Cash from line items consists of depreciation schedule, working capital schedule or debt schedule. We must complete depreciation and working capital schedule first.
Cash From Operating Activities:
Cash from operating activities comes from net income. Select net income before any distributions for making your analysis. Then look for other operating activities.
Difficult line items can be projected in following different methods:
Conservative: (Minimum of the past 3 years)
We assume money spent is more conservative than money received. Taking minimum amounts for the last 3 years may not be most accurate, but it is conservative approach.
Aggressive: (The maximum of the past 3 years)
Assuming more money received is more aggressive. We take the maximum amount from last 3 years.
Average:
In this method we take average of the last 3 years.
Last Year: (Recent Performance)
This is based on an assumption that company’s performance last year is most indicative of its future performance.
A combination of this method and conservative method is quite useful indicator.
Repeat The Cycle:
In this method a trend is followed. As an example, the easiest way to do this is to have the projected 2013 year to equal to the historical year 2010. This way 2014 will be same as 2011 and 2015 will equal 2012 and so on.
Year over Year Growth:
In this method we can assume year over year growth. Growth rate can be dependent on another line item. For example we can assume that rent will increase 5% each year.
Other line items can depend on another income statement or balance sheet items. For example, commission expense may be projected as percentage of gross sales.
An analyst should add details to his assumptions for clarity.
Cash from Investing Activities:
Basically management will provide guidance on capital expenditure. It is sometimes considered as percentage of sales.
Proceeds From Disposal of Property and Equipment:
A recommendation is to take a look at quarterly report of corporation’s activities and be conservative. Being very conservative can mean no more disposals.
Items Based on Cash Available:
Investments such as purchasing securities are not necessary to drive the operations of business. But if a company has a surplus of cash, it is wise to make such investments.
A company can choose to buy back its shares as a way to increase value in its stock.
These kind of items are almost unpredictable. It is recommended to listen to company’s latest conference call to see if cash management or future cash initiatives are discussed.
Cash Flow from Financing Activities:
- Raising or buying back equity.
- Raising or paying down debt.
Dividends = Shares outstanding x $/share
We can use “project out as a percentage of an income statement or a balance sheet line item”.
Purchase of common stock is a share buyback. When a company buys back its own shares, cash is spent and number of outstanding shares in the market reduces. The process of share buyback can be considered as an “item based on cash available”. A company will only buy back shares if it has excess cash.
Effect of Exchange Rate:
This is a volatile line item. Average or conservative methods can work.
Disclaimer:
This information is for educational purposes only. It does not constitute any legal advice or opinion. Please do not use any of its contents without seeking a professional advice.
References:
Financial modeling and valuation by Paul Pignataro