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Théorie Financière 2004 -2005 3. Tableau de financement et planning financier Professeur André Farber Théorie Financière 2004 -2005 3. Tableau de financement et planning financier Professeur André Farber Tfin 2004 03 Cash flows

Financial statements and cash flows • Objectives for this session August 23, 2004 Tfin Financial statements and cash flows • Objectives for this session August 23, 2004 Tfin 2004 03 Cash flows 2

Levers of Performance Return on Equity Return on Invested Capital Profit Margin August 23, Levers of Performance Return on Equity Return on Invested Capital Profit Margin August 23, 2004 Leverage Asset Turnover Tfin 2004 03 Cash flows 3

Summarized (managerial) balance sheet Assets Liabilities Fixed assets (FA) Stockholders' equity (SE) Working capital Summarized (managerial) balance sheet Assets Liabilities Fixed assets (FA) Stockholders' equity (SE) Working capital requirement (WCR) Interest-bearing debt (D) Cash (Cash) FA + WCR + Cash = SE + D Working capital requirement : definition Interest-bearing debt: definition + Accounts receivable + Inventories + Prepaid expenses + Long-term debt + Current maturities of long term debt + Notes payable to banks - Account payable - Accrued payroll and other expenses August 23, 2004 Tfin 2004 03 Cash flows 4

Net Working Capital • Net working capital can be understood in two ways: • Net Working Capital • Net working capital can be understood in two ways: • as an investment to be funded: Current Assets - Current Liabilities • as a source of financing=Stockholders' equity + LT debt - Fixed Assets Current Assets Stockholder’s equity Net Working Capital Long term debt Current ratio: a measure of NWC Current ratio = Current assets / Current liabilites Net working capital = Current assets - Current liabilites Current ratio > 1 NWC > 0 Current liabilities August 23, 2004 Tfin 2004 03 Cash flows 5

Net Working Capital vs Working Capital Requirement • Summarized balance sheet identity: • FA Net Working Capital vs Working Capital Requirement • Summarized balance sheet identity: • FA + WCR + CASH = SE + LTD + STD • can be written as: • WCR + (CASH - STD) = (SE + LTD - FA) Working Capital Requirement Net Liquid Balance Net Working Capital • WCR + NLB = NWC August 23, 2004 Tfin 2004 03 Cash flows 6

Return on invested capital • Return on assets (net)= Net income / Total assets Return on invested capital • Return on assets (net)= Net income / Total assets • • Advantage: fits with Du. Pont system • ROE = ROA x Equity multiplier Limitation: Net income = EBIT - Interest expense - Taxes – Depends on capital structure: • 1. Interest expense: function of interest-bearing debt • 2. Interest expense : tax deductible • Preferred measure: Return on Invested Capital (ROIC) • NB: ROIC = ROA (gross) (1 - Tax rate) • = ROE of a all equity financed firm August 23, 2004 Tfin 2004 03 Cash flows 7

Financial leverage • Financial leverage magnifies ROE only when ROA (gross) is greater than Financial leverage • Financial leverage magnifies ROE only when ROA (gross) is greater than the interest rate on debt. • • Balance sheet: Income statement: Interest expense Taxes • Remember : ROIC = ROAgross (1 - Tc) • ROE = ROIC + (ROAgross - r) (1 -Tc) (D/SE) August 23, 2004 TA = SE + D NI = EBIT - INT- TAX INT = r D (Interest expense = Interest rate x Interest-bearing debt) TAX = (EBIT - r D) Tc (Taxes = Taxable income x Tax rate) Tfin 2004 03 Cash flows 8

Sources of Cash Inflow and Cash Outflow Operating Activities Investing Activities Financing Activities Sales Sources of Cash Inflow and Cash Outflow Operating Activities Investing Activities Financing Activities Sales of goods and services Sale of fixed assets Sales of LT financial assets Issuance of stocks and bonds LT and ST borrowing CASH Operating Activities Investing Activities Purchase of supplies Selling, general and administrative expenses Tax expenses Capital expenditures and acquisitions LT financial investments CF from operating activities August 23, 2004 CF from investing activities Tfin 2004 03 Cash flows Financing Activities Repurchage of stocks and bonds Repayment of debt Dividend payment CF from financing activities 9

Farber. com: a fable • Starting a local version of Amazon. com • Initial Farber. com: a fable • Starting a local version of Amazon. com • Initial balance sheet t = 0 Cash 100 Book Equity • Operations year 1: a. Sell 2 books @ € 100 each a. Buy 2 books @ € 50 each • Income statement year 1: Revenue 200 Expenses 100 Net Income 100 • But…. cash account = 0 What happened? August 23, 2004 Tfin 2004 03 Cash flows 10

Farber. com: what happened…. • Final balance sheet t = 1 Cash Account Receivable Farber. com: what happened…. • Final balance sheet t = 1 Cash Account Receivable No payment from clients 0 200 Book Equity Initial Capital + Retained Earnings • Statement of cash flows: reconciles the two views – Direct method: + Cash collected from customers - Cash payment to suppliers = Cash flow from operations – Indirect method: Net Income - Working Capital Requirement = Cash flow from operations August 23, 2004 200 Tfin 2004 03 Cash flows 0 + 100 - 100 + 200 -100 11

Farber. com: additional complications • Initial balance sheet t = 0 Cash 100 Book Farber. com: additional complications • Initial balance sheet t = 0 Cash 100 Book Equity 100 • Operations year 1: a. Borrow and buy 2 d hand computer @ € 200 a. Sell 1 books @ € 100 each a. Buy 2 books @ € 50 each • Income statement year 1: Revenue 100 Cost of goods sold 50 Depreciation 100 Interest 10 Net Income -60 • Final cash account -10 August 23, 2004 Tfin 2004 03 Cash flows Straight-line depreciation 2 years 12

Farber. com: details • Final balance sheet t = 1 • Cash -10 • Farber. com: details • Final balance sheet t = 1 • Cash -10 • Account Receivable 100 • Inventories 50 • Fixed Assets 100 • Total 240 • Statement of cash flows: direct method Cash collection from customers -Cash payment to suppliers -Cash paid for interest Cash flow from operating activities Cash flow from investing activities Cash flow from financing activities Change in cash August 23, 2004 Book Equity Debt 40 200 Total 240 0 10 -110 -200 +200 -110 (=REV - AR) (=CGS+ INV) (= FA+Dep) Tfin 2004 03 Cash flows 13

Farber. com: statement of cash flows - indirect method • Statement of cash flows Farber. com: statement of cash flows - indirect method • Statement of cash flows Net Income +Depreciation - Working Capital Requirement = Cash flow from operations -60 +100 + 150 -110 Cash flow from investing activities Debt Cash flow from financing activities +200 Change in cash August 23, 2004 -200 -110 Tfin 2004 03 Cash flows 14

Notations • • • Income statement REV Revenue CGS Cost of goods sold SGA Notations • • • Income statement REV Revenue CGS Cost of goods sold SGA Selling, general and administrative expenses Depreciation EBIT Earnings before interest and taxes Interest expenses TAX Taxes Tc Tax rate NI Net income • • • Balance sheet FA Fixed assets, net AR Accounts receivable INV Inventories CASH Cash & cash equivalents SE Equity capital LTD Long term debt AP Accounts payable STD Short-term borrowing • • Statement of retained income DIV Dividendes • August 23, 2004 Tfin 2004 03 Cash flows 15

Income statement and balance sheet • Income statement • EBIT = REV - CGS Income statement and balance sheet • Income statement • EBIT = REV - CGS - SGA - Dep • TAX = Tc (EBIT - Int) • NI = EBIT - Int - TAX • Balance sheet equation • FA + AR + INV + CASH = SE + LTD + AP + STD Working capital requirement: WCR AR + INV - AP =(Current assets - CASH) - (Current liabilities - STD) Summarised balance sheet: FA + WCR + CASH = SE + D (D = LTD + STD) August 23, 2004 Tfin 2004 03 Cash flows 16

Cash flow statement : indirect method FA + WCR + CASH = SE + Cash flow statement : indirect method FA + WCR + CASH = SE + D FA = AQ - Dep AQ = Acquisitions - Disposals (investing & divesting) SE = NI - DIV + K K = New issuance of capital (NI + Dep - WCR) - (AQ) + ( K + D -DIV) = CASH Cash flow from operating activities August 23, 2004 + Cash flow from investing activities + Cash flow from financing activities Tfin 2004 03 Cash flows = 17

Statement of cash flows: direct method + Cash collection from customers - Cash payment Statement of cash flows: direct method + Cash collection from customers - Cash payment to suppliers and employees - Cash paid for interest - Cash paid for taxes = Cash flow from operating activities REV - AR CGS + INV + SGA - AP Int TAX (REV-CGS-SGA-Int-TAX)- WCR NI+Dep- WCR + Cash flow from investing activities -AQ + Cash flow from financing activity K + D - DIV = CASH August 23, 2004 (NI + Dep - WCR) + (-AQ) + ( K + D - DIV) = CASH Tfin 2004 03 Cash flows 18

Free Cash Flow • Free Cash Flow = Cash flow from operating activities + Free Cash Flow • Free Cash Flow = Cash flow from operating activities + Cash flow from investing activities • Calculating free cash flows of all equity firm: Free Cash Flow = EBIT(1 -TC) + Dep - WCR - AQ • Statement of cash flows for all-equity firm: Free Cash Flow = DIV - K + Cash August 23, 2004 Tfin 2004 03 Cash flows 19

Financial Forecasting Income Statement of Cash Flows EBITDA -Depreciation =EBIT -Taxes +Net Income CF Financial Forecasting Income Statement of Cash Flows EBITDA -Depreciation =EBIT -Taxes +Net Income CF from operating activities CF from investing activities CF from financing activities Update Balance Sheet August 23, 2004 Tfin 2004 03 Cash flows 20

Financial Planning • Based on ∆Revenues • Assumptions on key ratios relating Revenues to: Financial Planning • Based on ∆Revenues • Assumptions on key ratios relating Revenues to: • Gross margin: m = EBITDA /Revenues • Working capital requirement: w = WCR / Revenues • Net fixed assets: a = NFA / Revenues • Financial policy: • Payout ratio p = DIV/Net Income • Depreciation d = Depreciation / Fixed Assets-1 • Environment: • Tax rate TC • Cost of debt i August 23, 2004 Tfin 2004 03 Cash flows 21

Data • Revenues year 0: 2, 000 • Growth rate year 1: 25% • Data • Revenues year 0: 2, 000 • Growth rate year 1: 25% • Balance sheet end year 0 Net Fixed Assets 600 Working Capital Requirement 400 Cash 0 Total Assets 1, 000 Book Equity 600 Debt (financial) Gross margin: m = 30% WCR: w = 20% Net fixed assets: a = 30% Payout ratio p = 50% Depreciation d = 10% Tax rate TC = 40% Cost of debt i = 10% 400 Total Liabilities + Stockholders’ equity August 23, 2004 1, 000 Tfin 2004 03 Cash flows 22

Step 1: Income statement Year 0 Sales Year 1 2, 000 2, 500 Rev-1 Step 1: Income statement Year 0 Sales Year 1 2, 000 2, 500 Rev-1 (1+g) EBITDA m × Rev Depreciation 60 d × NFA-1 EBIT 690 Interests 40 Taxes 260 Net Income August 23, 2004 750 390 Tfin 2004 03 Cash flows i × D-1 23

Step 2: Statement of Cash Flows Year 0 Year 1 Net Income 390 From Step 2: Statement of Cash Flows Year 0 Year 1 Net Income 390 From Income Stat. Depreciation 60 From Income Stat. ∆WCR 100 w × Revenues CF from operations 350 ∆NFA 150 Depreciation 60 CF from investing -210 Div 195 a × Revenues p × Net Income Stock Issues/buy back 0 Assumption ∆Debt 55 Plug CF from financing ∆Cash August 23, 2004 -140 0 Tfin 2004 03 Cash flows 24

Step 3: Update balance sheet Year 0 Year 1 Net Fixed Assets 600 750 Step 3: Update balance sheet Year 0 Year 1 Net Fixed Assets 600 750 NFA-1 + Inv – Dep Working Capital 400 500 WCR-1 + WCR 0 0 Cash-1 + Cash 1, 000 1, 250 Book Equity 600 795 BEq-1+SI + NI – DIV Debt 400 455 D-1 + D 1, 000 1, 250 Cash August 23, 2004 Tfin 2004 03 Cash flows 25

The Full Model August 23, 2004 Tfin 2004 03 Cash flows 26 The Full Model August 23, 2004 Tfin 2004 03 Cash flows 26

Sustainable growth • What growth rate can a company achieve without requirement additional external Sustainable growth • What growth rate can a company achieve without requirement additional external equity? • Assets = (a+w) Revenues • Assets = Book Equity + Debt • = Book Equity + Book Equity • = Net Income (1 – Payout)(1 + ) • = (Revenues) (Profit Margin)(1 -Payout)(1+ ) • g • = Revenues / Revenues = (Profit Margin)(1 – Payout)(1+ ) / (a+w) August 23, 2004 Tfin 2004 03 Cash flows 27

Sustainable Growth: example • Back to previous example: – a+w = 0. 30 – Sustainable Growth: example • Back to previous example: – a+w = 0. 30 – Net Profit margin = 15% – Payout ratio = 50% – = Debt / Book Equity = 2/3 – g = [15% (1 - 0. 50) (1+2/3) ] / 0. 30 = 41. 67% August 23, 2004 Tfin 2004 03 Cash flows 28