Cash Flow Analysis and Forecasting E-Book

Timothy Jury

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Serie: Wiley Finance Series
• Sprache: Englisch

Seitenzahl: 520

Veröffentlichungsjahr: 2012

Beschreibung

This book is the definitive guide to cash flow statement analysis and forecasting. It takes the reader from an introduction about how cash flows move within a business, through to a detailed review of the contents of a cash flow statement. This is followed by detailed guidance on how to restate cash flows into a template format. The book shows how to use the template to analyse the data from start up, growth, mature and declining companies, and those using US GAAP and IAS reporting. The book includes real world examples from such companies as Black and Decker (US), Fiat (Italy) and Tesco (UK). A section on cash flow forecasting includes full coverage of spreadsheet risk and good practice. Complete with chapters of particular interest to those involved in credit markets as lenders or counter-parties, those running businesses and those in equity investing, this book is the definitive guide to understanding and interpreting cash flow data.

Leseprobe

Contents

Cover

Series

Title Page

Copyright

Dedication

Introduction

THE LOGIC OF THE BOOK DESIGN

COMPLEXITY

THE USE OF CASE STUDIES IN THE BOOK

GUIDE TO THE BOOK

Section One: Historic Cash Flow Analysis

Chapter 1: Understanding How Cash Flows in a Business

INTRODUCTION

THERE IS NOTHING NEW ABOUT BUSINESS

UNDERSTANDING MONEY IN BUSINESS

THE SIMPLE MANUFACTURING BUSINESS

HOW DOES ANY BUSINESS GENERATE CASH?

THE COMPLETE REAL BUSINESS MODEL

SUMMARY OF THE CHAPTER

CONCLUSION

Chapter 2: Understanding Cash Flows Properly

INTRODUCTION

THE NATURE OF THE BEAST

CASH FLOWS FROM OPERATING ACTIVITIES

CASH FLOWS FROM OPERATING ACTIVITIES – DETAILED REVIEW

CASH FLOWS FROM INVESTING ACTIVITIES

CASH FLOWS FROM INVESTING ACTIVITIES – DETAILED REVIEW

CASH FLOWS FROM FINANCING ACTIVITIES

CASH FLOWS FROM FINANCING ACTIVITIES – DETAILED REVIEW

THE NATURE OF THE BEAST – CONCLUSION

SUMMARISING AND RESTATING CASH FLOWS FOR ANALYSIS – INTRODUCTION

CONCLUSION

ANALYSING THE CASH FLOWS IN THE MASTER TEMPLATE

THE STATE OF PLAY

Chapter 3: Start-up, Growth, Mature, Decline

INTRODUCTION

THE START-UP PHASE

THE GROWTH PHASE

THE MATURE PHASE

THE DECLINE PHASE

CONCLUSION

SUMMARY

Chapter 4: Restating the Cash Flows of a Real Business

INTRODUCTION

OUR OBJECTIVE

THE IMPLICATION OF DIFFERENT GAAPS

RESTATING THE CASH FLOWS FROM OPERATING ACTIVITIES

IDENTIFYING THE OPERATING CASH MARGIN

CONCLUSION

Chapter 5: Restating US GAAP Cash Flows

INTRODUCTION

THE US GAAP CASH FLOW ANALYSIS PROCESS

SOURCES OF CASH FLOW DATA

RESTATING THE CASH FLOWS FROM OPERATING ACTIVITIES

IDENTIFYING THE OPERATING CASH MARGIN (AFTER INTEREST AND TAX PAYMENTS)

RESTATING THE CASH FLOWS FROM INVESTING ACTIVITIES

RESTATING THE CASH FLOWS FROM FINANCING ACTIVITIES AND DEALING WITH THE FINAL CASH BALANCE

INTRODUCING THE INTEREST AND TAXATION CASH FLOWS TO A US GAAP CASH FLOW TEMPLATE

CONCLUSION

Chapter 6: Analysing the Cash Flows of Mature Businesses

WHAT DO WE MEAN BY ‘MATURE’?

THE FIRST PROBLEM: INFLATION

THE SECOND PROBLEM: THE MARKET GROWTH RATE

THE THIRD PROBLEM: DO WE REALLY MEAN ‘MATURE’ COMPANY?

THE FOURTH PROBLEM: WHERE MATURE BUSINESSES COMPETE

IN CASH FLOW TERMS, WHAT CONSTITUTES SUCCESS FOR MATURE COMPANIES?

THE CONSEQUENCES OF FAILURE TO GENERATE SUFFICIENT CASH FLOW

ISSUES RELATED TO MATURE BUSINESS DIVERSITY

ISSUES RELATED TO BUSINESS SIZE

SUMMARY

Chapter 7: Analysing the Cash Flows of Growth Businesses

WHAT DO WE MEAN BY ‘GROWTH’?

IRRATIONAL INVESTOR BEHAVIOUR

NEGATIVE CASH FLOWS

CORPORATE COLLAPSE

TO SUMMARISE THIS INTRODUCTION

IN CASH FLOW TERMS, WHAT CONSTITUTES SUCCESS FOR GROWTH BUSINESSES?

GROWTH CASH FLOW EXAMPLES: THE SUCCESS

GROWTH CASH FLOW EXAMPLES: THE INVESTOR

CASH FLOW GROWTH EXAMPLES: THE ACQUIRER

CASH FLOW GROWTH EXAMPLES: THE ASPIRANT

SUMMARY

Chapter 8: Growth and Mature – Further Analysis Issues

ANALYSING NET WORKING ASSETS FROM A CASH FLOW VIEWPOINT

INTERPRETING THE MOVEMENT IN NET WORKING ASSETS

MOVEMENTS IN NET WORKING ASSETS – CONCLUSIONS

RESTATEMENT OF THE TEMPLATE CASH FLOWS ON A NO-GROWTH BASIS

WHAT DOES NO-GROWTH MEAN?

PHIBRO ANIMAL HEALTH CORPORATION

Chapter 9: Analysing the Cash Flows of Start-up Businesses

ANALYSING THE CASH FLOWS OF A START-UP PROJECT

AFTER THE POINT DEFINED ABOVE AS ‘START-UP’ EARLIER IN THIS CHAPTER

Chapter 10: Analysing the Cash Flows of Decline Businesses

HOW DOES DECLINE AFFECT CASH FLOWS?

CONCLUSIONS ABOUT DECLINING MARKETS

Chapter 11: What to do about Bad Cash Flows

THE ANALYST’S VIEWPOINT

CONCLUSIONS FROM THE ANALYST’S VIEWPOINT

THE MANAGER’S, DIRECTOR’S OR ENTREPRENEUR’S VIEWPOINT

CONCLUSION FROM A MANAGER’S VIEWPOINT

Chapter 12: Cash Versus Profit as a Measure of Performance

HISTORY OF THE P&L

SO, WHAT CAUSES THE DIVERGENCE BETWEEN PROFIT AND CASH FLOW?

WHAT ARE FUNDAMENTAL ACCOUNTING CONCEPTS?

CONCLUSIONS – FUNDAMENTAL ACCOUNTING CONCEPTS

CONCLUSION

Chapter 13: Cash Flow Analysis and Credit Risk

WHAT IS CREDIT RISK?

CASH VERSUS PROFITS

WHICH CASH FLOWS SHOULD WE BE INTERESTED IN?

WHY INCLUDE THE DIVIDEND?

BRITISH TELECOM AND 3G LICENCES

CONCLUSIONS ABOUT THIS STYLE OF ANALYSIS

INTEREST, DIVIDENDS AND DEBT REPAYMENT – THE IMPLICATIONS OF SIZE

COVENANTING AND CASH FLOWS

CONCLUSION

Chapter 14: Cash Flow Analysis and Performance Measurement

HOW CAN WE USE CASH FLOW INFORMATION?

WHAT IS SUCCESS IN BUSINESS?

CASH FLOWS AND INVESTMENT

CONCLUSION

Chapter 15: Analysing Direct Cash Flow Statements

WHAT IS DIFFERENT ABOUT A DIRECT CASH FLOW STATEMENT?

CONCLUSIONS ABOUT DIRECT CASH FLOWS

Chapter 16: Generating a Cash Flow Summary from Profit and Loss Account and Balance Sheet Data

THE NATURE OF THE PROBLEM

SO, IS AN ESTIMATED CASH FLOW SUMMARY USEFUL?

CONCLUSION

Chapter 17: Summarising Historic Free Cash Flow

THE ORIGIN OF FREE CASH FLOW

WHAT THEN, ARE THE FREE CASH FLOWS OF A BUSINESS?

THE CASH FLOW EFFECTS OF DEBT FINANCING

CONCLUSION

Section Two: Forecasting Cash Flows

Chapter 18: Introduction

FORECASTING VERSUS ANALYSING HISTORIC DATA

FORECASTS AND PREDICTION

REASONS FOR PREPARING CASH FLOW FORECASTS

FORECASTS AND THE COST OF NEGATIVE EVENTS

OTHER BENEFITS OF FORECASTING MODELS

Chapter 19: Spreadsheet Risk

INTRODUCTION

SPREADSHEET RISK

MANAGING SPREADSHEET RISK

OWNERSHIP

CONCLUSIONS ABOUT SPREADSHEET RISK

GOOD SPREADSHEET TECHNIQUE

CONCLUSIONS ABOUT SPREADSHEET RISK

Chapter 20: Good Practice Spreadsheet Development

DATA ENTRY, FORMATTING AND SPREADSHEET ERROR

LAYOUT

TYPES OF CASH FLOW SPREADSHEET MODELS

CONCLUSIONS ABOUT GOOD PRACTICE SPREADSHEET DEVELOPMENT

Chapter 21: The Use of Assumptions in Spreadsheet Models

INTRODUCTION

HOW ASSUMPTIONS ARE USED IN A SPREADSHEET

THE SELECTION OF ASSUMPTIONS

MACROECONOMIC ASSUMPTIONS

THE APPROPRIATE AND INAPPROPRIATE USE OF ASSUMPTIONS

CONCLUSIONS ABOUT FORECASTING CASE FLOWS

CONCLUSIONS ABOUT CASH FLOW ANALYSIS

Index

For other titles in the Wiley Finance series please see www.wiley.com/finance

This edition first published 2012 © 2012 Timothy D.H. Jury

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Library of Congress Cataloging-in-Publication Data:

ISBN 978-1-119-96265-6

A catalogue record for this book is available from the British Library.

Printed in Great Britain by TJ International Ltd, Padstow, Cornwall, UK

To my mother and father, brother and sisters for always being there

Introduction

This book is the definitive guide to cash flow analysis. It is designed to be the definitive first reference on all aspects of historic cash flow analysis. It also provides an incisive overview of the risks to be managed in preparing cash flow forecasts.

It has been written from a cash flow-centric point of view. Other financial and analytical information is introduced whenever relevant to support the process of cash flow analysis.

This book is designed for people trying to understand and analyse cash flows, probably in a professional context. Whilst it contains some theoretical content, the primary objective is to offer a practical handbook of cash flow analysis.

Ideally, it should first be read like a novel and then dipped into chapter-by-chapter as required; a detailed guide to the contents of each chapter follows this introduction. Much of the information in the book has been laid out to facilitate direct reference from the index; also allowing it to be used as a pure reference text.

Considerable effort has been expended to make the book as user friendly as possible. It has been designed to be relevant and useful both to persons who are coming to cash flows for the first time, and to those who are more experienced in the perils of financial statement analysis! I have paid particular attention to the needs of those who are not native English speakers. I have tried to keep the use of English as clear and concise as possible whilst avoiding the use of unnecessary complexity.

Whilst the book is written primarily for those employed as financial analysts, I have identified four other major user groups whose needs are specifically dealt with in different sections of the book. They are:

Novices in financial analysis and other persons new to, or relatively unfamiliar with, cash flows in general and their analysis in particular, in all fields of endeavour, who wish to improve their understanding of cash flow.Bankers, credit analysts and others involved in business lending and the management of credit exposures and credit risk.Investors, fund managers and credit analysts involved in taking investment decisions.Entrepreneurs, managers and business people involved in controlling business entities.

The guide to the book, which follows this introduction, provides an indication of the content of each chapter and its relevance to different users. For example, persons who have no desire to actually perform the analysis of the cash flows of a business themselves, but who still wish to understand cash flow, will initially gain little from Chapters 4 and 5 as they are written for persons who are seeking to practically apply the technique for the restatement of published cash flows.

THE LOGIC OF THE BOOK DESIGN

Years of experience as a financial trainer have taught me that people acquire technical knowledge in a very random way from a variety of sources as they come across information relevant to their needs. This sometimes results in a partial, incomplete and often inaccurate understanding of the particular subject in issue. As a trainer and author my objective is to organise the information relevant to a subject or task in a logical and structured way to facilitate and ease the assimilation process. The metaphor I like to use is that of a jigsaw. My audiences will typically have many of the pieces of the jigsaw already in their possession; however, until I facilitate the process of assimilation they have not previously assembled the pieces into a complete picture. When working as a trainer not only do I assist in completing the jigsaw, I also provide the missing pieces, which are different for each participant!

For this reason the book has been organised into specific blocks of knowledge. It can be read sequentially. It can also be used as a reference to provide answers to specific queries and problems by dipping into the relevant part of the book.

COMPLEXITY

The word complex is regularly misused to mean difficult, or beyond the users present comprehension. When things labelled complex are analysed it often becomes clear that what is actually meant is there is a lot of information to assimilate before comprehension of the whole can be gained. The information itself is not particularly demanding to comprehend; there is, however, a lot of it! Writing computer software or learning a musical instrument or foreign language are typical examples.

My strategy for this type of assimilation problem is to chop the information up into lots of little bits that are sufficiently elemental that they can be adequately digested by the person seeking to assimilate the whole area of knowledge and then build the knowledge in a pyramid form by adding blocks and layers in an ordered way. This is the approach I have taken in writing this book.

THE USE OF CASE STUDIES IN THE BOOK

Once the initial chapters have introduced the concepts upon which the analysis of cash flows rely, the book includes a number of case studies that illustrate the use of the technique for cash flow analysis offered. Most of these cases are based on financial information taken from the accounting statements of real business entities. I prefer to do this because there is then no challenge as to the reality of business behaviour. If I create fictional cases for the book there is a risk users will question my conclusions about them and cash flow analysis in general on the basis that the examples are fictionalised and therefore do not represent a reasonable representation of business reality.

However, this inevitably results in problems with dates! The question of how to deal with dates in the book is one that has vexed me significantly. The problem for the publisher and I is that the book will soon appear dated if we show the years from which the case studies were taken in the original. Users may wrongly assume the message and content of the book is somehow less relevant because the material used to illustrate the logic of the technique offered is ageing.

The logic of the cash flow analysis technique offered in the book is essentially timeless, it should work virtually anywhere and anytime financial information is available to perform the analysis. For this reason I have partially disguised the original dates of the material used to illustrate the cases. The timeline of most of the case studies offered is incidental; the examples are there to illustrate the use and benefits of the cash flow analysis technique that is the basis of this book.

Experienced analysts will know that in performing any business analysis the economic context in which the company operates is sometimes highly relevant. Matters such as inflation, interest rates and the state of the economy may affect the conclusions drawn about the relative performance of a business. For this reason, in a small number of cases and where the context of the example warrants it, I have left the dates as they were originally. This allows the reader to put the case into the context of the economic conditions prevailing at the time.

Considerable effort has been expended to keep the various examples, tables and other information both numerically and factually correct, however, it is inevitable in a work of this length that, despite our best efforts, errors may still creep into print. Please do not hesitate to bring these to my attention, to further improve the book as it develops.

I hope this book changes your life. For those whose job is to analyse cash flows for a living it may actually do so!

Capitalisation

Throughout the book, where you see CAPITALISED WORDS, these refer directly to key words in tables and figures that are being discussed and explained in the text.

GUIDE TO THE BOOK

The book is organised into two sections, the first dealing with the analysis of historic cash flow data, the second dealing with the forecasting of cash flow information.

Section One – Historic Cash Flow Analysis

Chapter 1 – Understanding How Cash Flows in a Business

Level basic – the chapter is designed as a layperson’s introduction to the whole subject of cash flow in business. In addition to introducing the cash flow patterns seen in business, it outlines a number of other fundamental issues and risks that managers must overcome in order to trade successfully. No prior knowledge of cash flow is assumed. The material is presented from the ground up through the use of straightforward examples.

Despite being offered as a basic introduction everyone seeking to utilise the cash flow analysis technique presented in the book should read this chapter as it introduces and defines part of the terminology used throughout the book.

Chapter 2 – Understanding Cash Flows Properly

Level intermediate – this chapter explains the knowledge and the steps required to analyse cash flows properly. It then commences the process by explaining all the terminology used in a simple cash flow example and introduces the analysis technique for the first time.

Chapter 3 – Start-up, Growth, Mature, Decline

Level intermediate – this chapter introduces the non-financial information needed to get the most out of the cash flow analysis technique offered in the book. Everything offered in this chapter is covered in more detail in Chapters 6 to 10.

Chapter 4 – Restating the Cash Flows of a Real Business

Level advanced – readers without some prior knowledge of financial statement analysis and accounting will find this chapter demanding. Considerable effort has gone into explaining the accounting and analytical knowledge required to properly utilise the cash flow analysis technique offered. The example chosen to illustrate the process being taken from a business preparing its accounts using International Financial Reporting Standards.

Chapter 5 – Restating US GAAP Cash Flows

Level advanced – this follows on from the previous chapter by taking an example of the technique based on a business following US financial accounting rules in the preparation of its financial statements. It is necessary to be familiar with the content of the previous chapter in order to get most benefit from this one.

Chapter 6 – Analysing the Cash Flows of Mature Businesses

Level advanced – this chapter defines the term ‘mature’ and presents the information required to comprehensively analyse the cash flows of a mature business.

Chapter 7 – Analysing the Cash Flows of Growth Businesses

Level advanced – this chapter defines the term ‘growth’ and presents the information required to comprehensively analyse the cash flows of a growth business.

Chapter 8 – Growth and Mature – Further Analysis Issues

Level advanced – this chapter presents two important further issues relevant to the analysis of both growth and mature businesses.

Chapter 9 – Analysing the Cash Flows of Start-up Businesses

Level advanced – this chapter defines the term ‘start-up’ and presents the information required to comprehensively analyse the cash flows of a start-up business.

Chapter 10 – Analysing the Cash Flows of Decline Businesses

Level advanced – this chapter defines the term ‘decline’ and presents the information required to comprehensively analyse the cash flows of a decline business.

Chapter 11 – What to do about Bad Cash Flows

Level advanced – this chapter offers a variety of strategies to make decisions about cash flows that are bad. It suggests a number of questions that the analyst should seek to answer, before coming to conclusions about bad cash flows.

Chapter 12 – Cash Versus Profit as a Measure of Performance

Level advanced – this chapter explains in detail the differences between profit and cash generation as a measure of performance. It points out the pitfalls of using profit alone as a performance indicator.

Chapter 13 – Cash Flow Analysis and Credit Risk

Level advanced – this chapter explains how to tailor the cash flow analysis technique offered specifically to the needs of bankers and others who are exposed to credit risk.

Chapter 14 – Cash Flow Analysis and Performance Measurement

Level advanced – this chapter looks at ways the cash flow analysis technique offered in the book can be used for business performance measurement.

Chapter 15 – Analysing Direct Cash Flow Statements

Level advanced – this chapter deals with the differences between direct and indirect cash flow statements and how to deal with them in applying the cash flow analysis technique. It is necessary to be familiar with the earlier content of the book in order to get the most out of this chapter.

Chapter 16 – Generating a Cash Flow Summary from Profit and Loss Account and Balance Sheet Data

Level advanced – this chapter illustrates how to arrive at a summary of the cash flows of a business entity that does not produce a cash flow statement as part of their financial information. It is essential to be familiar with all the earlier content of the book in order to get the most out of this chapter.

Chapter 17 – Summarising Historic Free Cash Flow

Level advanced – this chapter illustrates how to identify the historic free cash flow of a business entity from the cash flow information derived by using the cash flow analysis technique presented earlier in the book. It is necessary to be familiar with the earlier content of the book in order to get the most out of this chapter.

Section Two – Forecasting Cash Flows

Chapter 18 – Introduction

Level advanced – this chapter discusses the risks and benefits of forecasting when compared to the analysis of historic information.

Chapter 19 – Spreadsheet Risk

Level advanced – this chapter introduces spreadsheet risk and offers strategies to minimise the problem.

Chapter 20 – Good Practice Spreadsheet Development

Level advanced – this chapter introduces a number of techniques to reduce spreadsheet risk through good modelling practice. It illustrates four examples of common cash flow forecasting models.

Chapter 21 – The Use of Assumptions in Spreadsheet Models

Level advanced – this chapter offers guidance on dealing with assumptions in spreadsheet forecasting models. It then discusses the use of scenarios for risk analysis using spreadsheet forecasts.

Section One

Historic Cash Flow Analysis

1

Understanding How Cash Flows in a Business

INTRODUCTION

This chapter is designed to enable those with less direct experience of the operation of businesses to grasp the fundamental financial and economic logic that governs how successful businesses operate. It represents the starting point for our journey through the landscape of cash flow analysis. In order to gain benefit from this chapter no prior knowledge of either cash flow or business is required.

We start our journey by developing a model of how the cash flows in a simple business work. We then develop our knowledge of cash flows by incrementally adding complexity to this model.

Whilst developing this model based on the cash flows of a business we also introduce some fundamental logic about what different types of business must do in order to be successful.

THERE IS NOTHING NEW ABOUT BUSINESS

Humans have been engaging in trade for thousands of years, initially through some sort of barter process. Archaeologists have discovered ancient manufactured goods such as pottery and metal objects that have travelled vast distances from their point of manufacture. There are numerous examples of early Greek and Roman shipwrecks being discovered in many different parts of the Mediterranean dating back 2000 years or more. In the 1960s evidence was finally discovered that proved that the Vikings were the first Europeans to discover America some 500 years before Columbus. The remains of a Norse settlement at L’Anse aux Meadows on the northern tip of Newfoundland have been authenticated and dated to around 1000AD. During the excavation of the site over 100 objects of European manufacture were unearthed.

A more recent development in human history was the introduction of money in the form of coinage and, later, notes. Whilst there is much debate about what should be recognised as the first coin, a good candidate would be a small lump of electrum (a natural alloy of gold and silver) stamped with a design and minted around 600BC in Lydia, Asia Minor (now known as Turkey). Paper money seems to have emerged in China at about the same time.