Cash Flow

Question 1

Which components are included in the formula of WCR?

Answer 1

Accounts Receiveable (AR) + Inventory (INV) - Accounts Payable (AP)

Question 2

What happens to WCR if AR increases?

Answer 2

WCR increases as well

Question 3

What happens to WCR if INV increases?

Answer 3

WCR increases as well

Question 4

What happens to WCR if AP increases?

Answer 4

WCR decreases

Question 5

What happens to WCR if AR decreases?

Answer 5

WCR decreases

Question 6

What happens to WCR if INV decreases?

Answer 6

WCR decreases

Question 7

What happens to WCR if AP decreases?

Answer 7

WCR increases

Question 8

FA + WCR + CASH = SE + D can be formulated into another formula, which one and what is the difference?

Answer 8

Formula: FA + WCR + CASH = SE + LTD + STD_fin
Difference: The difference is that we separate debt (D) into Long-term debt and Short-term financial debt.

Question 9

What does the Operating Cycle measure?

Answer 9

The time interval between the arrival of an asset and the date that cash is collected from that asset. In other words, the interval when we pay the suppliers and when the cash of sales is received.

Question 10

What is the formula for the Operating Cycle?

Answer 10

INV-period + AR-period

Question 11

If the Operating Cycle is short then…

Answer 11

…the business is healthy and smooth. That’s because the time it takes for inventory to arrive, be sold, and have cash received, doesn’t take too long.

Question 12

This formula: FA + WCR + CASH = SE + LTD + STD_fin, can be translated into another formula, which one?

Answer 12

Formula: WCR + (CASH - STD_fin) = (SE + LTD -FA)

Question 13

This formula: WCR + (CASH - STD_fin) = (SE + LTD -FA), can be translated into another formula, which one and what does each notation mean?

Answer 13

Formula: WCR + NLB = NWC

Question 14

What are the two basic rules of Liquidity Management and why?

Answer 14

1. NWC > 0, otherwise illiquid assets could be financed by short-term liabilities. (Not always though, but the main issue, see notes from the lecture of CF, slide 13).
2. NWC > WCR, otherwise, the firms needs to rely on its cash or to use short-term borrowing to cover the gap between NWC and WCR

Question 15

What happens to NLB if there is an increase in CASH?

Answer 15

NLB increases and the firm becomes more liquid

Question 16

What happens to NLB if there is an increase in STD_fin?

Answer 16

NLB decreases and the firm becomes less liquid

Question 17

What happens to NWC if there is an increase in SE?

Answer 17

NWC will increase and the firm will become more liquid in the short term to finance short-term assets if needed.

Question 18

What happens to NWC if there is an increase in LTD?

Answer 18

NWC will increase and the firm will become more liquid in the short term to finance short-term assets if needed.

Question 19

What happens to NWC if there is an increase in FA?

Answer 19

NWC will decrease and the firm will become less liquid in the short term since more finance has to go to FA (I.e, Long term fixed assets).

Question 20

What are some differences between WCR and NWC?

Answer 20

1. WCR = AR + INV - AP while NWC = SE + LTD - FA.
2. WCR handles day-to-day operations while NWC handles Long term assets.
3. NWC has to be NWC > WCR but the opposite thing is not a must.

Question 21

What is the difference between NWC and NLB?

Answer 21

NLB measures the liquidity balance while NWC accounts for the long-term perspective.

Question 22

What does the Current ratio of NWC measure and what is a good level?

Answer 22

The current ratio of NWC is a balanced ratio that measures how much Current Assets make up for Current Liabilities, CA / CL. A good level is above 1, I.e more CA > CL.

Question 23

How do you calculate the NWC?

Answer 23

Current Assets - Current Liabilities.

Question 24

The NWC can be understood in two ways, which and what do they mean?

Answer 24

1. “as an investment to be funded”: Current Assets - Current Liabilities, the short-term view.
2. “as a source of financing”: Stockholders’ Equity + LT Debt - Fixed Assets, long-term view.

Question 25

If the value of the Operating Cycle is negative, what does it mean?

Answer 25

The operating cycle can be negative which means that cash is received from customers before any payment is done to suppliers

Question 26

If AP-days < AR-days + INV-days, do we pay suppliers before we receive cash or after?

Answer 26

pay before we receive cash from customers. This is the situation for most companies.

Question 27

In terms of “Operating Activities”, which activity creates an inflow of cash?

Answer 27

Sales of Gods and Services

Question 28

In terms of “Operating Activities”, which activities create an outflow of cash?

Answer 28

Purchase of supplies
Selling, General and Administrative Expenses (SGA)
Tax and interest expenses

Question 29

In terms of “Investing Activities”, which activities create an inflow of cash?

Answer 29

Sales of FA

Sales of LT Financial Assets

Question 30

In terms of “Investing Activities”, which activities create an outflow of cash?

Answer 30

Capital Expenditures and acquisitions (CAPEX)

LT Financial Investments

Question 31

In terms of “Financing Activities”, which activities create an inflow of cash?

Answer 31

Issuance of Stocks and Bonds

LT and ST Borrowing

Question 32

In terms of “Financing Activities”, which activities create an outflow of cash?

Answer 32

Repurchase of Stocks and Bonds
Repayment of Debt
Dividend Payment (HOWEVER; in BAM this is NOT the case!!)

Question 33

What is the formula for calculating the change in “CASH” by using the “Indirect Method”? What does each notation mean?

Answer 33

(NI + Dep - ΔWCR) - CAPEX + (ΔK + ΔD - DIV) = ΔCASH

NI = Net Income 
Dep = Depreciation
ΔWCR = Change in Working Capital Requirement 

CAPEX = Capital Expenditures and Acquisitions
* Derived by taking: ΔFA = CAPEX - Dep –> ΔFA + Dep = CAPEX

ΔK = New issuance of Capital
* Derived by taking: ΔSE = (NI-DIV) + ΔK –> ΔSE - (NI - DIV) = ΔK
ΔD = Change in debt
DIV = Dividends

Question 34

What is the formula for calculating the change in “CASH” by using the “Direct Method”? What does each notation mean?

Answer 34

1) + Cash collection from customers (REV - ΔAR)
- Cash payment to suppliers and employees
(CGS + ΔINV + SGA - ΔAP)
- Cash paid for interest (Int)
- Cash paid for taxes (TAX)
= Cash flow from operating activities
= (REV-CGS-SGA-Int-TAX) - ΔWCR
or (NI + Dep - ΔWCR) is the same.

2) + Cash flow from investing activities (- CAPEX)
3) + Cash flow from financing activity (ΔK + ΔD - DIV)

Question 35

How do you calculate “Free Cash Flow”?

Answer 35

FCF = CF from Operating Activities + CF from Investing Activities

Question 36

How do you calculate “Free Cash Flow (levered)”?

Answer 36

FCF (levered) = NI + Non-Cash items - ΔWCR - CAPEX

Question 37

Which are the two ways that you can calculate “Free Cash Flows from an all Equity-firm”, (I.e D=0)?

Answer 37

1. Free Cash Flow (unlevered) = EBIT*(1-Tc)+ Non-Cash items - ΔWCR - CAPEX
2. Free Cash Flow (unlevered) = DIV - ΔK + ΔCASH

Question 38

How do you calculate “Free Cash Flow to Equity”? There are 2 methods.

Answer 38

1. FCFE = NI + Non-Cash Items - ΔWCR - CAPEX +ΔD

2. Or Amount which may be used to buy back shares or pay dividends: FCFE = -ΔK + DIV + ΔCASH

Question 39

In terms of “Financial Planning”, name 3 key ratios related to ΔRevenue?

Answer 39

1. Gross Margin: m = EBITDA / REV
2. WCR: w = ΔWCR /ΔREV
3. Fixed Assets: a = ΔFA / ΔREV

Question 40

In terms of “Financial Planning”, name 2 key ratios related to “Financial Policy”?

Answer 40

1. Payout ratio: p = DIV / NI

2. Depreciation: d = Dep / FA_-1
I.e, FA based on the last year

Question 41

In terms of “Financial Planning”, name 2 key ratios related to “Environment”?

Answer 41

1. Tax rate

2. Cost of Debt