financial management

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ONE DAY SEMINAR
ON
“Assessment of borrower’s
financial position through CASH
Flow Analysis”
Scheduled at SBP auditorium
on 23rd September 2010

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PRESENTED BY:-
KHALID SULTAN ANJUM
AVP/Senior Manager.
Habib Bank Ltd.
MA Economics, DAIBP,
MA English, LLB, MBA.
& etc
Email: ksanjum_hbl@yahoo.com
0321-727 2877

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Objective of the Day
 To establish the awareness amongst the
participants
i) The importance & purpose of Cash Flow.
ii) How cash transactions are classified within a
statement of cash flows.
iii) Computing the major cash flows relating to
investing , financing & (operating) activities
using the indirect method.

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CASH FLOW.
The receipt & payment of cash in a given period;
or the expected stream of cash
receipts & payments over a future time period;
for business. It consists of the realized cash
amount from turnover or sales and payments for
business expenses in cash over a given period.

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CASH FLOW Analysis.
 A method of analysis to provide information
about a company’s ability to generate cash in a
given period, thus its liquidity & financial
flexibility
 A systematic presentation of net cash flows from
a business operations.
 It is usually carried out through comparison of
B/S information and cash flow statement that
reveals sources and uses of cash funds from
turnover/sales, working capital and financing of
business activities during a given period.

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CASH FLOW CYCLE.
 Starts from the purchase from raw materials,
inventories or tradable items followed by sales
and reconversion into cash;
 It is the continues inflow and outflow of cash at
various stages of a firm’s normal business
operations.

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CASH FLOW FORECAST.
 BASED ON EXPECTED cash receipts & payments
IN GIVEN PERIOD IN FUTURE.
 It gives the business trends and anticipated
business development involving sophisticated
analytical, decision parameters and judgments
regarding future market trends.
 It provides a forehand knowledge of when cash
surplus or shortage are likely to occur so that
appropriate actions can be taken or planned to
deal with these eventualities.

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CASH FLOW Statement.
The financial Statement that identifies the
amount and sources of cash receipts and
payments during a period of time in
future.
NET CASH FLOW
The total of the retained profits of a
business after tax, together with the
amount set a part for depriciation.

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Y Statement of Cash Flows?
 The company’s ability to generate positive future
cash flows.
 The company’s ability to meet its obligations and
pay dividends.
 The company’s need for external financing.
 The reasons for differences between the
company’s net income and associated cash
receipts and payments.
 Both the cash and noncash aspects of the
company’s investing and financing transactions.
The statement of cash flows helps users to assess--

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CASH FLOW Statement VS Cash Budget
Statement
Cash budget statement reveals projected cash
receipts cash payments and ends up with the
projected cash availability picture.
However Cash Flow Statement shows the
source of funds which includes cash and non
cash items and also shows the uses of funds.

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Operating activities include all the transactions
and other events related to its earnings process.
Investing activities include all the transactions
involving acquiring and selling long-term
investment, acquiring and selling property, plant,
and equipment, and lending money and collecting
on loans.
Financing activities include all the transactions
involved in obtaining and disbursing resources
from and to owners and repaying the amounts
borrowed.
Statement of Cash Flows

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Uses of Cash Flow Statement.
 It reveals the CO’S ability-----
 To generate the +ve cash flows in future.
 To meet the Obligation ,to pay dividends
as well as its debt servicing.
 Co’s need for external financing.

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Financing activities
 Financing activities include the inflow of cash from investors such as
banks and shareholders, as well as the outflow of cash to
shareholders as dividends as the company generates income. Other
activities which impact the long-term liabilities and equity of the
company are also listed in the financing activities section of the cash
flow statement.
 Under IAS 7,
 Proceeds from issuing short-term or long-term debt
 Payments of dividends
 Payments for repurchase of company shares
 Repayment of debt principal, including capital leases
 For non-profit organizations, receipts of donor-restricted cash that is
limited to long-term purposes

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Disclosure of noncash activities
 Under IAS 7, noncash investing and financing activities
are disclosed in footnotes to the financial statements.
Under US General Accepted Accounting Principles
(GAAP), noncash activities may be disclosed in a
footnote or within the cash flow statement itself.
Noncash financing activities may include
 Leasing to purchase an asset
 Converting debt to equity
 Exchanging noncash assets or liabilities for other
noncash assets or liabilities
 Issuing shares in exchange for assets

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Sample cash flow Direct method (Rs)
Operating activities
1.Cash receipts 27000
2.Paid to suppliers (20000)
3.Cash from operations 7500
4. Interest paid ( 2000)
Net cash flows 15000

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Cash from investing activities
Proceeds from the sale
of equipment
7,500
Dividends received 3000
Net cash flows from
investing activities
10500

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Cash flow from financing activities
Dividends paid (2,500)
Net cash flows used in
financing activities
(2,500).

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Net increase in cash and
cash equivalents
9500
Cash and cash
equivalents, beginning
of year
1000
Cash and cash
equivalents, end of
year$
10500

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Rules used to make adjustments
The following rules are used to make adjustments for changes in
current assets and liabilities, operating items not providing or using
cash and non operating items.
 Decrease in non-cash current assets are added to net income
 Increase in non-cash current asset are subtracted from net income
 Increase in current liabilities are added to net income
 Decrease in current liabilities are subtracted from net income
 Expenses with no cash outflows are added back to net income
(depreciation and/or amortization expense are the only operating
items that have no effect on cash flows in the period)
 Revenues with no cash inflows are subtracted from net income
 Non operating losses are added back to net income
 Non operating gains are subtracted from net income

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Three most important liquidity
ratio:
 Current ratio = current assets/current
liabilities
 It is interpreted as indicate the ability of
the borrower to meet its maturity
obligations. These standard most
commonly accepted is that current
assets should preferably be twice of
current liabilities i-e 2:1.

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Liquidity Ratios
 ii) Stock turnover = net sales/ inventory
 Comparison of result of this ratio from year
to year for the same company will show how it is
utilizing its inventory to generate sales. Declining
efficiency as shown by declining ratio forecast
slowness in converting assets into cash.
 Slow turnover of inventory may be indicative of
excess investment in old and slow moving stock.

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Liquidity Ratios
 iii) sales to networking capital = net sales
/current assets –current liabilities
 it defines the efficiency with which
networking capital is being utilized in
producing goods/sales.

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Solvency Ratios
 i) Debt to net worth = current debt =
long term liabilities /net worth
 it shows proportions outside creditors
in relation to equity investment by
owners.
 ii) Net profit to total assets
 it shows how efficiently total asset
are used in producing profit.

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Solvency Ratios
 iii) Net sales to total assets
 it shows the volume of sales
generated by total assets.

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Early warning signals:
Indicators of week loans
 Irregular and delinquent loan
repayment
 Frequent alternation of loan terms.
 Poor loan renewal past records i-e little
reduction of principal loan amount

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Indicators of week loans
 Rising debt to net worth ratio.
 Missing or defective documentation
 Usually a high loan price rate – to compensate for
high risk.
 Poor quality collateral
 Revaluation of assets held as collateral
 High accumulation of accounts receivables
 Absence of cash flow projections
 Borrower’s reliance on outside funds to meet
loan repayments

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Indicators of poor bank lending
policies
 Poor selection of risks among borrowing customer
 Lending money disproportionate to its funding
resources depending on outside inter bank
borrowings for liquidity
 Lending money because of customers promising
large deposits
 failure to specify loan repayment plan
 absence of defining a targeted market.

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Why early warning signals do not
reach timely?
 This is because bank’s do not carry out loan
review at a regular frequency
 The frequency period of loan review should be
based on the financial health, attitude of the
borrower and regularity of repayment frequency
.
 The banks remain in dark about the conduct of a
loan account and awake when the loan gripped
with the problem of debt servicing and by the
time out they move, it is already late and
damage is done.

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Why early warning signals do not
reach timely?
 Loan review should be carried out for all types of
loans on a periodical bases for example,
30,60,or,90 days.
 Structuring the loan review process carefully
make the loan checked which includes i) the
status of regular debt service according to the
repayment schedule ii) the quality and condition
of the collateral pledged iii) the perfection of
loan documents to ensure that bank has full
excess to any collateral pledged and have full
legal authority to take action against the
borrowers in the court if necessary.

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Negative Loan covenants embodied in
loan agreement for the purpose of :
 Cash flow control
 Balance sheet control
 To recall loan for non compliance

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Covenants:
 Covenants are agreements or stipulation express
or implied in contracts, deeds,leases,mortgages
and etc.
 It is lenders ability to successfully negotiate in
collision of various covenants in the loan
documents needed to protect lenders intrest.
 The purpose is to ensure a proper control on
borrowers, its operations and thus ensuring
timely repayment of the loan.
 Covenants are negative and positive which form
the part of the loan agreement.

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Covenants:
 Other covenents that can protect the
bank from the borrower’s financial
detoriation by establishing minimum
financial standards, that when violated
authorized the bank to recall the loan or
to restructure the loan terms to make it
still harder.

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Covenants:
 Balance sheet covenants’ protect the
loan by restraining the borrower from
taking action that unduly weaken the
balance sheet and jeopardize the value
of collateral.

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Positive loan covenants:
 a) To maintain certain level of working
capital or network.
 b) Pay all taxes and other obligations that
if unpaid might result in a lien.
 c) Maintain plant and equipment and other
properties in good repair and physical
condition of the asset.

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Business cash flow
 d) Permit bank personal to inspect
company assets verify the authenticity of
financial statements.
 e) Maintain his principal business account
with the lender bank.

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Business cash flow
 Not only an effective tool for assessment
of borrowers repayment capacity
 The effectively of the business cash flow is only
dependable source of loan repayment but it can
only be possible when the loan is used in
purchasing raw material or other inputs to be
used in business then only cash to cash cycle /
convergent cycle will create needed cash flow to
service the

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Business Cash Flow
 Sometimes when the real purpose of the
loan may be substantially different or
banks fund were used for a different
purpose the bank must have to protect
itself from such dishonest incompetent
and adversely subjective borrowers.

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Situations where cash flow alone
may not be sufficient
 Credit investigating into the credit
background of the borrower is essential
because such short term loan become
hundred percent defacto.
 The above are the different situations
where cash flow alone may not be
sufficient to repay the loan and hence
some collateral as alternative source of
repayment will be needed.

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RISK ADJUSTED
Loan pricing
 Less risky a customer (the more credit
worthy he is ) the lower the loan price and
vice versa.
 Loan pricing involves some combination of
target ROE and markup pricing.

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 The basic idea in this framework is to
develop a five target price for identifiable
risks and costs.
 The profit element is defined as a margin
or spared over the cost and risk factors,
thus the profit price is equal to cost factor
plus the risk factor plus profit margin.

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 Illustration of risk adjusted loan pricing
 profit margin--------------------- 4.5%
 Costs
 funds-------------- 6%
 overhead---------- 2% ----------- 8.00% RISKS
 Credit risk--------- 2%
 Maturity risk------ 1%
 Collateral value---0.50%--------- 3.5%

Total---------------------------------16%

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