PROJECT PRESENTATION

Ghufran Akhter
L1F17BSAF0040
Section “B”
Submitted To:
Sir Abid Noor
Submission Date:
04/05/20
 What Is Cash Flow Analysis

Cash Flow Analysis is the evaluation of a company’s cash inflows and outflows from
operations, financing activities, and investing activities. In other words, this is an examination
of how the company is generating its money, where it is coming from, and what it means
about the value of the overall company.
Cash Flow Analysis is a technique used by investors and businesses to determine the value of
overall companies as well as the individual branches of large companies by looking at how
much excess cash they produce. They typically use the Statement of Cash Flows, a document
that shows the actual cash that came in and out of the business during a certain period from
investing activities, financing activities, and operational activities, as well as a few other
reports.

• What are the ratios used in cash flows analysis?

i. Cash flow coverage ratio.

ii. Cash flow margin ratio.
iii. Current cash debt coverage ratio/current liability coverage ratio.
iv. Price to cash flow ratio.
v. Cash flow to income ratio.

1. CASH FLOW COVERAGE RATIO

The cash flow coverage ratio is a liquidity ratio that measures a company’s ability to pay off
its obligations with its operating cash flows. In other words, this calculation shows how easily
a firm’s cash flow from operations can pay off its debt or current expenses.

The cash flow coverage ratio shows the amount of money a company has available to meet
current obligations. It is reflected as a multiple, illustrating how many times over earnings
can cover current obligations like rent, interest on short term notes and preferred dividends.
Essentially, it shows current liquidity.

• What is the Cash Flow Coverage Ratio?

This measurement gives investors, creditors and other stakeholders a broad overview of the
company’s operating efficiency. Companies with huge cash flow ratios are often called cash
cows, with seemingly endless amounts of cash to do whatever they like.

For individuals, a high cash flow ratio is like having a nice buffer in a checking account to
save after all monthly living expenses have been covered. In business, an adequate cash flow
coverage ratio equates to a safety net if business cycles slow.
Banks look closely at this ratio to determine repayment risk when issuing a loan to a
business. This is similar to consumer lending practices where the lender wants the borrower
to remain under a certain debt-to-income threshold.
Let’s see how to calculate the cash flow ratio for a business.

• Formula

There are a few different ways to calculate the cash flow coverage ratio formula, depending
on which cash flow amounts are to be included. A general measure of the company’s ability
to pay its debts uses operating cash flows and can be calculated as follows:

• Cash Flow Coverage Ratio = Operating Cash Flows / Total Debt

Another way to figure cash flow coverage ratio is to add in depreciation and amortization
to earnings before interest and taxes (EBIT) first:

• Cash Flow Coverage Ratio = (EBIT + depreciation + amortization) / Total Debt

Now, let’s see an example of this calculation at work.

• Example

Suppose XYZ & Co. is seeking out a loan to build a new manufacturing plant. The lender
needs to review the company’s financial statements to determine XYZ & Co.’s credit
worthiness and ability to repay the loan. Properly evaluating this risk will help the bank
determine appropriate loan terms for the project.

One such measurement the bank’s credit analysts look at is the company’s coverage ratio. To
calculate, they review the statement of cash flows and find last year’s operating cash flows
total $80,000,000 and total debt payable for the year was $38,000,000.

Cash flow coverage ratio = $80,000,000 / $38,000,000 = 2.105

Additionally, a more conservative approach is used to verify, so the credit analysts calculate
again using EBIT, along with depreciation and amortization. The statement of cash
flows showed EBIT of $64,000,000; depreciation of $4,000,000 and amortization of
$8,000,000.

Cash flow coverage ratio = ($64,000,000 + $4,000,000 + $8,000,000) / $38,000,000 = 2

The credit analysts see the company is able to generate twice as much cash flow than what is
needed to cover its existing obligations. Depending on its lending guidelines, this may or may
not meet the bank’s loan requirements.

• Analysis and Interpretation

The cash flow coverage ratio does a good job of illustrating that, if a temporary slow-down in
earnings hit the company, current obligations would still be met and the business could make
it through such bumps in the road, though only for a short time. As with other financial
calculations, some industries operate with higher or lower amounts of debt, which affects this
ratio.

In the scenario above, the bank would want to run the calculation again with the presumed
new loan amount to see how the company’s cash flows could handle the added load. Too
much of a decrease in the coverage ratio with the new debt would signal a greater risk for late
payments or even default.

• Practical Usage Explanation: Cautions and Limitations

Lending is not the only time cash flow coverage becomes important. Investors also want to
know how much cash a company has left after paying debts. After all, common
shareholders are last in line in liquidation, so they tend to get antsy when most of the
company’s cash is going to pay debtors instead of raising the value of the company.
Shareholders can also gauge the possibility of cash dividend payments using the cash flow
coverage ratio. If a company is operating with a high coverage ratio, it may decide to
distribute some of the extra cash to shareholders in a dividend payment.

Using this in conjunction with other financial calculations, such as return on retained
earnings, investors can get a better sense of how well the company is using the earnings it
generates. Ultimately, if the cash flow coverage ratio is high, the company is likely a good
investment, whether return is seen from dividend payments or earnings growth.

2. CASH FLOW MARGIN RATIO

The cash flow margin is one of the more important profitability ratios for a company. It tells
how well the company converts sales to cash—and cash is of critical importance because it's
required to pay expenses. The conversion of sales dollars to cash is vital.

Profitability ratios show a company's overall efficiency and performance. These ratios can be
divided into two types: margins and returns.

Ratios that show margins represent the firm's ability to translate sales dollars into profits at
various stages of measurement. Ratios that show returns represent the firm's ability to
measure the overall efficiency of the firm in generating returns for its shareholders.
Levered free cash flow is the "free" cash flow that's left after a business has met its financial
obligations on any accrued debt. The levered cash flow is the amount of cash left over for
stockholders after all financial obligations are met.

• How Is Cash Flow Margin Calculated?

The cash flow margin is a measure of how efficiently a company converts its sales dollars to
cash. Because expenses and purchases of assets are paid from cash, this is an extremely
useful and important profitability ratio. It's also a margin ratio.

The cash flow margin is calculated as:

• Cash flows from operating activities/net sales = _______ percent

The higher the percentage, the more cash is available from sales. If cash flows were $500,000
divided by net sales of $800,000, this would work out to 62.5 percent—very good, indicating
strong profitability. It would drop to a 55.5 percent cash margin with an additional $100,000
in net sales.

Keep in mind that this is not the same as the net income margin, which includes non-cash
transactions such as bad debt expenses and depreciation. And although higher is better, there
is no "perfect" percentage to aim for because all companies are different. But a company that
shows an increasing cash flow margin from year-to-year is certainly getting stronger with
time, and this is a good indicator of its probability for long-term success.

• Company Use
Cash flows from operating activities, which is the numerator, come from the statement of
cash flows. Net sales come from the company's income statement.

If a company is generating negative cash flow, this would show up as a negative number in
the numerator in the cash flow margin equation. Therefore, the company is losing money
even as it is generating sales revenue. It would have to borrow money or raise money through
investors to continue operating.

But there's a flip side. Generating negative cash flow for a limited period of time can have
long-term beneficial results depending on where the cash is flowing. If it's going toward
expansion, this could be expected to not only balance cash flow again when the project is
completed but increase it into a far more positive and profitable range.

• Investor Use
Cash flow margin can be a shifty number for investors to rely upon because companies can
voluntarily adjust cash flows from operation, and they might want to do so periodically for a
number of reasons. They might temporarily hold off on paying accounts payable and other
expenses, thus retaining more cash.

The cash flow margin calculation is most often advantageous for the company itself as more
or less of a barometer as to how it's performing. If you want to use it to gauge investing
opportunities, consider looking at different cash flow margins for the company at incremental
periods of time to ascertain consistency. You want a panoramic view, not a single snapshot.

• What Is the Net Profit Margin Ratio?

The net profit margin ratio is a profitability ratio that is a margin ratio. It can be calculated by
using numbers from the company's income statement. The net profit margin is the number of
dollars of after-tax profit a firm generates for each dollar of sales.

For example, if a firm generates $1 of sales revenue and has a 5 percent net profit margin,
this means it generated 5 cents of profit.

It's calculated as:

• Net Income/Net Sales = ________ percent

Net sales are simply sales revenue with any returns and allowances subtracted out. Net
income is income with all expenses subtracted out, including taxes, interest expenses, and
depreciation. It is the "bottom line."

Meanwhile, the net profit margin indicates how well the company converts sales into profits
after all expenses are subtracted out. Because industries are so different, the net profit margin
is not very good at comparing companies in different industries.

3. CURRENT CASH DEBT COVERAGE

RATIO/CURRENT LIABILITY COVERAGE
RATIO

• What is Current Cash Debt Coverage Ratio?

If you want to invest in a stock, then it's critical to assess its state of solvency.

Establishing if that company can pay off its debt or not is just as vital, you can determine that

by calculating the current cash debt coverage ratio, or the current cash flow to debt ratio.

That's important no matter if you are an investor or a creditor. Still, as an investor, you are

more likely to analyze these numbers, as they interest you most.

Simply put, the current cash debt coverage ratio shows you a company's current operating

cash flow (OCF) in relation to its current debt obligations.

In other words, it indicates the firm’s capability of paying its short-term debt in the upcoming

years from its cash flow from operations.

• Formula

This ratio formula is similar to that of the cash flow to debt ratio; the only difference is that it

takes the company’s current liabilities into account, instead of the total debt.

You can arrive at this ratio by dividing the net cash derived from operating activities by the

average current liabilities.

Current Cash Debt Coverage Ratio = Operating Cash Flow / Average Current Liabilities

You can easily find the cash flow from operating activities on the company’s cash flow

statement, and the current liabilities on its balance sheet.

• Interpretation & Analysis

The current OCF to debt ratio measures a company’s capability of maintaining its short-term

debt levels on track. That’s why getting a high ratio is always better than getting a low one.

A high ratio highlights that there is income available for covering debt servicing. That means

the company doesn’t have to sell off its assets, use savings or borrow more money to stay on

track.
What’s a good current cash debt coverage ratio?

A current cash debt coverage ratio of 2.0 or higher is thought to be an excellent indicator of a

company’s financial stability.

A ratio of less than 1.0 might be problematic, considering that the most minimal reduction in

earnings could determine the company to become financially overwhelmed, leading to

possible complications.

• Cautions & Further Explanation

The current cash flow to debt ratio can provide you with useful insights into a company’s

financial situation; however, bear in mind that it tells only one side of the story. This means

that this ratio also has its limitations, as well. In other words, this ratio evaluates a company’s

performance in a given timeframe, most of the time in the past.

This means that we cannot depend entirely on it for indicating the company’s stability and

potential future.

An example would be an innovative start-up, which is bound to grow quickly. This way, it

enhances its capability of paying off the debt over time.

In short, you should use this ratio with other debt ratios, such as the asset coverage ratio,
interest coverage ratio, or fixed charge coverage ratio, for getting a broader view of a

company’s debt settlement capacity.

4. PRICE TO CASH FLOW RATIO

The Price to Cash Flow ratio (P/CF) is a profitability ratio that compares the price of a
company to the underlying cash flow. It is a valuation metric, which indicates the worth of
the company based on the cash flow generated by it. In other words, it shows the dollar value
an investor is willing to pay for the cash flow generated by the firm. Investors and analysts
typically use this ratio to describe the valuation of a company with respect to one of the most
important consideration in a company’s balance sheet: cash.

• What is the Price to Cash Flow Ratio?

Accounting statements are filled with creative adjustments to non-cash items. These items
tend to blur the clarity of the underlying profitability of a firm. This is where the cash flow
statement comes in useful. It adjusts for all non-cash items and provides a picture of the
underlying cash generated by a business. Thus, the P/CF ratio compares the cash flow of the
business to its market value in an effort to demonstrate if the valuation is justified or not.
Generally, a low P/CF indicates an undervaluation of a firm’s potential. However, like any
valuation ratio, P/CF needs to be analyzed compared to the historical, industry (sector), and
market point of view. Of all these factors, we can argue that ‘investor expectation’ is the most
important parameters, because it normally encompasses the previous two parameters and
future expectations.

Let’s look at how to calculate the price to cash flow ratio.

• Formula

The Price to Cash Flow ratio formula is calculated by dividing the share price by the
operating cash flow per share:

• Price to Cash Flow = Share Price (or Market Cap) / Operating Cash Flow per share (or
Operating Cash Flow)

The P/CF ratio equation can also be calculated using the market cap like this:

Operating cash flow is mentioned in the cash flow statement of the annual report. The
number of shares outstanding is typically listed in the income statement and the annual
report.

Operating Cash Flow can be calculated using the following formula:

• OCF = Net Income + Depreciation + Amortization + Change in WC + Any other non-

cash item

Share Price or Market Cap is price that a share of stock is traded at on the open market. Due
to this factor, every valuation metrics (such as P/CF) needs to be time stamped.
 • Example

The table below is Company A’s numbers taken from their year-end financial statements and
reports. We can see that in the year 2 and 3, the OCF has increased from 7 to 9, but P/CF has
remained at 1.7x. This is because the share has increased by similar proportion during the
same period, keeping the valuation unchanged.

This means that Company A investors are willing to pay $2 for every dollar of cash flows in
year 1. In year 3, however, investors aren’t will to pay $2 anymore. Now they are only
willing to pay a multiple of 1.7 for the cash flows of the business. Thus, they will only pay
$1.70 for every dollar of cash flows.

Let us consider two real world examples of Steel companies: ArcelorMittal & ThyssenKrupp.
We have computed the P/CF ratio for both of these companies and presented our findings in
the table below. We have used year-end share price for calculation. The ratio can be
calculated at current share price to get a different perspective of the numbers. While most of
their business is comparable (steel production), it is worth noting that ThyssenKrupp also has
few other business lines, which might impact the multiples.

• Analysis and Interpretation

P/CF is one of the most used multiples in the investment industry. Analysts often need to
know the valuation of a company with respect to the cash it generates from the underlying
operations. Cash flows analysis with respect to price also helps us compare different
companies in the same industry irrespective of certain accounting differences.

In the example of the steel companies presented above, we see that ArcelorMittal has a large
P/CF compared to ThyssenKrupp. Intuitively, it might mean that the Arcelor is costlier than
Thyssen. While, that might be the case, an analyst needs to look at it from an overall business
point of view. It is possible that the cash flows of Arcelor have been very weak while the
share price has not corrected to the same extent. On the other hand, investors might pay a
premium for the company given it is one of the largest steel producers in the world, so they
expect strong turnaround in the company. Again, if the excitement is unfounded, it is
advisable to stay away from such companies. Valuation is also dependent on perception and
risk appetite of investors.

Analysts should always compare the multiple against the market expectations. They should
also explore the drivers of a ratio. Detailed financial analysis is required to determine if the
management is not doing any creative business practices to boost cash flows for a short
period, at the expense of long-term value erosion.

• Practical Usage Explanation: Cautions and Limitations

Analysts need to be careful about which cash flow numbers they use and make sure they keep
it consistent while doing a peer analysis. Operating cash flow and free cash flow are the most
commonly used multiples. However it is important to understand how each company reports
these numbers and perform a like-for-like analysis.
Analysts need to also ensure that the management is not doing any fancy adjustments to boost
short-term cash position (especially, if their incentives are linked to these numbers).

P/CF is a powerful tool to value companies that have positive cash flow but might be having
negative cash earnings due to large non-cash items. On the other hand, this ratio becomes
useless in the case a company is not generating positive cash flows. Hence, P/CF should be
analyzed in parallel with valuation rations such as the PE Ratio and Dividend Yield. It can
also be used with absolute valuation metrics like Discounted Cash Flow – which provides the
absolute value of a company based on future expectation.
In conclusion, P/CF is a very useful valuation tool to compare the cash profitability to market
value of a company, but it should be used while considering its limitations and biases.

5. CASH FLOW TO INCOME RATIO

Cash to income ratio is a cash flow ratio which measures dollars of cash flows from operating
activities per dollar of operating income. It is calculated by dividing cash flows from
operations by the operating income. Operating income roughly equals earnings before interest
and taxes.

Because accrual-based income measures such as net income, earnings before tax and
operating income, etc. are subject to a range of accounting policies and estimates which are
based on management discretion, analysts evaluate cash flow-based measures of financial
performance and financial strength to validate the results obtained from accrual-based
performance measures. Cash to income ratio is a litmus test which tells use the proportion of
operating income which is based by operating cash flows. A low cash to income ratio might
be because of management’s attempt to accelerate recognition of revenue. A very high ratio
might also indicate revenue management.

• Formula
Cash to income ratio can be calculated using the following formula:

• Cash to Income Ratio = CFO/Operating Income

Where CFO stands for cash flows from operations and it represents the net cash generated
from operating activities. It is reported on a company’s statement of cash flows.
Alternatively, it can be calculated by adjusting net income for depreciation and other non-
cash charges and changes in current assets and current liabilities.

Operating income equals earnings before interest and taxes (EBIT). Non-operating income
such as interest income is also excluded. A major difference exists between CFO and EBIT
on account of depreciation and amortization expense as we will illustrate below.

The numerator and denominator of the cash to income ratio are both highly relevant. The
numerator is the cash-flow equivalent of the denominator i.e. both exclude taxes and interest
expense and non-operating income

• Example

The following data is extracted from financial statements of Sprint Corp for the last 3 years:

USD in million 2015 2016 2017

Net cash provided by operating activities 2,450 3,897 4,168
Interest Expense 2,051 2,182 2,495
Other income (expense) (2,410) (391) (106)
Provision for income taxes (574) 141 435
Net income from continuing operations (3,345) (1,995) (1,206)
EBITDA 3,481 7,416 9,874
Net cash flows from operations for the three years is obtained from the cash flow statement
and the net income, provision for income tax, interest expense and other income (expense) is
obtained from income statement.

Operating income in 2015 is $542 million (i.e. -3,345 million + (-574 million) - (-2,410
million) + $2,051 million). Similarly, operating income for 2016 and 2017 work out to $719
million and $1,830 million.

The cash to income ratio for 2015, 2016 and 2017 works out to 4.52, 5.42 and 2.28.

The cash flows from operations is multiple times the operating income mainly due to
depreciation and amortization expense which is a non-cash item. This difference will always
exist. We need to consider only the movement in the ratio to see if it they are in line.