Corporate Finance 2

What is a cash flow statement?

a statement that records all cash inflows and outflows of a company over a period.

it measures the variation in cash between the beginning and the end of a period

why is it important ?

Because profit ≠ cash. A company can be profitable and still run out of cash

Different Cash Flow Categories

1. Operating Cash flows (OCF)

cash generated by core business activity

2. Investing Cash Flows (ICF)

Cash used to buy or sell assets (factories, stores, equipment)

3. Financing Cash Flows (FCF)

Cash flows between the company and those who provide money: Shareholders (equity) and Lenders (debt)

What happens to cash generated by operations? (3points)

• reinvested in the business

• paid as dividends to shareholders

• used to repay debt and interest

What is Working Capital

Long term capital available to finance day to day operations of the business

WC Formula

Equity + LT Debt - Fixed Assets

What does WC represent?

Excess long-term resources left once fixed assets are financed

What is it used for ?

To finance the WCR

How do we calculate WCR? What is it used for ?

current assets - current liabilities

represents the cash used to finance day to day trading operations

WCR formula

Inventories + Trade Receibables - TRade Payables

Relationship between WC and WCR

WC finances WCR

• if WC > WCR → excess cash (can be reserved or returned as dividends)

• if WC < WCR → need to borrow

Why is WCR cyclical?

• Calendar effects

• End of period inventories (retail)

• Seasonality (fashion cycles)

Why does the date on the balance sheet matter?

Because WCR can be high or low depending on the moment of the year.

Why is WCR risky for frast growing companies?

Growth increases inventories and receivables → cash trap risk

What does cash trapped mean?

Profitable growth but not enough cash due to high WCR.

Chanel Application : WCR

• inventories: 2.3

• Trade receivables 3.3

• Trade payables: 3.3

• WCR: ~1.2bn$

Chanel WC

• Equity: 10.7

• LT debt: 3.2

• Lease liabilities: 2.3

• Fixed asssets: 11.9

WC: ~4.3bn$

What does this tell us ?

→ WC > WCR → excess cash

Where is Chanel’s extra cash ? Why is this a problem?

• Short-term financial investments

• Cash & Cash Equivalents

→ Cash loses value due to inflation if it just sits idle

Why do we express WCR in days of sales?

To measure how many days of sales need to be financed in cash.

How does the Cash Flow statement link to BS & P&L

P&L → performance

BS → stoc of assets/liabilities

CF statement → cash movement

What are financing activities?

Cash flows linked to equity and debt.

Equity vs Debt

Equity → ownership & voting rights

Debt → obligation to repay

Debt advantages

• Tax leverage

• No dilution of ownership

Equity advantages

• No brankruptcy risk

• No mandatory repayment

Equity-related cash flows

• Capital increases

• Dividends paid

Debt-related cash flows

• Loans received

• Loans repaid

• Interest paid

Examples of investing cash flows

• PPE

• Intangible assets

• Financial assets

• Disposal of assets

How do we go from profit to operating cash flow?

Operating result

• non-cash adjustments

  ± change in WCR

Why do we add back depreciation?

Because it is a non-cash expense

Non-cash adjustments

• Depreciation & amortisation

• provisions

• Write-down

• Gains/losses on asset sales

Cucinelli Key insight

• High depreciation added back

• Large increase in receivables

• Cash decreased significantly

L’oréal - key insight

• Strong operating cash flow

• Controlled WCR despite growth

• Dividends, debt repayment, share buybacks

→ mature company generating lots of cash and returning it to shareholders.