Layout of Part II

1
Layout of Part II
Part II Page 208
Chapter 7 The business activities - Financing -
Investing - Operating and the financial statements
Chapter 11 The Analysis of Profitability
2
Cash Flows Between the Firm and Claimants in the
Capital Market
Chapter 7 Page 212 Figure 7.1
Capital Markets
The Firm
Debt Holders or Issuers
Net Financial Assets (NFA)
Share Holders
Financing Activities

• F is net cash flow to debt holders (or issuers)

• d is net dividend to shareholders

3
Business ActivitiesALL THE CASH FLOWS
Chapter 7 Page 214 Figure 7.2
Capital Markets
The Firm
Debt Holders or Issuers
F
Net Financial Assets (NFA)
Net Operating Assets (NOA)
Share Holders
d
Operating Activities
Financing Activities

• I is net cash invested in operating assets

• C is net cash (flow) from operations

• C-I is free cash flow

• If NFA are negative, they are Net Financial
  Obligations (NFO)

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The Cash Conservation Equation
Chapter 7 Pages 213-215

• A fundamental accounting identity
• C Net cash from operations
• I Net cash outflow for investing (purchases,
  divestments)
• C - I Free cash flow
• d Net dividends to shareholders (including
  common dividends, stock issues...)
• F Net cash outflow for debt financing
  (principal interest)
• The treasurers rule
• If C - I - i gt d lend or buy down own debt
• If C - I - i lt d borrow or reduce lending
• i is net interest paid

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Financial ActivitiesStocks Flows

• The cash flows flow into/out of the financial
  assets their change must be explained by the
  four flows components of the equation.
• For Financial Assets (FA)
• For financial obligations (FO)
• (it is interest paid)
• For given interest payments and net dividends,
  cash flow from operations (C) reduces borrowing
  and cash investment (I) increases it

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Reformulated Statementof Cash Flows
Chapter 7 Page 215

• Cash flows from operations C
• Cash investment in operations (I)
• Free cash flow from operations C - I
• Equity financing flows
• Dividends and share repurchases XX
• Share issues (XX) d
• Debt financing flows
• Net purchase of financial assets XX
• Interest on financial assets (XX)
• Net issue of debt (XX)
• Interest on debt XX F
• Total financing flows d F

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Balance Sheet
Chapter 7 Page 216

• Assets
• Operating assets OA
• Financial assets FA
• Total Assets OA FA
• Equities
• Operating liabilities OL
• Financial obligations FO
• Common stockholders equity CSE
• Total Equities OL FO CSE

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Balance Sheet Reformulated
Chapter 7 Page 216

• Operating Assets
• Operating assets OA
• Operating liabilities (OL)
• Net operating assets NOA
• Financial Obligations Owners Equity
• Financial liabilities FO
• Financial assets (FA)
• Net financial obligations NFO
• Common equity CSE
• Total NFO Equity NFO CSE

NOA OA - OL NFA FA - FO CSE NOA NFA
(Usually NFA is negative NFO) CSE NOA - NFO
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Business ActivitiesAll the Stocks Flows
Chapter 7 Page 218 Figure 7.3
OR - OE OI

• OR is operating revenue
• OE is operating expense
• NFI is net financial income

• D indicates change
• NFA can be negative (NFO)

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Business ActivitiesAll the Stocks Flows
Chapter 7 Page 218 Figure 7.3
OR - OE OI

• OR is operating revenue
• OE is operating expense
• NFI is net financial income

• D indicates change
• NFA can be negative (NFO)

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Business ActivitiesAll the Stocks Flows
Chapter 7 Page 218 Figure 7.3
OR - OE OI

• OR is operating revenue
• OE is operating expense
• NFE is net financial expense

• D indicates change
• NFA can be negative (NFO)

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Income Statement
Chapter 7 Page 217

• The difference between operating revenue and
  operating expense is called operating income
• OI OR - OE
• Net financing expense can be negative (net
  financial income)

Income Statement Operating income Operating
revenue OR Operating expense (OE) OI Net
financing expense Interest expense
XX Interest revenue (XX) (NFE) Comprehensive
income Earnings
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Business Activities and theFinancial Statements
Chapter 7 Summary
14
Stocks FlowsOperating Activities
Chapter 7 Pages 220-221

• The change in NFO is given by
• The change in NOA is given by
• Operating income in the income statement flows to
  net operating assets in the balance sheet.
• Free cash flow reduces NOA and reduces NFO
  (increases NFA). Free cash flow can be seen as a
  dividend paid from operating to financial
  activities

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Stocks Flows RatiosBusiness Profitability
Chapter 7 Page 224

• Separating operating and financing activities in
  the Income Statement identifies profit flows
• Comparison of these flows with their asset base
  yields the corresponding rates of return
• Return on Net Operating Assets
• Return on Net Financial Assets
• If there are NFO rather than NFA, net borrowing
  cost
• Forecasting ROCE (at the heart of the valuation
  model) involves both the forecast of RNOA and
  RNFA (or NBC)