Cash Flow Analysis and Forecasting: The Definitive... (PDF) (2024)

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Cash Flow Analysisand Forecasting

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For other titles in the Wiley Finance seriesplease see www.wiley.com/finance

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Cash Flow Analysisand ForecastingThe Definitive Guide to Understandingand Using Published Cash Flow DataTimothy D.H. JuryA John Wiley & Sons, Ltd., Publication

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This edition first published 2012© 2012 Timothy D.H. JuryRegistered OfficeJohn Wiley & Sons Ltd, The Atrium, Southern Gate, Chichester, West Sussex, PO19 8SQ,United KingdomFor details of our global editorial offices, for customer services and for information about how toapply for permission to reuse the copyright material in this book please see our website atwww.wiley.com.The right of the author to be identified as the author of this work has been asserted in accordance withthe Copyright, Designs and Patents Act 1988.All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, ortransmitted, in any form or by any means, electronic, mechanical, photocopying, recording orotherwise, except as permitted by the UK Copyright, Designs and Patents Act 1988, without the priorpermission of the publisher.Wiley also publishes its books in a variety of electronic formats and by print-on-demand. Somecontent that appears in standard print versions of this book may not be available in other formats. Formore information about Wiley products, visit us at www.wiley.com.Designations used by companies to distinguish their products are often claimed as trademarks. Allbrand names and product names used in this book are trade names, service marks, trademarks orregistered trademarks of their respective owners. The publisher is not associated with any product orvendor mentioned in this book. This publication is designed to provide accurate and authoritativeinformation in regard to the subject matter covered. It is sold on the understanding that the publisheris not engaged in rendering professional services. If professional advice or other expert assistance isrequired, the services of a competent professional should be sought.Library of Congress Cataloging-in-Publication Data:ISBN 978-1-119-96265-6A catalogue record for this book is available from the British Library.Set in 10/12pt Times by Aptara Inc., New Delhi, IndiaPrinted in Great Britain by TJ International Ltd, Padstow, Cornwall, UK

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To my mother and father,brother and sisters for always being there

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ContentsIntroduction ixSECTION ONE HISTORIC CASH FLOW ANALYSIS1 Understanding How Cash Flows in a Business 32 Understanding Cash Flows Properly 213 Start-up, Growth, Mature, Decline 474 Restating the Cash Flows of a Real Business 595 Restating US GAAP Cash Flows 836 Analysing the Cash Flows of Mature Businesses 997 Analysing the Cash Flows of Growth Businesses 1358 Growth and Mature – Further Analysis Issues 1539 Analysing the Cash Flows of Start-up Businesses 17110 Analysing the Cash Flows of Decline Businesses 17911 What to do about Bad Cash Flows 18512 Cash Versus Profit as a Measure of Performance 191

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viii Contents13 Cash Flow Analysis and Credit Risk 20114 Cash Flow Analysis and Performance Measurement 21515 Analysing Direct Cash Flow Statements 22316 Generating a Cash Flow Summary from Profit and Loss Accountand Balance Sheet Data 23117 Summarising Historic Free Cash Flow 247SECTION TWO FORECASTING CASH FLOWS18 Introduction 25519 Spreadsheet Risk 26320 Good Practice Spreadsheet Development 27521 The Use of Assumptions in Spreadsheet Models 295Index 305

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IntroductionThis book is the definitive guide to cash flow analysis. It is designed to be thedefinitive first reference on all aspects of historic cash flowanalysis. It also providesan incisive overview of the risks to be managed in preparing cash flow forecasts.It has been written from a cash flow-centric point of view. Other financial andanalytical information is introduced whenever relevant to support the process ofcash flow analysis.This book is designed for people trying to understand and analyse cash flows,probably in a professional context. Whilst it contains some theoretical content, theprimary objective is to offer a practical handbook of cash flow analysis.Ideally, it should first be read like a novel and then dipped into chapter-by-chapter as required; a detailed guide to the contents of each chapter follows thisintroduction. Much of the information in the book has been laid out to facilitatedirect reference from the index; also allowing it to be used as a pure reference text.Considerable effort has been expended to make the book as user friendly aspossible. It has been designed to be relevant and useful both to persons who arecoming to cash flows for the first time, and to those who are more experiencedin the perils of financial statement analysis! I have paid particular attention to theneeds of those who are not native English speakers. I have tried to keep the useof English as clear and concise as possible whilst avoiding the use of unnecessarycomplexity.Whilst the book is written primarily for those employed as financial analysts,I have identified four other major user groups whose needs are specifically dealtwith in different sections of the book. They are:• Novices in financial analysis and other persons new to, or relatively unfamiliarwith, cash flows in general and their analysis in particular, in all fields ofendeavour, who wish to improve their understanding of cash flow.

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x Introduction• Bankers, credit analysts and others involved in business lending and the man-agement of credit exposures and credit risk.• Investors, fund managers and credit analysts involved in taking investmentdecisions.• Entrepreneurs, managers and business people involved in controlling businessentities.The guide to the book, which follows this introduction, provides an indicationof the content of each chapter and its relevance to different users. For example,persons who have no desire to actually perform the analysis of the cash flows ofa business themselves, but who still wish to understand cash flow, will initiallygain little from Chapters 4 and 5 as they are written for persons who are seekingto practically apply the technique for the restatement of published cash flows.THE LOGIC OF THE BOOK DESIGNYears of experience as a financial trainer have taught me that people acquiretechnical knowledge in a very random way from a variety of sources as they comeacross information relevant to their needs. This sometimes results in a partial,incomplete and often inaccurate understanding of the particular subject in issue.As a trainer and author my objective is to organise the information relevant to asubject or task in a logical and structured way to facilitate and ease the assimilationprocess. The metaphor I like to use is that of a jigsaw. My audiences will typicallyhave many of the pieces of the jigsaw already in their possession; however, untilI facilitate the process of assimilation they have not previously assembled thepieces into a complete picture. When working as a trainer not only do I assist incompleting the jigsaw, I also provide the missing pieces, which are different foreach participant!For this reason the book has been organised into specific blocks of knowledge.It can be read sequentially. It can also be used as a reference to provide answersto specific queries and problems by dipping into the relevant part of the book.COMPLEXITYThe word complex is regularly misused to mean difficult, or beyond the userspresent comprehension. When things labelled complex are analysed it often be-comes clear that what is actually meant is there is a lot of information to assimilatebefore comprehension of the whole can be gained. The information itself is notparticularly demanding to comprehend; there is, however, a lot of it! Writing com-puter software or learning a musical instrument or foreign language are typicalexamples.

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Introduction xiMy strategy for this type of assimilation problem is to chop the information upinto lots of little bits that are sufficiently elemental that they can be adequatelydigested by the person seeking to assimilate the whole area of knowledge and thenbuild the knowledge in a pyramid form by adding blocks and layers in an orderedway. This is the approach I have taken in writing this book.THE USE OF CASE STUDIES IN THE BOOKOnce the initial chapters have introduced the concepts upon which the analysisof cash flows rely, the book includes a number of case studies that illustrate theuse of the technique for cash flow analysis offered. Most of these cases are basedon financial information taken from the accounting statements of real businessentities. I prefer to do this because there is then no challenge as to the reality ofbusiness behaviour. If I create fictional cases for the book there is a risk users willquestion my conclusions about them and cash flow analysis in general on the basisthat the examples are fictionalised and therefore do not represent a reasonablerepresentation of business reality.However, this inevitably results in problems with dates! The question of howto deal with dates in the book is one that has vexed me significantly. The problemfor the publisher and I is that the book will soon appear dated if we show theyears from which the case studies were taken in the original. Users may wronglyassume the message and content of the book is somehow less relevant because thematerial used to illustrate the logic of the technique offered is ageing.The logic of the cash flow analysis technique offered in the book is essentiallytimeless, it should work virtually anywhere and anytime financial information isavailable to perform the analysis. For this reason I have partially disguised theoriginal dates of the material used to illustrate the cases. The timeline of most ofthe case studies offered is incidental; the examples are there to illustrate the useand benefits of the cash flow analysis technique that is the basis of this book.Experienced analysts will know that in performing any business analysis theeconomic context in which the company operates is sometimes highly relevant.Matters such as inflation, interest rates and the state of the economy may affect theconclusions drawn about the relative performance of a business. For this reason,in a small number of cases and where the context of the example warrants it, Ihave left the dates as they were originally. This allows the reader to put the caseinto the context of the economic conditions prevailing at the time.Considerable effort has been expended to keep the various examples, tables andother information both numerically and factually correct, however, it is inevitablein a work of this length that, despite our best efforts, errors may still creep intoprint. Please do not hesitate to bring these to my attention, to further improve thebook as it develops.