Introduction to Financial Introduction to Financial ManagementManagement

FIN 102 – 9FIN 102 – 9thth Week of Class Week of Class

Professor Andrew L. H. ParkesProfessor Andrew L. H. Parkes““A practical and hands on course on the valuation A practical and hands on course on the valuation

and financial management of corporations”and financial management of corporations”

卜安吉卜安吉

Funds and Cash FlowFunds and Cash Flow

Financial Management Fall 2007Financial Management Fall 2007

ShanghaiShanghai

Chapter 7a: Funds Analysis and Planning

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Sources and Use of FundsSources and Use of Funds

Funds are Cash and Cash Funds are Cash and Cash equivalentsequivalents

We already know that We already know that understanding the cash inflow understanding the cash inflow – and - outflow of a business is – and - outflow of a business is extremely important.extremely important.

Remember: Remember:

V= FCF/WACCV= FCF/WACC ? ?

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Changes in the Balance Changes in the Balance SheetSheet

We first noticed this flow of funds when We first noticed this flow of funds when calculating FCF on Week 1!calculating FCF on Week 1!

Four Key Points:Four Key Points:

Increasing Increasing assetsassets consume cash (cash out) consume cash (cash out)

Decreasing Decreasing assetsassets create cash (cash in) create cash (cash in)

Increasing Increasing liabilitiesliabilities or shareholder’s or shareholder’s capital (equity) creates cashcapital (equity) creates cash

Decreasing Decreasing liabilitiesliabilities or shareholder’s or shareholder’s capital (equity) consumes cashcapital (equity) consumes cash

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Example…Net Working Capital Example…Net Working Capital (Johnson & Johnson)(Johnson & Johnson)

In FY 2003, the In FY 2003, the inventoriesinventories of J&J of J&J increasedincreased (the difference between the (the difference between the inventories per the end of FY2003 and inventories per the end of FY2003 and FY2002) by $285m. A FY2002) by $285m. A cash outcash out for the for the company during FY2003.company during FY2003.

Also the Also the accounts receivableaccounts receivable of J&J of J&J increasedincreased in FY2003 by $1,175m. in FY2003 by $1,175m. Another largeAnother large cash outcash out for the for the company in FY 2003.company in FY 2003.

The The accounts payableaccounts payable (bills to be paid (bills to be paid to the suppliers) to the suppliers) increasedincreased by $1,375m. by $1,375m. A largeA large cash incash in for the company in for the company in FY2003.FY2003.

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Example … Liabilities and Example … Liabilities and Equity (Johnson & Johnson)Equity (Johnson & Johnson)

Long term debt increased in FY Long term debt increased in FY 2003 by $ 933m. A 2003 by $ 933m. A cash incash in for J&J. for J&J.

Shareholders equity increased by Shareholders equity increased by $4,192m. Another $4,192m. Another cash incash in..

If we include If we include all the other cash all the other cash effectseffects from the balance sheet, the from the balance sheet, the net cash increasenet cash increase in FY2003 was in FY2003 was $2,048m.$2,048m.

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Example … OVERALL Example … OVERALL (Johnson & Johnson)(Johnson & Johnson)

The cash position on the balance The cash position on the balance sheet at the sheet at the end of FY2002end of FY2002 was $ was $ 7,475 m.7,475 m.

The cash position at the The cash position at the end of end of FY2003FY2003 was $ 9,523m. was $ 9,523m.

Thus the Thus the cash increasecash increase was $ 2,048m. was $ 2,048m. The increased cash is the result of: The increased cash is the result of:

Cash from Operations, Cash changes Cash from Operations, Cash changes from Investments and Cash changes from Investments and Cash changes from Financing activitiesfrom Financing activities……

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Remember – Overall, if …Remember – Overall, if …

AssetsAssets Liabilities Liabilities and Equityand Equity

Source of Funds Source of Funds (cash in)(cash in)

If assets If assets go go downdown it’s a it’s a source of fundssource of funds

If liabilities and If liabilities and equity equity go upgo up that is a source that is a source of fundsof funds

Use of Funds Use of Funds

(cash out)(cash out)If assets If assets go upgo up it’s a use of it’s a use of fundsfunds

If liabilities and If liabilities and equity equity go downgo down that is a use of that is a use of fundsfunds

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So now you can do it…So now you can do it… FOR YOURFOR YOUR company company

(or any company) you (or any company) you can calculate per item of can calculate per item of the balance sheet the the balance sheet the cash in and cash out.cash in and cash out.

The result is the change The result is the change in cash (the net cash in cash (the net cash generated during the generated during the year).year).

Let’s use the example…Let’s use the example…

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Current assets excl. cash increased with $ 1,246 Mln.

Cash increased $ 2,483 Mln.

Total assets excl. cash increased $ 5,224 Mln.

So cash out as a result of increased assets $ 5,224 m.

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Current liabilities increased with $ 1,999 Mln.

Long term liabilities increased with $ 1,536 Mln.

Shareholders Equity increased with $ 4,172 Mln.

A total cash in of$ 7,707 m. due to Increased liabilities.

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Total Cash In Total Cash In $ 7,707 m.$ 7,707 m. Total Cash Out Total Cash Out $ 5,224 m.$ 5,224 m. Net Cash In: Net Cash In: $ 2,483 m.$ 2,483 m.

Cash position at the end of FY 2002: Cash position at the end of FY 2002: $ 2,894 m.$ 2,894 m. Net Cash In in FY 2003: + Net Cash In in FY 2003: + $ 2,483 m.$ 2,483 m. Cash position at the end of FY 2003: Cash position at the end of FY 2003: $ 5,377 m$ 5,377 m..

Note the balance sheet FY 2003.Note the balance sheet FY 2003.

ConcludingConcluding

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The Income Statement The Income Statement (P&L)(P&L)

Net Income to Cash Flow Statement

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Operational Cash Flow Operational Cash Flow StatementStatement

Net Income See Income Statement

Change in NOWC

Depreciation

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Cash Flow from Investing Cash Flow from Investing ActivitiesActivities

Capital Expenditures Capital Expenditures (CAPEX)(CAPEX) Net Net

CAPEX

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Cash Flow from Financing Cash Flow from Financing ActivitiesActivities

Here is where the capital comes FROM that is, from DEBT or EQUITY (Stock).

Net Cash Flow – See above!

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End of the Section – Chapter 7aEnd of the Section – Chapter 7a

Go Get ‘em Tiger!