it means that the company financed its growth mostly with debt, which means a legal requirement to consistently pay interest and the principal eventually

31
Q

what is inventory turnover ratio

A
  • Measures a company’s effectiveness in selling its inventory throughout the period
  • Tells you how many times a company sold its average level of inventory in a specified period
  • Ex. If a company has an inventory turnover of “4” for the year = average level of inventory has been sold 4 times during the year
31
Q

what is the cash conversion cycle (in days) formula & what do you generally want to see

A

Cash Conversion Cycle (in days) = Days in Inventory + Days in A/R - Days in A/P
- Want this # to be lower

31
Q

what is the analysis of inventory turnover ratio

A
  • Lower turnover is usually considered bad
  • Too high a turnover can signal that the company isn’t stocking enough inventory and is potentially losing out on sales
  • Should compare metric overtime and to industry averages and/or competitors to determine how the company is performing
31
Q

what is Days Inventory Outstanding (DIO)

A
  • Tells us how long, in days, it takes to SELL the average level of inventory (only relevant for merchandisers)
  • Calculates the days’ inventory outstanding in a year
  • If inventory turnover was calculated for a month, would use 30 or 31 instead of 365
31
Q

what is Accounts Receivable Turnover Ratio

A
  • Measures a company’s effectiveness in collecting its accounts receivable/revenue
  • Tells you how many times a company collects its accounts receivable in a specified period
32
Q

what is the analysis of A/R turnover ratio

A
  • Tells you how many times a company collects its accounts receivable in a specified period
  • Higher the ratio = the company is collecting its A/R more times/frequently throughout the analysis period (a good thing, want it to be higher)
  • Too high of a ratio can signal that the company’s credit terms are too aggressive, and could end up losing potential customers
32
Q

what is net credit sales

A
  • sales made on credit in the period
  • If not given, use total revenue
32
Q

what is Days’ Sales Outstanding (DSO)

A
  • Indicates how long, in days, it takes for the company to COLLECT it’s sales on account
  • Calculates the days’ sales outstanding in a year
  • If A/R turnover was calculated for a month, would use 30 or 31 instead of 365
32
Q

what is Accounts Payable Turnover Ratio

A

Measures the number of times a company pays its creditors in a specified period

33
Q

what is Days’ Payables Outstanding (DPO)

A
  • Indicates how long, in days, it takes for a company to PAY off its accounts payable
  • Calculates the days’ payables outstanding in a year
  • If A/P turnover was calculated for a month, would use 30 or 31 instead of 365
33
Q

what is the analysis of A/P turnover ratio

A
  • Usually want the ratio to be lower instead of higher without impacting business relationships
  • Lower ratio may signal that the company has the ability to pay quickly, but companies usually want to collect receivables as quickly as possible and make payments as slowly as possible to maximize liquidity and cash on hand
  • Payments, however, should still be made within the timeframe specified by its vendors
33
Q

what are Solvency/Leverage Ratios

A

Assess a company’s ability to take on additional debt in the future

34
Q

why is important to monitor the level of debt a company has

A

because a company can have significant implications because of the legal obligations of payment associated with the debt

34
Q

what is debt ratio

A

Measures the extent to which a company’s assets are financed by debt

35
Q

what is the analysis of debt ratios

A
  • Ratio = 1 means all assets are financed by debt
  • Ratio = 0.5 means that half of assets are financed by debt
  • Usually want the ratio to be < 1, you want it to be as low as possible
  • Some companies may not have access to equity, so their ratio would be higher
  • Debt ratio is usually analyzed in the context of other metrics
  • If a company chooses to maintain a high level of debt, they need to make sure they can cover the associated interest costs and eventually pay back the debt
  • Debt ratio can be set by a bank as a covenant
36
Q

what is times-interest-earned ratio

A
  • Measures the number of times a company can pay its interest expense with the operating income that it generates
  • When companies take on debt to finance their operations, they need to make sure they can cover the interest costs that come with it
37
Q

what is the analysis of times-interest-earned ratio

A
  • The higher the ratio, the better
  • Higher ratio means the company is able to pay off its interest obligations through its normal operations
  • Low ratio could imply the company isn’t generating enough operating income to cover its interest obligations, or that it’s carrying a large amount of debt or paying a high cost of debt

AFM 182 (11 decks)

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