Part III – Financial Analysis

7. Cash Flow Analysis

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The concept of Cash-Flow

 Cash Flow (fluxo de caixa): difference between cash

inflows/cash receipts and cash outflows/cash
disbursements.
– Alternative Cash Flow Measures:
1) Statement of Cash Flows
reports cash receipts and cash payments by operating,
financing, and investing activities
Cash flow analysis helps in assessing liquidity, solvency,
and financial flexibility.
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 The concept of Cash-Flow

2) Net income plus depreciation and amortization

– Based on the Income Statement:
Earnings before income tax expense
+ Depreciation, Amortization and Impairments (losses/reversals)
+/- Provisions (Increases/decreases)
+/- Increases/Decreases in Fair Value
= Gross Cash Flow
- Income tax expense
= Net Cash Flow
– EBITDA (Earnings before interest, taxes, depreciation, and
amortization) 131

The concept of Cash-Flow

Issues with EBITDA

• The using up of long-term depreciable assets is a real
expense that must not be ignored
• The add-back of depreciation expense does not generate
cash. It merely zeros out the noncash expense from net
income. Cash is provided by operating and financing
activities, not by depreciation
• Net income plus depreciation ignores changes in working
capital accounts that comprise the remainder of net cash
flows from operating activities. Yet changes in working
capital accounts often comprise a large portion of cash
flows from operating activities

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 Cash-Flow vs Self-financing

 Self-financing (Autofinanciamento): the financing that is

generated by the company and is obtained by retained
earnings
Earnings before Income tax expense
+ Depreciation, Amortization and Impairments (losses/reversals)
+/- Provisions (Increases/decreases)
+/- Increases/decreases in Fair Value
- Income tax expense
- Dividends payable
= Self-financing
Thus, self-financing is a portion of the Cash Flow 133

Self-financing

 Self-financing vs Dividends Distribution Policy

Pay-Out Ratio = Dividends/Net Income
The higher the pay-out ratio the lower the self-financing
The Retention Rate Ratio or Plowback Ratio:
Retained Earnings/Net Income
 Sustainable growth rate: Retained Earnings/Net
Income*ROE

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 Self-financing

 Advantages and disadvantages of self-financing vs

Dividends Distribution Policy
– Advantages:
Improves the solvency position of the company making it less
dependent on creditors
– Disadvantages:
Higher self-financing will mean lower payment of dividends
what may lead to unmotivated current and potential investors
The company may be losing financial leverage opportunities
135

Statement of Cash Flows

Demonstração de Fluxos de Caixa (DFC)

 Main purpose: to provide information on cash inflows and

outflows for a period
 Cash flows refer to the current period’s cash inflows less
cash outflows
 It also distinguishes among the sources and uses of cash
flows by separating them into operating, investing and
financing activities.

136

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 Statement of Cash Flows

– Operating activities: are the earning-related activities of a

company. They include the net inflows and outflows of cash
resulting from related operating activities like extending credit
to customers, investing in inventories, and obtaining credit from
suppliers
– Investing activities: are means of acquiring and disposing of
noncash assets. These activities involve assets expected to
generate income for a company such as purchases and sales
of PPE and investment in securities. They also include other
non-current assets such as lending funds and collecting the
principal on these loans
137

Statement of Cash Flows

– Financing activities: are means of contributing, withdrawing,

and servicing funds to support business activities. They include
borrowing and repaying funds with bond and other loans,
contributions and withdrawals by owners and their return on
investment (dividends)

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 Statement of Cash Flows

 Methods for reporting cash flows from operations:

– Direct method: each income item is adjusted for its related
accruals.
– Indirect method: net income is adjusted for non-cash income
(expense) items and accruals to yield cash flows from
operations. An advantage is the disclosure of a reconciliation of
differences between net income and operating cash flows that
may aid some users to predict cash flows
The format for computing net cash provided by investing and
financing activities is the same for both methods. Only the
presentation of net cash flows from operations differs. 139

Statement of Cash Flows

 Indirect method

140

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 141

Statement of Cash Flows

 The direct (or inflow-outflow) method reports gross cash

receipts and cash disbursements related to operations -
essentially adjusting each income statement item from
accrual to cash basis
– Reports total amounts of cash flowing in and out of a
company from operating activities: cash receipts from
customers, cash paid for inventories, cash paid for
operating expenses,…
– Preferred by analysts and creditors
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 143

Statement of Cash Flows

Implications to financial analysis
Interpreting Cash
Limitations Flows
in Cash andReporting
Flow Net Income
• An Income Statement records revenues when earned
and expenses when incurred
– It does not show the timing of cash inflows and outflows, nor
the effect of operations on liquidity and solvency
– This information is available in the Statement of Cash Flows
• Cash flows from operations (CFO) is a broader view of
operating activities than is net income
– It is not a measure of profitability
• Note: A net measure, be it net income or cash flows
from operations, is of limited usefulness. The key is
144
information about components of these net measures.

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 Statement of Cash Flows
Implications to financial analysis

 In evaluating sources and uses of cash, the analyst should

focus on questions like:
 Are asset replacements financed from internal or external funds?
 What are the financing sources of expansion and business
acquisitions?
 Is the company dependent on external financing?
 What are the company’s investing demands and opportunities?
 What are the requirements and types of financing?
 Are managerial policies (such as dividends) highly sensitive to
cash flows?
… 145

Statement of Cash Flows

Implications to financial analysis

 The ability to generate cash flows from operations is

vital to financial health. No business survives in the long
run without generating cash from operations.

146

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 Statement of Cash Flows
Implications to financial analysis
Limitations in Cash Flow Reporting
• Some limitations of the current reporting of cash flow:
– Practice does not require separate disclosure of cash
flows pertaining to either extraordinary items or
discontinued operations
– Income taxes are classified as operating cash flows
– Removal of pre-tax (rather than after-tax) gains or
losses on sale of plant or investments from operating
activities distorts our analysis of both operating and
investing activities (this is because their related taxes
are left in total tax expense among operating 147
activities)

Statement of Cash Flows

Demonstração de Fluxos de Caixa
Método Directo Método Indirecto
Actividades Operacionais: Actividades Operacionais:
Alternative model Recebimentos de Clientes Resultados Operacionais
Outros Recebimentos Operacionais + Amortizações do exercício
suggested by Neves Pagamentos a Fornecedores + Provisões do exercício

(2012, p. 209)
Pagamentos ao Pessoal - Acréscimos das NFM
Outros Pagamentos Operacionais - Investimentos de substituição
Investimentos de substituição
Fluxos de caixa operacional (1) Fluxos de caixa operacional (1)
Actividades Compulsivas:
Encargos financeiros
Recebimentos/pagamentos extraordinários
Imposto sobre lucros
Fluxos de caixa compulsivos e extraordinários (2)
Meios disponíveis para decisões estratégicas
(3=1+2)
Investimentos de expansão (4)
Meios libertos pelo negócio (5=3-4)
Investimentos de diversificação (6)
Meios disponíveis para accionistas e credores
(7=5-6)
Fluxos de financiamento estável (8)
Meios libertos líquidos (9=7-8)
Fluxos de financiamento curto prazo (10)
Variação dos depósitos bancários e caixa
(11= 9-10) 148

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 Bibliography:
– Subramanyam (2014). Financial Statement Analysis,
McGraw-Hill International Edition (Chapter 7)
– Neves, J. C. (2012). Análise e Relato Financeiro – uma visão
integrada de gestão, Texto Editores (Parte III – Solidez financeira
e equilíbrio financeiro, cap. 7 e 12)

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