Evaluating Cash Flow 1

Key questions for cash flow statement analysis How did this year’s cash flow impact the company’s:  Credit profile?  Liquidity?  Growth opportunities?  Shareholder distributions?  Valuation model? 2

Cash Flow From Operations Section Net income  Strength of sales growth and profit margins on income statement  Ability to comfortably fund dividends from net income Compare dividend payout ratio with industry  Dividends ÷ Net Income 3

Cash Flow From Operations Section Net Working capital  Consuming significant cash beyond the level suggested by sales growth? Compare Net Working Capital growth to Sales growth (trend in NWC) NWC turnover: Sales-to-NWC (level of NWC) Does CFFO include unsustainable working capital contraction, either from short-term asset contraction or liability growth?  Check Current Ratio 4

Cash Flow From Operations Section Overall CFFO result  CFFO-to-Capital  CFFO-to-Sales  Growth in CFFO 5

Investing activities Growth in Net PP&E  Capital Expenditures less Depreciation  Evaluate level and trend of Property Plant & Equipment turnover Sales-to-PP&E Investing activities are volatile  need to average and consider maintenance requirements in worst case  Are unsustainable asset sales being used to generate cash? Capex vs Depreciation 6

Financing activities: Creditor Perspective If company is a net borrower of funds  Treating debt as the residual cash flow  What are the uses of proceeds for additional debt? NWC growth? PP&E growth? Dividends or stock buybacks? Cover operating losses? Compare Debt growth with growth in:  Sales and profits  CFFO  Assets (collateral) Resulting impact on credit ratios Assets Equity 7

Financing activities: Creditor Perspective Does the company have significant additional debt capacity?  Credit ratios  Has stock issuance been necessary to fund cash flow shortfalls and build Equity, suggesting a lack of access to debt markets and excessive leverage? Is short-term debt growth commensurate with short-term asset acquisition (or are short-term sources funding long-term needs)?  Liquidity ratios level and trend 8

Financing activities: Stockholder Perspective Are we using debt effectively to support growth?  Too much debt can lead to Missing future investment opportunities due to cash flow being directed to debt  Too little debt can unnecessarily Dilute returns to stockholders Limit cash distributions to stockholders Constrain growth today Did cash flow available to stockholders grow sufficiently?  Impact on stock price this year 9

Discretionary Cash Is it used to:  Increase dividends?  Repurchase stock?  Make growth investments?  Reduce debt?  Build cash on balance sheet? 10