Introduction to CashFlows

8/15/2019 Introduction to CashFlows

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Important

points

Notes

Right hand side are real assets . A fnancial frm may have

fnancial assets.

Real assets are things which generate value or you. Ex:

machines

This is where action o value creation is happening

Real asset do two things:

enerate cash !ow

o fgure out what r is to evaluate

"ia#ilities side

$e fnance our idea % u can use e&uity or de#t

To 'udge a pro'ect ( we do not see how it is fnanced.

Instead we loo) at its cash !ow

*ecide how may periods

$hich point are you standing at +

,igure out cash !ows

-ro'ect lie depends on how ar you are comorta#le.

New #iness (which is un)nown( use short horion.

,amiliar idea ( we use long duration

/alue is always relative % "aw o one price 0 use mar)et to

fgure out the price

Eles to design something similar to coco%cola

without )nowing co)e1s prioce is di2cult

/aluation needs:

o 3ash!ows

4elongs to the pro'ect


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o 3osto capital

4elongs to mar)et

$E loo) at uture cash !ows and not past

o 5ource is -roorma Income statements and

4alance sheets

Income statement is a !ow (li)e cash !ow

o To get the !ow( ta)e two snapshots li)e two

google snapshots to see how your city has

changed

4alance 5heet is a snapshot o assets6stoc)s

Revenue 7 -rice 8 9uantity

3omes rom Income 5tatement

-rice is what people are ready to pay

35

5A

Not Incremental with with the pro'ect inhand

;ow much more in general am I adding

#ecause o the new pro'ect

*epreciation


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Net operating profts ater tax

Add #ac) depreciation

3apaital Ex

This is not a !ow

IT is li)e a snapshot

3apex is the amount o money you spend

on that lasts a while

"i)ely to #e =(>iddle o the pro'ect

3omes rom 465. Everything else comes

rom I65

Increases in $or)ing 3apital

As soon as you see ?3apital? thin) o 465

5napshot is nit a !ow. ;ence we need to

thin) o changes ie delta

3ash li)e a undamental inventory

Inventory mangement and $or)ing

3apital management is the #iggest #oom

o internet

$almart is the )ing o the wor)ingcapital management.

3apital used to manage the system

It is li)e the grease used to operate the

machine

3ash ,low rom operations


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3ash ,lows -rinciples:

Estimate all cash !ows on an incremental #asis

o ,ind cash !ows with and without the pro'ect

o -ro'ects are always incremental

o 3ash !ows are always incremental. Thin) o

what the world would li)e with the pro'ect and

without the pro'ect.

*o not orget importance o year = and the last year

o the chosen timeline o the pro'ect

o @ear = : expenditure on #uying machinery

o @ou would li)e to ta)e ull tax advantage o

the machinery cost and expense it.

o Ideally you would want to save all the tax at

the #eginning. $hy +

4ecause o time value o money.


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And compounding . The higher the

compound rate ( the higher the time

value o money

o $or)ing capital ingredients : 5ome cash or

#usiness inventory Account receiva#le %Account -aya#le

3ash( Inventory( A6R( A6- all these are

stoc) . This is a level. The higher the

$3 ( the less e2cient you are.

o 4oth 3A-EB and $or)ing 3apital are coming

rom #alance sheet

Accounting issues

*epreciation is important (#ecause it is made up.

o 5imilar non%cash items

3apital

o $or)ing 3apital

o 3A-EB

-rinciple C: *o no mix fnancing with operations

o $hile doing pro'ect analysis stay on the assets

side.

o /alue is generated on the assets o the #6s.

>oney is not generated #y fnancing .IT

created #y ideas

o I you are thin)ing a#out fnancing ( you are

not thin)ing a#out what adds value to the

pro'ects

o

The fnancing part i ta)en care #y ?r? Include the eDects o in!ation6de!ation

o R has ?in!ation?

o Every item in cash !ow statement has

diDerent in!ation or diDerent items

Revenue has diDerent in!ation

35 has diDerent in!ation

$hen we do detail analysis( we need to

consider the in!ation.


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-ro'ect : *o not compare pro'ects with une&ual

lives.

o ,igure out the Terminal value %do not orget

a#out last year in the pro'ect time line

o -/A 7 FG.HF and -/4 7 FH.HF

>a)e everything e&ual. I )eep #uying

machines so that the lives o the to two

horions are the same. *oing analysis

over years is one way to do.

o -er year cost o machine A is F.H(ad'usted

or time value o money and that o >6c 4 is

=.J . ;ence >achine 4 is cheaper.

o 5hort%term lie span costs less. -ro'ect A costs

lesser.

3onsider FH.H as annuity over two

years. -er year cost is determined using

->T

•

r KL

>63 A = F

F= F F


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F= .M=CHF .JC=K

M

FG.HJJ

F

Annuit

y

Rs.

%F.H

each o the two

years

T

= F

>63 4 FK

FK =.MKFGJ =.M=H=F

M

FH.HFGF

K

Annuit

y

Rs.

%=.J

each o the three

years

T


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5ummary Estimate all cash !ows on an incremental #asis

*o the c6 analysis on two timelines

*o two analysis

*o not orget importance o year = and thelast year o the chosen timeline o the pro'ect

Time = : 3apital % . 3A-EB ( $or)ing

capital.

Always thin) o changes

Accounting issues are important

*epreciation

5imilar when we sell e&uipment at the

end o the pro'ect( we need to thin) o

terminal value

$or)ing capital

*o not mix fnancing with operations

,inancing is captured in the ?r?

3hoosing #6w ipad and samsung ( do we

thin) whether ipad is produced with de#t

+

Include the eDects o in!ation6de!ation

In!ation is included in r.

*o not compare pro'ect with une&ual lives

$e all love great ideas( #ut they come very seldom. And

one thing I have against the way we teach( especially at

4usiness 5chool( is we sell something as( oh( positive N-/

ideas are 'ust !oating around or you to 'ust go pluc) oD

thin air. No( it ta)es a lot o eDort to create value. And thereason is you gotta #e #etter than the competitor( right.

It1s very tough.

"ength o time line

-ro'ect have fnite lie . ,irms do not have frm lie


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At @ear =(

o 5ell Inventory

o 5ell >63

o $e are getting #ac) the wor)ing capital

Alternately( we are not selling . $E can thin) o a pro'ect

li)e a frm which goes or ever.

Terminal /alue 7 3 6r%gO 0 perpetuity

o 5ay 3= 7 F=>

o 3 7 F=gO

3ash ,low is net o expenses

-ro#lems 5alvage value vs Terminal value

Another way to loo) at the diDerence is terminal value

normally reers to the value o an asset or entity at the

end o an investment period( while residual value( or

salvage value( normally reers to an asset at the end o its

useul lie.

*epreciation does not matter when we are not paying

taxes

-urchasing inventory on credit will increase the value o a

frm1s net wor)ing capital.% alse

= F G C K

; %

F===

=

%K=== %K=== %K=== %K=== %K===

To calculate N-/ o the a#ove investment using Excel (

exclude year = in the set o values. Ater calculating N-/ (

add the value o year =.


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3A-EB is not taxed ( since it is an expense( while taxes

usually are paid on operating profts.

Introduction to CashFlows

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