Modern cash flow meters - Corporate financial management

9.3.2. Modern cash flow meters

Net operating cash flow can be recorded somewhat differently:

Net operating cash flow = Marginal component ±

± The investment component, (9.18)

where the marginal component is the difference between sales and the amount of costs (sales cost, administrative costs, taxes); investment component - changes in the need for working capital.

The problem of applying cash flows in management practice is now clear. If marginal decisions are made without taking into account their impact on investment in the operational cycle, the result can be devastating for operating cash flow.

Operating cash flow as the basis of strategic decisions. From this statement it follows that the company must control its operational activity, based not on the margin, but on the net operating cash flow. If you monitor the activities of operational managers based on assessing their contribution to the growth of net operating cash flow, this can stimulate their desire to increase the margin without additional investment in the growth of the scale of operating activities. All this will eventually lead to an increase in net operating cash flow.

Any company can be represented as a machine for the production of money. It must make strategic investment and financial decisions in order to constantly generate money. Strategic investment decisions involve the construction of plants, the purchase of equipment, mergers and acquisitions. Strategic financial decisions include long-term borrowings and share issues.

Strategic decisions are key to creating value, but do not give guarantees of "production" extra money. And only when they are supported by quality effective operational decisions aimed at optimizing the operational cycle, the company has the right to count on surplus money based on its performance. The effectiveness of this activity is measured by the net operating cash flow. Management of operational activities (and not the sale of assets or bank loans) acts as a pledge and guarantee of the successful existence of the company. Net operating cash flow is the best indicator that characterizes the company's ability to generate cash flows. Unlike the cash flow of the banker, where changes in working capital are not taken into account, the net operating cash flow includes this most important indicator of operating activity.

In the practice of modern financial management, three types of documents on cash flows are used: the first involves the division of cash flows into three types of the company's activities; the second allows you to distinguish between pediscretionary cash flows and cash flows over which the company establishes tight control; the third is built in accordance with international financial reporting standards.

EBITDA - profit before interest, taxes and depreciation. Like many other financial indicators, EBITDA, if properly used, can give an opportunity to see the state of affairs in the company from an unexpected point of view. However, it can lead to false conclusions, if the context of its application is incorrect. Let's give a simple example. If you add depreciation to the numerator of the coverage ratio, it is quite likely that the operating profit may not be enough to pay interest, but the money will be more than enough to realize this goal. That is why lenders experience certain comfort and confidence in using loans EBITDA .

When adding depreciation to the coverage factor, care must be taken. The argument in favor of EBITDA when calculating the coverage ratio is built on one implicit assumption: adding depreciation to the numerator of the coverage factor is only possible for the period during which the company intends to recoup its investments. Strictly speaking, the cash flow represented by depreciation is not really real, they can not be paid for by debt, at least on a continuous basis. In fact, the letter D in EBITDA plays the role of the spare wheel in case the treasurer discovers that the operating profit or EBIT is not enough to pay interest. Under the current conditions, the company can temporarily reduce its capital expenditures, thus freeing up some of the depreciation for interest payments. Of course, you can do this only for a very short period, because the purchase of equipment or repairs can be postponed, but only for a while, otherwise there is a threat of losing competitive advantages.

EBITDA allows you to distinguish between the credit risks of companies with the same interest coverage (interest for credit). However, this indicator has its own limitations in use, in particular:

o problems of after-tax profits;

o search for alternatives to net profit;

o Limits of net profit as valuation;

o the same net profit for different values ​​of the two companies;

o the same profit, the same interest and different financial risks.

For the near term, the use of EBITDA by the largest auditing companies is defined as:

o First, using EBITDA and the corresponding coefficients as the only cash flow measure can lead to errors;

o Secondly, EBITDA is best reduced to estimating the profit before interest and taxes, to which depreciation is added. Thus, the greater the share of profit before interest and taxes, the more accurate the estimate of cash flow;

o Thirdly, EBITDA replaces the definition of cash flow when a company is in extreme circumstances. EBITDA remains an effective tool for analyzing risk loans at the bottom of the life-cycle curve. For other phases of the life cycle, for loans with a high rating, this indicator is less effective;

o fourth, EBITDA - is the best measurer for companies whose assets have a long life, but it does not suit companies with assets with a short life or inherent they are serious technological changes;

o Fifth, the indicator EBITDA is easily manipulated through aggressive accounting policies related to the calculation of costs and profits.

Despite the problems of using EBITDA in management practice, one should keep in mind: this indicator plays a huge role in the analysis of securities. Many analysts see it as a synonym for cash flow or, more precisely, operational cash flow. Nevertheless, the practice of modern financial management is actively discussing the question of replacing EBITDA with operating cash flow.

EBITDA and operating cash flow. In 1966, William J. Beaver tested various financial ratios in their studies for their ability to predict corporate bankruptcy. Among these coefficients was the cash flow, so widely used in the practice of modern financial management. According to Beaver's definition, the cash flow looks like this:

Cash flow = Net profit + Amortization.

У. Beaver found that among the tested indicators the best was the ratio, which is the ratio of cash flow and total debt. From a practical point of view, this is understandable. The risk of bankruptcy increases if the net profit decreases or the aggregate debt grows or the ratio of the cash flow to the total debt decreases.

Of course, the definition of cash flow given by W. Biewer did not include interest and taxes added to net profit for the construction of EBITDA . Nevertheless, all modern analysts are trying to assess the risk of default using the indicator EBITDA, replacing the cash flow. In fairness, it should be noted: U. B and faith only pointed out that the ratio of cash flow and total debt is better than others predicts bankruptcy. Later, many researchers emerged who created models for assessing and predicting bankruptcy, based on a multiple set of financial ratios. True, there is no "cash flow" indicator among them.

Operating cash flow for risk assessment. Investment managers sometimes ask analysts to determine the real credit risk of companies. In their opinion, only the ratio of the cash flow with fixed liabilities predicts bankruptcy better than all existing quantitative and qualitative contrivances. Thus, investment managers today realize what was invented 40 years ago, with one exception: instead of cash flow, they use the indicator EBITDA.

In the 1980s. it became clear: neither EBITDA, nor the net profit with the addition of depreciation are identical to the replacement of cash flows. In support of what has been said, as an example, let us cite the case of the bankruptcy of the famous American universal store, "Grant". Analysts used the measure "earnings + depreciation and scanned a company with a significant need for working capital. The "Grant", the largest bankruptcy of the retailer, had positive and stable cash flows ("net profit + depreciation" according to the definition of W. Beaver). Nobody could even think about bankruptcy. However, it turned out that it was necessary to investigate two more balance items linking money - stocks and accounts receivable. It was equally important to establish whether it is legitimate to manipulate accounts payable, trying to save live money. Recognizing the need for such an analysis, the World Committee on International Financial Reporting Standards gave a modern definition of operating cash flow (Article 95 of the IFRS, 1987):

Operating cash flow = Net profit + Amortization ±

± Changes in working capital requirements, (9.19)

Where Need for working capital = Accounts receivable + + Inventories - Accounts payable.

This definition focuses on the elements of working capital, which grow in proportion to the scale of operating activities. The definition given in international standards excludes money and their equivalents, as well as short-term debt.

Cash flow and cyclical development of the company. Any company in its development passes through different phases, similar to the stages of life. Then) it is important to understand at what phase of the life cycle the company is in, and with what financial problems it is in this phase that it faces or collides. Revenues are slowly forming in the initial stage of the life cycle, when the company organizes its business, launches production. Growth and profit quickly increase in the stage of growth, when a company product penetrates the market and begins to be in demand, and production reaches a profitable stage. In the active growth phase , sales and earnings growth begins to fall as the market becomes saturated. In the saturation phase sales are limited to the replacement of previously sold products and the growth of population demand. At this stage, price competition is often intensified as the company increases sales growth through the growth of market share. The recession phase does not automatically follow the saturation stage, however, during a long stay in the saturation phase, companies are sorely in need of a technological update. In the recession phase, sales and revenues fall sharply, the likelihood of bankruptcy increases significantly.

The characteristics of the company in different phases of development correspond to cash inflows and outflows. For example, companies in the initial phase refer to those who use money, and they are characterized by negative cash flows or outflows. At this stage, companies are supported by venture capital, and analysts give an assessment of the prospects of venture companies from the perspective of generating revenue sufficient to turn the company into a public one.

In the phases of birth and growth, companies need a long time to reach the entry phase into the food market. The market is characterized by rapid growth, but no investment income. In the phase of fixed growth, companies reach a level of sufficient profitability. Capital expenditure still exceeds depreciation, but the difference is not as great as in the previous stage. At the saturation stage, the cash flow from depreciation is fully covered by the capital budget. Moreover, the company has a constant positive cash flow from operations. Consolidation is a typical feature of the saturation phase, because companies take advantage of economies of scale, trying to overcome the beginning of the trend of lowering the profit margins. In the recession phase, companies are actively engaged in restructuring, dramatically increasing their financial leverage.

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