1. FINANCE 2. Cash flows + financial planning Solvay Business School Université Libre de Bruxelles Fall 2006

2. MBA 2006 Cash flows + financial planning |2|2 Sources of Cash Inflow and Cash Outflow Operating Activities Sales of goods and services Investing Activities Sale of fixed assets Sales of LT financial assets Financing Activities Issuance of stocks and bonds LT and ST borrowing Operating Activities Purchase of supplies Selling, general and administrative expenses Tax expenses Investing Activities Capital expenditures and acquisitions LT financial investments Financing Activities Repurchage of stocks and bonds Repayment of debt Dividend payment CASH CF from operating activities CF from investing activities CF from financing activities

3. MBA 2006 Cash flows + financial planning |3|3 Farber.com: a fable Starting a local version of Amazon.com Initial balance sheet t = 0 Cash100Book Equity100 Operations year 1:  Sell 2 books @ €100 each  Buy 2 books @ € 50 each Income statement year 1: Revenue200 Expenses100 Net Income100 But….cash account = 0 What happened?

4. MBA 2006 Cash flows + financial planning |4|4 Farber.com: what happened…. Final balance sheet t = 1 Cash 0Book Equity200 Account Receivable200 Statement of cash flows: reconciles the two views –Direct method:+ Cash collected from customers 0 - Cash payment to suppliers+ 100 = Cash flow from operations- 100 –Indirect method: Net Income+100 -  Working Capital Requirement+ 200 = Cash flow from operations-100 No payment from clientsInitial Capital + Retained Earnings

5. MBA 2006 Cash flows + financial planning |5|5 Farber.com: additional complications Initial balance sheet t = 0 Cash100Book Equity100 Operations year 1:  Borrow and buy 2d hand computer @ €200  Sell 1 books @ €100 each  Buy 2 books @ € 50 each Income statement year 1: Revenue100 Cost of goods sold50 Depreciation100 Interest10 Net Income-60 Final cash account -10 Straight-line depreciation 2 years

6. MBA 2006 Cash flows + financial planning |6|6 Farber.com: details Final balance sheet t = 1 Cash-10Book Equity40 Account Receiv.100Debt200 Inventories 50 Fixed Assets100 Total240Total240 Statement of cash flows: direct method Cash collection from customers0(=REV -  AR) -Cash payment to suppliers100(=CGS+  INV) -Cash paid for interest10 Cash flow from operating activities-110 Cash flow from investing activities-200(=  FA+Dep) Cash flow from financing activities+200 Change in cash-110

7. MBA 2006 Cash flows + financial planning |7|7 Farber.com: statement of cash flows - indirect method Statement of cash flows Net Income-60 +Depreciation+100 -  Working Capital Requirement+ 150 = Cash flow from operations-110 Cash flow from investing activities-200  Debt+200 Cash flow from financing activities+200 Change in cash-110

8. MBA 2006 Cash flows + financial planning |8|8 Notations Income statement REVRevenue CGSCost of goods sold SGASelling, general and administrative expenses DepDepreciation EBITEarnings before interest and taxes IntInterest expenses TAXTaxes T c Tax rate NINet income Balance sheet FAFixed assets, net ARAccounts receivable INVInventories CASHCash & cash equivalents SEEquity capital LTDLong term debt APAccounts payable STDShort-term borrowing Statement of retained income DIVDividendes

9. MBA 2006 Cash flows + financial planning |9|9 Income statement and balance sheet Income statement EBIT = REV - CGS - SGA - Dep TAX = T c (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)

10. MBA 2006 Cash flows + financial planning | 10 Cash flow statement : indirect method  FA +  WCR +  CASH =  SE +  D  FA = CAPEX - Dep CAPEX = Acquisitions - Disposals (investing & divesting)  SE = NI - DIV +  K  K = New issuance of capital (NI + Dep -  WCR) - (CAPEX) + (  K +  D -DIV) =  CASH Cash flow from operating activities Cash flow from investing activities Cash flow from financing activities ++ =

11. MBA 2006 Cash flows + financial planning | 11 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 + Cash flow from investing activities + Cash flow from financing activity =  CASH REV -  AR CGS +  INV + SGA -  AP Int TAX (REV-CGS-SGA-Int-TAX)-  WCR -CAPEX  K +  D - DIV =NI+Dep-  WCR (NI + Dep -  WCR) + (-CAPEX) + (  K +  D - DIV) =  CASH

12. MBA 2006 Cash flows + financial planning | 12 Free Cash Flow Free Cash Flow = Cash flow from operating activities + Cash flow from investing activities Free Cash Flow = DIV -  K -  D +  Cash Calculating free cash flows of all equity firm: Free Cash Flow = EBIT(1-T C ) + Dep -  WCR - CAPEX Statement of cash flows for all-equity firm: Free Cash Flow = DIV -  K +  Cash

13. MBA 2006 Cash flows + financial planning | 13 Financial Forecasting EBITDA -Depreciation =EBIT -Taxes +Net Income Income Statement Statement of Cash Flows CF from operating activities Update Balance Sheet CF from investing activities CF from financing activities

14. MBA 2006 Cash flows + financial planning | 14 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 T C Cost of debt i

15. MBA 2006 Cash flows + financial planning | 15 Data Revenues year 0: 2,000 Growth rate year 1: 25% Balance sheet end year 0 Net Fixed Assets600 Working Capital Requirement400 Cash0 Total Assets1,000 Book Equity600 Debt (financial)400 Total Liabilities + Stockholders’ equity 1,000 Gross margin: m = 30% WCR: w = 20% Net fixed assets: a = 30% Payout ratio p = 50% Depreciation d = 10% Tax rate T C = 40% Cost of debt i = 10%

16. MBA 2006 Cash flows + financial planning | 16 Step 1: Income statement Year 0Year 1 Sales2,0002,500Rev -1 (1+g) EBITDA750m × Rev Depreciation60d × NFA -1 EBIT690 Interests40T C × D -1 Taxes260 Net Income390

17. MBA 2006 Cash flows + financial planning | 17 Step 2: Statement of Cash Flows Year 0Year 1 Net Income390From Income Stat. Depreciation60From Income Stat. ∆WCR100 w ×  Revenues CF from operations350 ∆NFA150 a ×  Revenues Depreciation60 CF from investing-210 Div195p × Net Income Stock Issues/buy back0Assumption ∆Debt55Plug CF from financing-140 ∆Cash0

18. MBA 2006 Cash flows + financial planning | 18 Step 3: Update balance sheet Year 0Year 1 Net Fixed Assets600750NFA -1 + Inv – Dep Working Capital400500 WCR -1 +  WCR Cash00 Cash -1 +  Cash 1,0001,250 Book Equity600795BEq -1 +SI + NI – DIV Debt400455 D -1 +  D 1,0001,250

19. MBA 2006 Cash flows + financial planning | 19 The Full Model