Cash Flow Analysis and Forecasting: The Definitive Guide to Understanding and Using Published Cash Flow Data

323 Pages·2012·3.49 MB·English

by  Timothy Jury

Cash Flow Analysis
and Forecasting
ForothertitlesintheWileyFinanceseries
pleaseseewww.wiley.com/finance
Cash Flow Analysis
and Forecasting
The Definitive Guide to Understanding
and Using Published Cash Flow Data
Timothy D.H. Jury
A John Wiley & Sons, Ltd., Publication
Thiseditionfirstpublished2012
©2012TimothyD.H.Jury
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Contents
Introduction ix
SECTIONONE HISTORICCASHFLOWANALYSIS
1 UnderstandingHowCashFlowsinaBusiness 3
2 UnderstandingCashFlowsProperly 21
3 Start-up,Growth,Mature,Decline 47
4 RestatingtheCashFlowsofaRealBusiness 59
5 RestatingUSGAAPCashFlows 83
6 AnalysingtheCashFlowsofMatureBusinesses 99
7 AnalysingtheCashFlowsofGrowthBusinesses 135
8 GrowthandMature–FurtherAnalysisIssues 153
9 AnalysingtheCashFlowsofStart-upBusinesses 171
10 AnalysingtheCashFlowsofDeclineBusinesses 179
11 WhattodoaboutBadCashFlows 185
12 CashVersusProfitasaMeasureofPerformance 191
viii Contents
13 CashFlowAnalysisandCreditRisk 201
14 CashFlowAnalysisandPerformanceMeasurement 215
15 AnalysingDirectCashFlowStatements 223
16 GeneratingaCashFlowSummaryfromProfitandLossAccount
andBalanceSheetData 231
17 SummarisingHistoricFreeCashFlow 247
SECTIONTWO FORECASTINGCASHFLOWS
18 Introduction 255
19 SpreadsheetRisk 263
20 GoodPracticeSpreadsheetDevelopment 275
21 TheUseofAssumptionsinSpreadsheetModels 295
Index 305
Introduction
This book is the definitive guide to cash flow analysis. It is designed to be the
definitivefirstreferenceonallaspectsofhistoriccashflowanalysis.Italsoprovides
anincisiveoverviewoftheriskstobemanagedinpreparingcashflowforecasts.
Ithasbeenwrittenfromacashflow-centricpointofview.Otherfinancialand
analyticalinformationisintroducedwhenever relevant tosupporttheprocessof
cashflowanalysis.
Thisbookisdesignedforpeopletryingtounderstandandanalysecashflows,
probablyinaprofessionalcontext.Whilstitcontainssometheoreticalcontent,the
primaryobjectiveistoofferapracticalhandbookofcashflowanalysis.
Ideally, it should first be read like a novel and then dipped into chapter-by-
chapterasrequired;adetailedguidetothecontentsofeachchapterfollowsthis
introduction.Muchoftheinformationinthebookhasbeenlaidouttofacilitate
directreferencefromtheindex;alsoallowingittobeusedasapurereferencetext.
Considerable effort has been expended to make the book as user friendly as
possible.Ithasbeendesignedtoberelevantandusefulbothtopersonswhoare
coming to cash flows for the first time, and to those who are more experienced
intheperilsoffinancialstatementanalysis!Ihavepaidparticularattentiontothe
needs of those who are not native English speakers. I have tried to keep the use
ofEnglishasclearandconciseaspossiblewhilstavoidingtheuseofunnecessary
complexity.
Whilstthebook iswrittenprimarilyforthoseemployed asfinancial analysts,
Ihaveidentifiedfourothermajorusergroupswhoseneedsarespecificallydealt
withindifferentsectionsofthebook.Theyare:
• Novicesinfinancialanalysisandotherpersonsnewto,orrelativelyunfamiliar
with, cash flows in general and their analysis in particular, in all fields of
endeavour,whowishtoimprovetheirunderstandingofcashflow.
x Introduction
• Bankers, credit analysts and others involved in business lending and the man-
agementofcreditexposuresandcreditrisk.
• Investors, fund managers and credit analysts involved in taking investment
decisions.
• Entrepreneurs, managers and business people involved in controlling business
entities.
Theguidetothebook,whichfollowsthisintroduction,providesanindication
of the content of each chapter and its relevance to different users. For example,
personswhohavenodesiretoactuallyperformtheanalysisofthecashflowsof
a business themselves, but who still wish to understand cash flow, will initially
gainlittlefromChapters4and5astheyarewrittenforpersonswhoareseeking
topracticallyapplythetechniquefortherestatementofpublishedcashflows.
THELOGICOFTHEBOOKDESIGN
Years of experience as a financial trainer have taught me that people acquire
technicalknowledgeinaveryrandomwayfromavarietyofsourcesastheycome
across information relevant to their needs. This sometimes results in a partial,
incompleteandofteninaccurateunderstandingoftheparticularsubjectinissue.
Asatrainerandauthormyobjectiveistoorganisetheinformationrelevanttoa
subjectortaskinalogicalandstructuredwaytofacilitateandeasetheassimilation
process.ThemetaphorIliketouseisthatofajigsaw.Myaudienceswilltypically
havemanyofthepiecesofthejigsawalreadyintheirpossession;however,until
I facilitate the process of assimilation they have not previously assembled the
piecesintoacompletepicture.WhenworkingasatrainernotonlydoIassistin
completingthejigsaw,Ialsoprovidethemissingpieces,whicharedifferentfor
eachparticipant!
Forthisreasonthebookhasbeenorganisedintospecificblocksofknowledge.
Itcanbereadsequentially.Itcanalsobeusedasareferencetoprovideanswers
tospecificqueriesandproblemsbydippingintotherelevantpartofthebook.
COMPLEXITY
The word complex is regularly misused to mean difficult, or beyond the users
present comprehension. When things labelled complex are analysed it often be-
comesclearthatwhatisactuallymeantisthereisalotofinformationtoassimilate
before comprehension of the whole can be gained. The information itself is not
particularlydemandingtocomprehend;thereis,however,alotofit!Writingcom-
puter software or learning a musical instrument or foreign language are typical
examples.
Introduction xi
Mystrategyforthistypeofassimilationproblemistochoptheinformationup
into lots of little bits that are sufficiently elemental that they can be adequately
digestedbythepersonseekingtoassimilatethewholeareaofknowledgeandthen
buildtheknowledgeinapyramidformbyaddingblocksandlayersinanordered
way.ThisistheapproachIhavetakeninwritingthisbook.
THEUSEOFCASESTUDIESINTHEBOOK
Once the initial chapters have introduced the concepts upon which the analysis
of cash flows rely, the book includes a number of case studies that illustrate the
useofthetechniqueforcashflowanalysisoffered.Mostofthesecasesarebased
on financial information taken from the accounting statements of real business
entities.Iprefertodothisbecausethereisthennochallengeastotherealityof
businessbehaviour.IfIcreatefictionalcasesforthebookthereisariskuserswill
questionmyconclusionsaboutthemandcashflowanalysisingeneralonthebasis
that the examples are fictionalised and therefore do not represent a reasonable
representationofbusinessreality.
However, this inevitably results in problems with dates! The question of how
todealwithdatesinthebookisonethathasvexedmesignificantly.Theproblem
for the publisher and I is that the book will soon appear dated if we show the
yearsfromwhichthecasestudiesweretakenintheoriginal.Usersmaywrongly
assumethemessageandcontentofthebookissomehowlessrelevantbecausethe
materialusedtoillustratethelogicofthetechniqueofferedisageing.
Thelogicofthecashflowanalysistechniqueofferedinthebookisessentially
timeless,itshouldworkvirtuallyanywhereandanytimefinancialinformationis
available to perform the analysis. For this reason I have partially disguised the
originaldatesofthematerialusedtoillustratethecases.Thetimelineofmostof
thecasestudiesofferedisincidental;theexamplesaretheretoillustratetheuse
andbenefitsofthecashflowanalysistechniquethatisthebasisofthisbook.
Experienced analysts will know that in performing any business analysis the
economic context in which the company operates is sometimes highly relevant.
Matterssuchasinflation,interestratesandthestateoftheeconomymayaffectthe
conclusionsdrawnabouttherelativeperformanceofabusiness.Forthisreason,
in a small number of cases and where the context of the example warrants it, I
haveleftthedatesastheywereoriginally.Thisallowsthereadertoputthecase
intothecontextoftheeconomicconditionsprevailingatthetime.
Considerableefforthasbeenexpendedtokeepthevariousexamples,tablesand
otherinformationbothnumericallyandfactuallycorrect,however,itisinevitable
in a work of this length that, despite our best efforts, errors may still creep into
print.Pleasedonothesitatetobringthesetomyattention,tofurtherimprovethe
bookasitdevelops.