Cash Flow Analysis &

Projections
2018

Prepared by
Amr Mehesen
Course Objectives and Learning Outcomes
The main objective is to provide • The capability to distinguish between
credit trainees with the knowledge operating, investing and financing
and skills they need to assess cash flows?.
business cash flow.
repayment ability of the borrower. • To be familiar with Six blocks format
Loans are repaid with cash and only Cash Flow Statement.
cash. • TO be familiar with Debt service
coverage ratios.
Learning Outcomes:
•The main dimension is to assess • Develop Cash Flow Analysis Skills.
strengths and quality of • Developing cash flow projections.
client/sponsor cash flow.
• Developing sensitivity analysis
•What is the purpose of cash flow (Stress Test Scenario).
Statement ?
Cash Flow : Lender’s perspective

“Numbers talk and analysts need to listen”

A simple quote from Mr. J. P. Morgan

“Lending is not based primarily on money or
property. No sir, the first thing is character”
What is the Cash Flow Statement?
• Before GAAP became a provider of the cash flow
statement , lenders worked out a similar statement
, known as “ the sources and uses of cash
statement”.

What are needed to prepare Cash Flow Statement ?

• Two consecutive balance sheets and the current
year’s income statement will be needed to prepare
the cash flow statement.
Basic Cash Flow Concepts
The Income Statement is not a Cash Flow Statement:
cash receipts and disbursements do not equal revenues
and expenses for two reasons:

i. Due to accrual accounting nature of the net income.

ii. A firm receives cash from sources that are not directly
related to the earnings process and therefore are not
included in net income. These include cash from
capital increase or bonds, new bank loans, selling fixed
assets, etc. Also, the firm disburses cash in
transactions not related directly to the earnings
process.
Purpose of Cash Flow Statement ( Lender’s perspective)
 The cash flow statement allows the lenders evaluate the
managerial decisions regarding cash.
 Help the lender predict whether and why a company would seek
a loan and whether it has the capacity to repay debt.
 Evaluate the size, composition, and stability of operating cash
flow.
 Determine how wisely and prudent the company manages its
cash

The analyst focuses on the company’s ability to produce cash

that is used to
 Repay debt
 Invest in fixed asset
 Support sales growth
CASH SOURCE AND USE

Source of cash Use of cash

Assets Decrease Increase

Liabilities Increase Decrease

Equity Increase Decrease

In cash flow analysis you need to:
• Distinguish between profit and cash flow
• Understand the three categories of cash flow
 Operating
 Investing
 Financing
• Analyze the quality of the cash flow.
• Identify operating and extraordinary demands on cash
flow.
• Isolate historical cash flow available for debt service.
•Project cash flows that will be available for future debt
service.
Cash Flow Methods
There are different methods to submit Cash Flow
Statement such as :-
1. Direct Cash Flow Statement.
2. Indirect Cash Flow Statement.
3. Six Blocks Cash Flow Statement (Chase format).
4. UCA (Uniform Credit Analysis )Cash Flow
Statement. (Lenders’ cash flow statement)
 Cash Flow Methods
• The beginning and ending balances of cash are shown
on the company's balance sheets for the previous and
current years, and the bottom of the cash flow statement
reconciles beginning cash with ending cash.
• The relationship, stated in general terms, is as shown
below:
Beginning Balance Sheet Statement of Cash Flows Ending Balance Sheet
31st Dec. 2014 31st Dec. 2015 31st Dec. 2015
Beginning Cash + Cash receipts - Cash Payments = Ending Cash
 DIRECT VS INDIRECT CASH FLOW

What are the differences between direct and indirect

methods?
 Direct cash flow is known as the “top down” approach”.
Starts with net sales on the income statement and adjusts
the corresponding balance sheet account (sometimes
referred to as the “buddy accounts”).
 Indirect cash flow is known as the “bottom up” approach in
that it starts with the “bottom” line on the income statement
(net income after tax), adds depreciation and amortization,
and then adjusts for changes in balance sheet operating
accounts to arrive at Operating Cash Flow.
 Direct Method Format

Cash flows from operating activities

Cash receipts from customers
Cash paid to suppliers
Cash paid to employees
Cash generated from operations Summary of the previous items in this section
Interest paid
Income taxes paid
Net cash from operating activities Summary of the previous items in this section
Cash flows from investing activities
Purchase of fixed assets
Proceeds from sale of fixed assets
Net cash used in investing activities Summary of the previous items in this section
Cash flows from financing activities
Proceeds from issuance of common stock
Proceeds from issuance of long-term debt
Principal payment under capital leases
Dividends paid
Net cash used in financing activities Summary of the previous items in this section
Net change in cash and cash equivalents Summary of all previous subtotals
 Indirect Method Format
Cash flows from operating activities
Net income From the net income line on the income statement
Adjustments for:
Depreciation and amortization Corresponding line items in the income statement
From the change in the allowance for doubtful accounts
Provision for losses on accounts receivable
in the period
Gain/loss on sale of Asset From the gain/loss accounts in the income statement
Change in trade receivables during the period, from the
Increase/decrease in trade receivables
balance sheet
Change in inventories during the period, from the
Increase/decrease in inventories
balance sheet
Change in trade payables during the period, from the
Increase/decrease in trade payables
balance sheet

Cash generated from operations Summary of the preceding items in this section

Cash flows from investing activities

Purchase of fixed assets Itemized in the fixed asset accounts during the period
Proceeds from sale of fixed assets Itemized in the fixed asset accounts during the period
Net cash used in investing activities Summary of the preceding items in this section
Cash flows from financing activities
Proceeds from issuance of common stock
Proceeds from issuance of long-term debt
Dividends paid
Net cash used in financing activities Summary of the preceding items in this section
Net change in cash and cash equivalents Summary of all preceding subtotals
SIX BLOCKS Cash Flow Statement
SIX BLOCKS FORMAT DIVIDES THE CASH FLOW STATEMENT
INTO SIX GROUPS OR 'BLOCKS

NOPAT ( NORMALIZED OPERATING PROFIT AFTER TAXES)

COPAT ( CASH OPERATING PROFIT AFTER TAXES)
CACO (CASH AFTER CURRENT OPERATIONS)
CBLTU (CASH BEFORE LONG TERM USE)
CBF (CASH BEFORE FINANCE )
NET CASH FLOW
 2- CASH OPERATING PROFIT AFTER TAX (COPAT)
Balance Sheet Income
Statement
NOPAT
+ Depreciation (RS)Depreciation
+ Amortization (RS)Amortization
COPAT
 Balance Sheet Income Statement
COPAT
Working Investment Items
(WI):
 Accounts Receivable (Y1-Y2)
Net Inventory:
Raw Materials (Y1-Y2)
Work in Process (Y1-Y2)
Finished Goods (Y1-Y2)
Others (Y1-Y2)
Advance Payments (Y1-Y2)
Accounts Payables (Y2-Y1)
Accrued Expenses (Y2-Y1)
Down Payments (Y2-Y1)
WI
 Due from Sis Companies (Y1-Y2)
 Due to Sis Companies (Y2-Y1)
 Other Current Assets (Y1-Y2)
 Other Current Liabilities (Y2-Y1)
CACO
4-CASH BEFORE LONG-TERM USES (CBLTU)
Balance Sheet Income Statement
CACO
Financial Payments (FP):
- Interest Expense (SS) Interest Expense
 Interest Payable (Y2-Y1)
CPLTD - Y1 (Previous year).
Total FP
CBLTU
5. CASH BEFORE FINANCING (CBF)
Balance Sheet Income Statement
CBLTU
 Net Plant Expenditures Net PP&E (Y1-Y2) (SS) Depreciation
(SS) Sale of Plant
 Intangibles Net Intangibles (Y1-Y2) (SS) Amortization
 Marketable Securities (Y1-Y2) (SS) Interest Income

 Investments (Y1-Y2) (SS) Dividends Income

(SS) Investment G/L
 Non Current Asset (Y1-Y2)
 Non Current Liabilities (Y2-Y1)

+/- Unusual Items (SS) Unusual items

+/- Sundry (SS) Sundry Expense
(SS)Sundry Income
+/- FX G/L (SS) FX G/L
CBF
6- Net Cash Flow

Balance Sheet Income Statement

CBF
 STD (Y2-Y1)

 LTD CPLTD Y2 + LTD (Y2-Y1)

 Grey Area Provisions (Y2-Y1) (SS) Provisions
 Net Worth Net Equity (Y2-Y1) (RS)Dividends
Declared
(RS)NPAUI
- Dividends Paid Dividends Payable (Y2- Y1) (SS)Dividends
Declared
Net Cash Flow
Description
Beginning Cash Balance Sheet Cash (Y1)
+/- Net Cash Flow Cash flow Statement
= Ending Cash Equal to Balance Sheet Cash (Y2)
Important Notes on Six Block CFS
1.Change in Net Plant Expenditures (NPE)
(Beginning Net Fixed Assets –Depreciation Exp- Ending Fixed Assets) +
(Capital Gain) / – (Capital Loss).

2. Dividends Paid
Dividends declared + ∆ Dividends Payable

Dividends decaled = (Y2 R.E – Y1 R.E) – NPAUI + RESERVES

3. Change in Net Equity

( Ending Equity – Beginning Equity ) – NPAUI + Dividends Declared

4. Change in LTD value

( Ending CPLTD + Ending LTD) – Beginning LTD

Important Notes on Six Block Format

5- CPLTD is related to the previous year

6- Interest Expense is related to the current year

Block # 4 (Cash Before Long Term Use)

Consider ( FX gain or loss , sundry income or sundry
expense) that have been added back or deducted in block # 1

7- Change in Investment Value

( Y1 investment value + investment income or – investment loss)
– Y 2 investment value ).
Cash Flow Analysis
Block # 1,2 &3 (NOPAT, COPAT,CACO)
The objective is to
• Determine the operating cash flow drivers
• How the company is managing operating cash flow and
• Determine why the company is generating positive or negative
cash flow from operations.
• Is the operating cash flow is greater or lower than net income?

Block #4 CACO
Is Cash after current Operations (real cash) enough to meet the
financial payments ? and the surplus will cover the NPE or not as
a conservative approach.
Block #5 CBLTU
• Help to know how much cash the company spent on CAPEX to support
the growth.
• Help to know how much cash company has spent on investment or
collected from sale of investments such as acquisitions, sale of
discontinued operations, sale of stocks or buy stocks.
• What about the sources of finance to fund the new investments (from
equity or operating cash flow surplus)?

Block #6 CBF
• This block is considered very important because it shows where the
financing cashflow are coming from?
Such as the increase / decrease in short term debt, new LTD, how much
cash the company has spent on dividends, capital increase (is there fresh
funds or cash diversion?
• Also, you can explore the source of finance to fund the increased working
investment and new CAPEX.
 CASH SOURCES AND USES
Sources of Cash Uses of Cash

NOPAT Interest & CPLTD Payment

Depreciation
Decrease in Working Investment Dividends
Items New CAPEX
Sale of fixed assets &  Cash Pool  Increase in W.I
Investments
Losses
STD Settlement
Increase in STD & LTD
Increase in Equity
 Analysis of Cash flow

CASH FLOW QUALITY

Cash flow quality depends on the source and repeatability of
the cash flow. Cash flow sources important to you are:
 Those that are sustainable and reasonably predictable over
the ensuing three to five years.
 Those that increase your margin of protection and indicate
your customer’s economic viability
Analysis of operating cash flow
•Make sure to analyze what uses of funds are financed by
which sources of funds.

•Make analytical conclusions about the matching of sources

and uses of funds.

•It is preferable for your debt to be repaid out of operating

cash flows, rather than to be paid from additional debt or the
disposal of assets, especially operating assets.

•If the company can pay its interest and CPLTD from operating
cash flow and have cash remaining, then the lender is looking
at a quality credit, so long as the operating cash flow is
sustainable.
Cash Flow Analysis

For funding purposes, the primary sources of cash

for operating and investing activities will be:
 Cash from operations.
 Cash from external financing (either debt or
equity).
 Drawing down on existing cash balances.
Debt Service Coverage Ratios

There are two ratios that will help you evaluate cash flow:
 FCFNOPAT(1)= NOPAT – (Financial Payments + Dividends Paid)
 FCFCOPAT(2) = COPAT – (Financial Payments + Dividends Paid +
Plant Maintenance).

DSCR EBITDA = EBITDA

(Interest Exp. + Previous Year CPLTD)
Debt Service Coverage Ratios
DSCR (1) NOPAT = NOPAT

(Interest Exp. + Previous Year CPLTD)

DSCR (2) NOPAT = NOPAT

(Interest Exp. + Previous Year CPLTD + Dividends Paid)

DSCR (1) COPAT = (COPAT–Plant Maintenance)

(Interest Exp. + Previous Year CPLTD)

DSCR (2) COPAT = (COPAT–Plant Maintenance)

(Interest Exp. + Previous Year CPLTD + Dividends Paid)

 CASH FLOW RATIO ANALYSIS
 A ratio of greater than 1:1 indicates no reliance
on external financing to make the required
payments.
 A ratio of less than 1:1 means that a company
must raise equity to service its obligations to
lenders and to stockholders and to fund CAPEX
requirements.
Cash Flow Analysis
 Ratios based on cash flow measure a firm’s ability to
service existing debt and its capacity for additional
debt.
 Coverage ratios are useful, especially in examining
trends, but must be supplemented by a study of
cash flow statements to identify where cash was
used—for example, working capital, debt
repayment, capital expenditures, dividends, or
treasury stock.
 Surplus cash flow is like an extra oxygen to breath
smoothly.
CASH FLOW Coverage RATIOs
When NOPAT is used ?
It is a conservative measure and mainly used in the trading
activities or manufacturer with fully depreciated assets.

When COPAT is used?

It is mainly used with the manufacturers provided that the
remaining life of fixed assets is long.

What is the difference between EBITDA and COPAT ?

 COPAT = EBITDA –TAXES Paid
CASH FLOW RATIO ANALYSIS
These ratios have severe limitations because:
 It implies that all net income has equal potential
 It does not account for major demands on cash flow
such as:
 Dividends
 Working Capital changes because of sales growth
or declining efficiency
 It implies that loan repayment will have a first claim
on cash flow.
Analysis of operating cash flow
It is important to distinguish between the two types of
cash flows included in this category: Profits and cash
Conversion cycles.
Cash flow derived from profit is dependent on business
fundamentals, whereas the cash Conversion cycle is
driven by swing factors.
• Positive operating cash flow can be attributable to
strong profit margins (fundamentals).
• Changes in the swing factors reflect a company’s
ability to manage its working investment or W.C
items.
Analysis of Operating Cash flow
Analyzing cash flow means determining if there are sufficient high-
quality and continuous sources of funds to meet all the financial
demands placed on the cash flow, while still leaving enough cash to
repay your customer’s obligations.

Take care,
Your customer can have positive cash flows but be in a declining
financial condition—a scenario that does not bode well for debt
repayment over the long-term.
However,
The opposite is also true, in that a growing company can have
negative cash flow but exhibit profitable operations. In this case, you
need to understand the nature of the growth and assure yourself that
management has control of the expanding business.
 Analysis of Cash flow

To analyze the demands on cash flow you should:

• Look carefully at the statement of cash flows and identify
the negative flows within each category.
• Consider whether each negative cash flow is a one-time,
irregular event or if it is likely to be repeated.
• Decide if the event or transaction producing the
negative cash flow is within the control of management.
• Compare historical demands with historical sources, and
expected future demands with expected future sources.
Analysis of operating cash flow
The following factors can contribute to “negative
operating cash flow”: (NOCF /CACO )
 Operating losses due to insufficient sales volume, poor
pricing of product, or poor cost controls.
 Inefficient management of Inventory and receivables.
 Growth in sales and current assets.(inventory build up)
 Seasonal factors (low season, high inventory; operating
cash flow is consumed)
 Changes in the business cycle (Cyclical
developments), recession, booming ….
 Transition period in a company’s life cycle.
Analysis of operating cash flow (continued)

A company’s profits and operating cash flow have certain relationships depend
on the stage of life cycle in which it operates. That is, operating cash flow may
be positive or negative and higher or lower than profits depending on whether
the company is in the start up , growth , maturity or decline stage of its life
cycle.
ANALYSIS OF INVESTING CASH FLOWS

This includes cash flow from investment activities, such as

 Buying and selling plant and equipment,
 Rental properties, Stock in affiliates or subsidiaries.

 Investing activities are negative for most companies until

they enter a declining stage in their life cycle, i.e. they
reinvest less than they dispose.
 If a company has positive investing cash flows, you should
determine if this is a one-time event or a trend.
 If the investing cash flow is negative, ask questions to
determine future requirements and explore the lending
opportunities.
ANALYSIS OF FINANCINGCASH FLOWS

Financing activities include external sources of

debt and equity such as
 Increase in short term debt
 New LTD /Bonds.
 Dividends paid
 Capital increase (Fresh Funds from owners)
Examples of management decision that affect cash flow are :
 Credit or collection policies that result in accounts
receivable increase.
 The amount of inventory that is kept on hand to support
sales.
 Accounts payable policies that affect supplier relations
and cash requirements.
 Fixed assets additions that increase capacity;
replacements that improve operations.
 Debt structure – aggressive repayment versus the life of
assets.
 Dividends policy – excessive dividends to support an
owner’s lifestyle.
CASH FLOW PROJECTIONS
We are lending to businesses, not to financial statements.
The analyst must think beyond the financial statements by
examining the bank’s position as a lender.

Go beyond the statements, talking to management, suppliers,

competitors and others. “Good analysis requires a creative and
inquiring mind”.
competitors for cash are suppliers, shareholders, employees
and contingent creditors.
CASH FLOW PROJECTIONS
The purpose of a projection
is to help determine whether your customer can repay your
institution’s debt based on reasonable estimates about the
company’s future operating strategy and management’s ability to
implement it.

Cash flow projections are:

•Quantitative assessment of the future financial performance and
financing needs of a company
•Forecast of a company’s ability to repay debt from its internally-
generated cash
•Test of the vulnerability of a company to possible risks that may
affect its repayment capacity
KEY PROJECTION REFERENCE POINTS
There are four key reference points that are used to build a
projection:
1. Past operating results of a company.
2. Objectives and goals of a company for the future as defined by
management and outlined in a business plan.
3. Likely impact of economic, competitive, and regulatory factors
on a company.
4. Supplemental action plans and alternatives available to help
management meet performance projections

Of these four reference points, the first one represents hard data:
the historical operating results. The other three points represent a
subjective assessment.
CASH FLOW PROJECTIONS

CASH FLOW DRIVERS

By understanding the quality and demands of cash flow, you can utilize the
following cash flow-related ratios to fine-tune the analysis and stress test
the company’s ability to repay debt.
Not surprisingly, ratio analysis focuses on the business fundamentals and the
swing factors.

In combination, they are the primary determinants of cash flow. Together,

business fundamentals and swing factors are sometimes called “cash flow
drivers.” These are the critical ratios that require “what if” analysis when
reviewing any projections for the company.
CASH FLOW PROJECTIONS
We analyze Business Fundamentals using four ratios that
evaluate the company’s key profitability components. We
analyze Swing Factors using three turnover ratios that
relate to the company’s efficiency in managing its
working capital assets.

Business Fundamentals
With the exception of sales growth, the following ratios
are measures of performance:
1. Sales growth
2. Gross profit margin
3. SG&A
4. EBITDA Margin
CASH FLOW PROJECTIONS
Swing Factors
Swing factors, are also called efficiency ratios. These
swing factors bring the cash flow effect of the current
section (working capital assets) of the balance sheet
into the focal point of the credit analysis.
 A/R DOH
 INV. DOH
 Adv. pay DOH
 A/P DOH
 D/P DOH
 (New Money Need)
Proj. Current Liabilities
Projected Known Proj. LT Liabilities
Total Assets Known Proj. Grey Area
Known beginning Net Worth
NMN

NMN= Projected Total Assets - Projected Known Liabilities & Equity items

NMN is the needed additional finance to fund the assets

growth or the expansion. There are two sources of finance
NMN = ∆ R.E + N.D.N

Projected NPAUI - dividends New Debt Need

CASH FLOW PROJECTIONS
This amount of NMN is very important to complete the
projections and balance the company’s balance sheet.

∆ RE=((NOP-NOI-(NDN×IR%))×(1-D)×(1-T)

NOI = Non -Operating Items

NDN = New Debt Need
IR = Interest Rate
D = Dividends rate = Payout Ratio
T = Taxes Rate
CASH FLOW PROJECTIONS

NPAUI Formula:

NPAUI=((NOP-NOI-(NDN×IR%))×(1-T)

Dividends = NPAUI X Div. Rate

Legal Reserve = NPAUI X 5%
Total Reserves = Historical Reserves+ (NPAUI X 5%)
SENSITIVITY ANALYSIS
The purpose and function of a sensitivity analysis are to:
 Identify and assess the key/critical financial variables.
These variables, when changed, will positively or negatively
affect the future financial performance of the company and
its ability to service debt.
 Identify what would cause the change in these critical
variables (external factors, management actions, and so
forth).
 Determine the amount of change in the drivers that can
occur without materially affecting your customer’s ability to
service its debt.
SENSITIVITY ANALYSIS

The primary reasons you should conduct a thorough sensitivity

analysis include:
 The analysis enables you to determine whether your customer
can repay its debt in less favorable business and economic
circumstances.
 It shows whether the amount of financing requested is sufficient
given all the demands on the company’s cash flow.
 It indicates whether you have identified all the key areas in your
customer’s operations and financial condition that need to be
monitored throughout the life of a loan, so that deterioration in
these key areas does not adversely affect its repayment.
SENSITIVITY ANALYSIS

The primary reasons you should conduct a thorough

sensitivity analysis include:

 It determines, in the light of prospective changes, the most

reasonable loan structure.

 It enables you to say that all the possible developments that

might relate to the repayment of your customer’s debt have
been considered and therefore the risk has been fully
evaluated.
SENSITIVITY ANALYSIS

 You might consider doing both a “most likely” case as

well as a “pessimistic” set of projections to ensure that
the debt can be repaid even in the most difficult of
times as delineated by that pessimistic set of
projections.

 It enables you to say that all the possible developments

that might relate to the repayment of your customer’s
debt have been considered and therefore the risk has
been fully evaluated.
Thank You