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Company Cash Flow
(Financing Basics for Engineers)
By
Moustafa M. Elsayed
Professor & Consultant
1
• Arabic Terminology
• Assets & Liabilities
• Equity
• Liquidity and Solvency
• Working Capital
• Working Capital Management
• Optimum Working Capital
• Cash Management Overview
• Cash Budget
• Hints for Improving Cash flow
• Cash Flow Controlling Indices
• Examples
• Discussion
Contents
2
Term Arabic Term Term Arabic Term
Asset ‫أصول‬ Working Capital ‫العامل‬ ‫المال‬ ‫راس‬
Fixed Asset ‫ثابتة‬ ‫أصول‬ Cash Flow ‫التدفق‬‫المالي‬
Current Asset ‫متداولة‬ ‫أصول‬ Accounts
Receivable
‫العمالء‬ ‫حسابات‬
Liability ‫الخصوم‬ Accounts
Payable
‫الموردين‬ ‫حسابات‬
Current Liability ‫المتداولة‬ ‫الخصوم‬
Long Term
Liability
‫المدى‬ ‫طويلة‬ ‫الخصوم‬
Equity ‫الملكية‬ ‫حقوق‬
Liquidity ‫السيولة‬
Solvency ‫المالية‬ ‫المالءة‬
Back
Arabic Terminology
3
• An asset is any resource owned by the business.
• Simply stated, assets represent value of ownership that can be
converted into cash
Assets and Liabilities
4
Assets and Liabilities
• A liability is defined as the future sacrifices of economic
benefits that the entity is obliged to make to other entities as a
result of past transactions or other past events.
5
Assets and Liabilities
6
Assets and Liabilities
Current Assets
• Current assets represent all the assets of a company that are
expected to be conveniently sold, consumed, utilized or
exhausted through the standard business operations, which
can lead to their conversion to a cash value over the next one
year period.
• Current assets include cash, cash equivalents, accounts
receivable, stock inventory, marketable securities, pre-paid
liabilities, and other liquid assets.
• Current assets are important to businesses because they can
be used to fund day-to-day business operations and to pay for
ongoing operating expenses.
• Since the term is reported as a dollar value of all the assets and
resources that can be easily converted to cash in a short period
of time, it also represents a company’s liquid assets.
7
Assets and Liabilities
Current Liabilities
• Current liabilities are a company's debts or obligations that are
due within one year or within a normal operating cycle.
• Furthermore, current liabilities are settled by the use of a
current asset, such as cash, or by creating a new current
liability.
• Current liabilities appear on a company's balance sheet and
include short-term debt, accounts payable, accrued liabilities,
and other similar debts.
8
Back
Equity
• Equity are the assets that remain available for the owners after
all financial obligations have been paid. ...
• Equity is the shareholders capital invested in the Company
and is part of total liability of the Company.
• Equity is the value of an asset less the value of all liabilities on
that asset.
Equity
9
Back
• Liquidity is firm’s ability to
meet its short term obligation.
• Solvency is the ability of a
company to meet its long-term
debts and financial obligations.
• Solvency is essential to staying
in business as it demonstrates
a company’s ability to continue
operations into the foreseeable
future.
• Liquidity is needed to thrive
and pay off short-term
obligations.
• A company that is insolvent
will often enter bankruptcy.
Liquidity and Solvency
10
Back
Working Capital
• Working capital represents
operating liquidity available to
a business.
• Working capital, also known as
net working capital (NWC), is
the difference between a
company’s current assets
and its current liabilities.
• Working capital is a measure
of a company’s liquidity,
operational efficiency and its
short-term financial health
Working Capital
11
Working Capital = Current Assets – Current Liabilities
Working Capital
Working Capital
• If a company has
substantial working
capital, then it should have
the potential to invest and
grow.
• If a company's current
assets do not exceed its
current liabilities, then it
may have trouble growing
or paying back creditors, or
even go bankrupt.
12
Working Capital
• The amount of working capital a small business needs to run
smoothly depends largely on the type of business, its operating
cycle and the business owners' goals for future growth.
• However, while very large businesses can get by with negative
working capital because of their ability to raise funds quickly,
small businesses should maintain positive working capital
figures.
13
Back
• This is management of CA (Current Assets) as well as CL (Current
Liabilities).
• If current assets are less than current liabilities, an entity has a
working capital deficiency, also called a working capital deficit.
Working Capital Management
14
Working Capital Management
• The fundamental principles of
working capital management
are reducing the capital
employed and improving
efficiency in the areas of
receivables, inventories, and
payables.
• When trying to attain greater
efficiency, it is important not to
focus exclusively on income and
expense items, but to also take
into account the capital
structure, whose improvement
can free up valuable financial
resources
15
Working Capital Management
• Benefit of low working capital
• Money otherwise tied up in
current assets can be
invested in activities that
generate higher payoff
• Reduces need for costly
financing
• Cost of low working capital
• Risk of shortages in cash,
inventory
• Difficulties in operation
16
High or Low Working Capital
Working Capital Management
Permanent & Temporary Working Capital
• Permanent working capital should be financed with long-term
sources, such as long-term debt and/or equity.
• Temporary (seasonal) should be financed with short-term
borrowing
17
Working Capital Management
Working Capital Financing Policies
18
Conservative Policy
Use Long Term Resources
Aggressive Policy
Use Short Term Resources
Back
• Working Capital = Current Assets –
Current Liabilities
• The optimum amount of working
capital theoretically would be zero.
• If a company could structure its
finances so that the liquidity risk were
somehow reduced to zero, there
would be no need for working capital.
• The fact remains that working capital
is needed to meet current obligations.
• How much working capital does a
business need to account for the
liquidity risk, but at the same time,
not invest excess funds in the
process?
Optimum Working Capital
19
Minimum Working Capital
• AR TOD = 365 X AR/ Revenue
• Inventory TOD = 365 X Inventory / Cost of Revenue
• AP TOD = 365 X AP / Cost of Revenue
• Asset Conversion Days = ACD
= AR TOD + Inventory TOD – AP TOD
• Daily Sales = DS = Revenue / 365
• Minimum Working Capital = ACD X DS
Example To Calculate Min WC
Optimum Working Capital
20
Turnover Days (TOD) Method
(How long does it take to convert AR and inventory, less AP, into cash)
• Common cause of business
failure: Cash crisis!
• A business can be earning a
profit and be forced to close
because it runs out of cash!
• National Federation of
Independent Business (NFIB)
study:
– 67% of small business
owners have at least
occasional problems
managing cash flow.
– 19% report cash flow as a
continuing problem.
Cash Management Overview
21
Cash Management
Cash
Accounts Payable
Decrease in Cash
Cash Purchases
Inventory
Accounts Receivable
Cash Sales
Increase in Cash
Leakage
Leakage
Cash Management Overview
22
Back
Cash Flow Components
• Increase amount and
speed of cash flowing
into the company
• Reduce the amount and
speed of cash flowing
out
• Make the most efficient
use of available cash
• Finance seasonal
business needs
Cash Management Overview
Back 23
Benefits of Cash Management
• Determine a Minimum Cash
Balance
• Forecast Sales
• Forecast Cash Receipts
• Forecast Cash Disbursements
• Estimate End-of-Month Cash
Balance
Cash Budget
24
Preparing a Cash Budget
Cash Budget
Causes of Cash Flow Problems
25
Cash Budget
Causes of Cash Flow Problems In Small Business
26
13.1%
15.4%
22.8%
29.7%
0.0% 5.0% 10.0% 15.0% 20.0% 25.0% 30.0%
Percent of Small Businesses
Weak sales
Unexpected variations in sales
Seasonal sales patterns
Difficulty collecting accounts
receivable
Causes of Cash Flow Problems in Small Businesses
Cash Budget
27
Back
28
Accounts Receivable
• A sale is not a sale until you collect the
money.
• The goal is to collect your company’s cash as
fast as you can.
Account Payable
• Stretch out payment times as long as
possible without damaging your credit
rating.
• Verify all invoices before paying them.
Inventory
• Monitor it closely; it can drain a company’s
cash.
• Avoid inventory “overbuying.”
• Arrange for inventory deliveries at the latest
possible date.
Hints for Improving Cash flow
29
Hints for Improving Cash flow
28%
18% 18%
12%
11%
4%
0%
5%
10%
15%
20%
25%
30%
PercentageofSmallBusinessUsing
Investing personal
or private funds
Postponing
purchases
Obtaining a line of
credit
Using a credit card Using a short-term
loan
Leasing rather than
purchasing
Tactic
Coping with a Cash Crunch
Tactics Used by Small Businesses
30
Hints for Improving Cash flow
Back
Cash Flow Controlling Indices
31
Cash Flow Controlling Indices
Leverage Ratios
• This is any one of several
financial measurements that
look at how much capital comes
in the form of debt (loans) or
assesses the ability of a company
to meet its financial obligations.
• Common ratios include the debt-
equity ratio, equity multiplier,
degree of financial leverage, &
consumer leverage ratio.
• Banks have regulatory oversight
on the level of leverage they are
able to have, as measured by
leverage ratios.
32
Cash Flow Controlling Indices
Debit to Equity Leverage Ratio
• Leverage ratio is used to
determine the relative level
of debt load that a
business has incurred.
• Construction firms use
construction loans to finance
most of their projects.
• Although this leads to a high
debt to equity ratio, the firm
is not at risk of insolvency.
• The owners of each
construction project are
essentially paying to service
the debt themselves.
33
Cash Flow Controlling Indices
34
Cash Flow Controlling Indices
• The debt-to-capital ratio is a
measurement of a company's
financial leverage.
• Debt includes all short-term
and long-term obligations.
• Capital includes the
company's debt and
shareholder's equity.
• This ratio is used to evaluate a
firm's financial structure and
how it's financing operations.
35
• Typically, if a company has a
high debt-to-capital ratio
compared to its peers, then it
may have a higher default
risk due to the effect the debt
has on its operations.
Debt-to-Capital Ratio
Debt-to-Capital Ratio = Total Debt / Total Capital
Cash Flow Controlling Indices
The Equity Multiplier
• The equity multiplier is similar, but replaces debt with assets in
the numerator:
Equity Multiplier = (Total Assets) / (Total Equity)
36
A lower equity multiplier
is preferred because it
indicates that the
company is taking on
less debt to buy assets.
In this case
Cash Flow Controlling Indices
Working Capital Ratios
37
• Working Capital = Current Assets – Current Liabilities
• Current Ratio (CR) = Current Assets / Current Liabilities
• This ratio should be about 2 or more for safe and healthy
operation.
• As this ratio approaches one or less than 1, there will be strong
indicator that the company has a liquidity problem.
• Care must be given for cases with high value of CR because of
high inventory value. Could this inventory really be sold at
estimated value?
• Quick Ratio = (Current Assets – Inventory) / Current Liabilities
Back
Excel Sheet Examples
Examples
38Back
Open
Discussion
Discussion
Back 39

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Company cash flow, financing basics for engineers 190818

  • 1. Company Cash Flow (Financing Basics for Engineers) By Moustafa M. Elsayed Professor & Consultant 1
  • 2. • Arabic Terminology • Assets & Liabilities • Equity • Liquidity and Solvency • Working Capital • Working Capital Management • Optimum Working Capital • Cash Management Overview • Cash Budget • Hints for Improving Cash flow • Cash Flow Controlling Indices • Examples • Discussion Contents 2
  • 3. Term Arabic Term Term Arabic Term Asset ‫أصول‬ Working Capital ‫العامل‬ ‫المال‬ ‫راس‬ Fixed Asset ‫ثابتة‬ ‫أصول‬ Cash Flow ‫التدفق‬‫المالي‬ Current Asset ‫متداولة‬ ‫أصول‬ Accounts Receivable ‫العمالء‬ ‫حسابات‬ Liability ‫الخصوم‬ Accounts Payable ‫الموردين‬ ‫حسابات‬ Current Liability ‫المتداولة‬ ‫الخصوم‬ Long Term Liability ‫المدى‬ ‫طويلة‬ ‫الخصوم‬ Equity ‫الملكية‬ ‫حقوق‬ Liquidity ‫السيولة‬ Solvency ‫المالية‬ ‫المالءة‬ Back Arabic Terminology 3
  • 4. • An asset is any resource owned by the business. • Simply stated, assets represent value of ownership that can be converted into cash Assets and Liabilities 4
  • 5. Assets and Liabilities • A liability is defined as the future sacrifices of economic benefits that the entity is obliged to make to other entities as a result of past transactions or other past events. 5
  • 7. Assets and Liabilities Current Assets • Current assets represent all the assets of a company that are expected to be conveniently sold, consumed, utilized or exhausted through the standard business operations, which can lead to their conversion to a cash value over the next one year period. • Current assets include cash, cash equivalents, accounts receivable, stock inventory, marketable securities, pre-paid liabilities, and other liquid assets. • Current assets are important to businesses because they can be used to fund day-to-day business operations and to pay for ongoing operating expenses. • Since the term is reported as a dollar value of all the assets and resources that can be easily converted to cash in a short period of time, it also represents a company’s liquid assets. 7
  • 8. Assets and Liabilities Current Liabilities • Current liabilities are a company's debts or obligations that are due within one year or within a normal operating cycle. • Furthermore, current liabilities are settled by the use of a current asset, such as cash, or by creating a new current liability. • Current liabilities appear on a company's balance sheet and include short-term debt, accounts payable, accrued liabilities, and other similar debts. 8 Back
  • 9. Equity • Equity are the assets that remain available for the owners after all financial obligations have been paid. ... • Equity is the shareholders capital invested in the Company and is part of total liability of the Company. • Equity is the value of an asset less the value of all liabilities on that asset. Equity 9 Back
  • 10. • Liquidity is firm’s ability to meet its short term obligation. • Solvency is the ability of a company to meet its long-term debts and financial obligations. • Solvency is essential to staying in business as it demonstrates a company’s ability to continue operations into the foreseeable future. • Liquidity is needed to thrive and pay off short-term obligations. • A company that is insolvent will often enter bankruptcy. Liquidity and Solvency 10 Back
  • 11. Working Capital • Working capital represents operating liquidity available to a business. • Working capital, also known as net working capital (NWC), is the difference between a company’s current assets and its current liabilities. • Working capital is a measure of a company’s liquidity, operational efficiency and its short-term financial health Working Capital 11 Working Capital = Current Assets – Current Liabilities
  • 12. Working Capital Working Capital • If a company has substantial working capital, then it should have the potential to invest and grow. • If a company's current assets do not exceed its current liabilities, then it may have trouble growing or paying back creditors, or even go bankrupt. 12
  • 13. Working Capital • The amount of working capital a small business needs to run smoothly depends largely on the type of business, its operating cycle and the business owners' goals for future growth. • However, while very large businesses can get by with negative working capital because of their ability to raise funds quickly, small businesses should maintain positive working capital figures. 13 Back
  • 14. • This is management of CA (Current Assets) as well as CL (Current Liabilities). • If current assets are less than current liabilities, an entity has a working capital deficiency, also called a working capital deficit. Working Capital Management 14
  • 15. Working Capital Management • The fundamental principles of working capital management are reducing the capital employed and improving efficiency in the areas of receivables, inventories, and payables. • When trying to attain greater efficiency, it is important not to focus exclusively on income and expense items, but to also take into account the capital structure, whose improvement can free up valuable financial resources 15
  • 16. Working Capital Management • Benefit of low working capital • Money otherwise tied up in current assets can be invested in activities that generate higher payoff • Reduces need for costly financing • Cost of low working capital • Risk of shortages in cash, inventory • Difficulties in operation 16 High or Low Working Capital
  • 17. Working Capital Management Permanent & Temporary Working Capital • Permanent working capital should be financed with long-term sources, such as long-term debt and/or equity. • Temporary (seasonal) should be financed with short-term borrowing 17
  • 18. Working Capital Management Working Capital Financing Policies 18 Conservative Policy Use Long Term Resources Aggressive Policy Use Short Term Resources Back
  • 19. • Working Capital = Current Assets – Current Liabilities • The optimum amount of working capital theoretically would be zero. • If a company could structure its finances so that the liquidity risk were somehow reduced to zero, there would be no need for working capital. • The fact remains that working capital is needed to meet current obligations. • How much working capital does a business need to account for the liquidity risk, but at the same time, not invest excess funds in the process? Optimum Working Capital 19 Minimum Working Capital
  • 20. • AR TOD = 365 X AR/ Revenue • Inventory TOD = 365 X Inventory / Cost of Revenue • AP TOD = 365 X AP / Cost of Revenue • Asset Conversion Days = ACD = AR TOD + Inventory TOD – AP TOD • Daily Sales = DS = Revenue / 365 • Minimum Working Capital = ACD X DS Example To Calculate Min WC Optimum Working Capital 20 Turnover Days (TOD) Method (How long does it take to convert AR and inventory, less AP, into cash)
  • 21. • Common cause of business failure: Cash crisis! • A business can be earning a profit and be forced to close because it runs out of cash! • National Federation of Independent Business (NFIB) study: – 67% of small business owners have at least occasional problems managing cash flow. – 19% report cash flow as a continuing problem. Cash Management Overview 21 Cash Management
  • 22. Cash Accounts Payable Decrease in Cash Cash Purchases Inventory Accounts Receivable Cash Sales Increase in Cash Leakage Leakage Cash Management Overview 22 Back Cash Flow Components
  • 23. • Increase amount and speed of cash flowing into the company • Reduce the amount and speed of cash flowing out • Make the most efficient use of available cash • Finance seasonal business needs Cash Management Overview Back 23 Benefits of Cash Management
  • 24. • Determine a Minimum Cash Balance • Forecast Sales • Forecast Cash Receipts • Forecast Cash Disbursements • Estimate End-of-Month Cash Balance Cash Budget 24 Preparing a Cash Budget
  • 25. Cash Budget Causes of Cash Flow Problems 25
  • 26. Cash Budget Causes of Cash Flow Problems In Small Business 26 13.1% 15.4% 22.8% 29.7% 0.0% 5.0% 10.0% 15.0% 20.0% 25.0% 30.0% Percent of Small Businesses Weak sales Unexpected variations in sales Seasonal sales patterns Difficulty collecting accounts receivable Causes of Cash Flow Problems in Small Businesses
  • 28. 28 Accounts Receivable • A sale is not a sale until you collect the money. • The goal is to collect your company’s cash as fast as you can. Account Payable • Stretch out payment times as long as possible without damaging your credit rating. • Verify all invoices before paying them. Inventory • Monitor it closely; it can drain a company’s cash. • Avoid inventory “overbuying.” • Arrange for inventory deliveries at the latest possible date. Hints for Improving Cash flow
  • 30. 28% 18% 18% 12% 11% 4% 0% 5% 10% 15% 20% 25% 30% PercentageofSmallBusinessUsing Investing personal or private funds Postponing purchases Obtaining a line of credit Using a credit card Using a short-term loan Leasing rather than purchasing Tactic Coping with a Cash Crunch Tactics Used by Small Businesses 30 Hints for Improving Cash flow Back
  • 31. Cash Flow Controlling Indices 31
  • 32. Cash Flow Controlling Indices Leverage Ratios • This is any one of several financial measurements that look at how much capital comes in the form of debt (loans) or assesses the ability of a company to meet its financial obligations. • Common ratios include the debt- equity ratio, equity multiplier, degree of financial leverage, & consumer leverage ratio. • Banks have regulatory oversight on the level of leverage they are able to have, as measured by leverage ratios. 32
  • 33. Cash Flow Controlling Indices Debit to Equity Leverage Ratio • Leverage ratio is used to determine the relative level of debt load that a business has incurred. • Construction firms use construction loans to finance most of their projects. • Although this leads to a high debt to equity ratio, the firm is not at risk of insolvency. • The owners of each construction project are essentially paying to service the debt themselves. 33
  • 34. Cash Flow Controlling Indices 34
  • 35. Cash Flow Controlling Indices • The debt-to-capital ratio is a measurement of a company's financial leverage. • Debt includes all short-term and long-term obligations. • Capital includes the company's debt and shareholder's equity. • This ratio is used to evaluate a firm's financial structure and how it's financing operations. 35 • Typically, if a company has a high debt-to-capital ratio compared to its peers, then it may have a higher default risk due to the effect the debt has on its operations. Debt-to-Capital Ratio Debt-to-Capital Ratio = Total Debt / Total Capital
  • 36. Cash Flow Controlling Indices The Equity Multiplier • The equity multiplier is similar, but replaces debt with assets in the numerator: Equity Multiplier = (Total Assets) / (Total Equity) 36 A lower equity multiplier is preferred because it indicates that the company is taking on less debt to buy assets. In this case
  • 37. Cash Flow Controlling Indices Working Capital Ratios 37 • Working Capital = Current Assets – Current Liabilities • Current Ratio (CR) = Current Assets / Current Liabilities • This ratio should be about 2 or more for safe and healthy operation. • As this ratio approaches one or less than 1, there will be strong indicator that the company has a liquidity problem. • Care must be given for cases with high value of CR because of high inventory value. Could this inventory really be sold at estimated value? • Quick Ratio = (Current Assets – Inventory) / Current Liabilities Back