Using of cash flow
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Transcript of Using of cash flow
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Using of cash flow
for the financial stability and causes for changes in the amount of financial means,
for the short-term planning of incomes and expenses,
to plan long-term financial prognosis ,
for the valuation of financial effectiveness of investments,
a form for finding market price of the enterprise (discounted CF).
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Investment activities
From the economic theory:Capital assets, which are not determined for the immediate consumption, but for the usage in the manufacture of other capital assets. It is a postponement of current consumption on purpose to gain higher future benefits. From the business administration point of view:Single expended sources, which will bring financial incomes during future periods (longer than one year).
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Which form of investments do you
know?
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Clasification of investments
1) Tangible (material, capital) investments – make or spread production capacity of the enterprise, building of new properties, routes, buying of land, machines etc.
2) Intangible (non-material) investments – buying of technical knowledge, licenses, software
3) Financial investment – purchase of long-term equities, borrowing of money to gain interests, dividends or profit.
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Forms of tangible investments
1) Recovery investments.
2) Changes of machines on purpose to decrease costs.
3) Expansion of current production and market enlargement.
4) Investments based on law requirements (safety at work, ecology),
5) Other investment projects.
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Forms of procurement of investment assets
purchase (machines, land, equities),
investment construction, supplier (building of shop floor), own overheads cost (smaller construction changes),
financial leasing,
donation.
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Participants of investment activities
1) Investors – organization, which is the customer of investment and who pays it.
2) Draftsmen – prepare project including budget.
3) Suppliers – realize construction.
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Which sources for investments do you
know?
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Sources for financial investments1) Own sources:
depreciation, profit, benifits form the sale or liquidation of tangible assets, new issue of shares or contributions of co-partners.
2) External sources: loan for fixed assets, issued bonds (obligace), leasing, subsidies from state or regional budgets.
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Valuation of efectivness of investments
Comparing of input of capital invested (expenses on investment) with benefits (incomes), which the investment brings. Crucial criteria for investment valuation: profitability (rate of return) – relationship between profit
(cash flow) and costs for its procurement and working,risk – degree of danger, that we will not receive expected
benefits, liquidity (payback period) – period of transformation of
investment back to cash form.Ideal investment – high rate of return, without risk and liquidity.
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Procedure of investment valuation
1) Find out the capital expenses for the investment,
2) Estimation of future net cash flow, which will bring the investment and also risk, with which are these investments connected,
3) Selection of suitable criteria for valuation of effectiveness of investment.
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Capital expences for investment
Investment costs
expences for the procerument of land, buildings, machines and equipment.
Expences connected with sale and liquidation of fixed assets,
expenses for project documentation, expences for research and development connected
with the investment,Expenses for the training of employees,Increase of net working capital.
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Expected cash incomes
Expectation of income flow from suggested investment is more difficult than finding out of costs, because on icome act many factors like inflation, changed conditions in the market) and their influence is very difficult to say and expect.
Total cash income structure is:
net profit, depreciation, income from the sale of equipement after its finished
period of service.
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http://www.youtube.com/watch?v=n4QINzCCKGE&feature=related
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Methods of valuation of investment
1) Static methods – they not include factor of time: payback period,return on investment, accounting rate of return.
2) Dynamic methods – přihlížejí k působení faktoru času:
net present value, internal rate of return, discounted payback period, index of profitability.
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Payback periodPeriod, in which the cumulated incomes cover totol capital expenses on this investment.
If the incomes are each year equal, the payback period is:
years income(CF) annual
costt investemenTu
If the incomes are different, the payback period is a summ of the expected incomes in each year till time when it is equal to invested costs. Rule of investments: The investment is profitable when the payback period is shorter than the life-cycle (time of service) of this investment.
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Return on investmentROI measures how effectively the firm uses its capital to generate profit; the higher the ROI, the better.More generally, the income that an investment provides in a year.
% 100*costs investment
proftnet annual avarageROI
Rule for investment: The investment is profitable, when the return on investment is higher than the rate of return expected by the investor.
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Accounting rate of return
Similar to ROI, but instead of profit uses money (cash) income (profit + depreciation).
% 100*costs investmentincome annual avarageARR
Rule for investment : The investment is profitable, when ARR is higher than the rate of return expected by the investor.
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Dynamic methods of valuation of investment
They suppose, that the value of money changes during the time, e.g. Current capital 1 000 000 CZK with the interest rate 10 % p.a. will have in one year value 1 100 000 CZK, but one year ago had the value 909 091 CZK.
All the cash flow (possitive or negative) have to be hold out to a suitable dat (present time) and converted (discounted) to a present value.
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Time value of money
Methods to find out curent value or future value of money.
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Net present valueSum of discounted net cash flows for the during the whole life-cycle of the investment.
CZK i)(1
CNPVn
0tt
t
Ct cash flow from the givin date for the period t období,
i discounted rate as a decimal number (e.g. the rate of return of an alternative investment)n life-cycle of the investment.
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Rule for investing using NPV
NPV > 0 accept the investment,
NPV = 0 we achieved just expected rate of return,
NPV < 0 refuse the investment.
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Internal rate of return
Finding of discount rate, with which the NPV is equal to zero, it means NPV of expected incomes is equal to present value of expences on investment.
IIR
*
n
0tt*
t
i
0)i(1
C
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Rule for investing using IRR
If IRR is higher than discount rate (expected rate of return including the risk), it investment project is
possible to accept.
If the investment is financed by the loan, it means, that the IIR should be higher than the intrest rate of this loan.
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Relationship between NPV and IRR
Závislost čisté současné hodnoty na diskontní míře
-100 000,00
0,00
100 000,00
200 000,00
300 000,00
400 000,00
500 000,00
600 000,00
700 000,00
800 000,00
900 000,00
5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35
Diskontní míra (%)
Čis
tá s
ouča
sná
hodn
ota
v K
č
IRR
Discount rate %
NPV
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Discounted payback period
The period, when cumulated discounted incomes from the investment are paid back by the discounted capital expenses.
Rule for investment: Investment is profitable, if the discounted payback period is shorter than the expected life time of the investment.
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Index of profitabilityProportion between discounted net incomes and discounted invested invested costs of the project.
DNCDNC
DNCDNIIP NPV
Relationship between NPV and index of rate of return:NPV = 0 ↔ IP = 1NPV > 0 ↔ IP > 1NPV < 0 ↔ IP < 1Rule for investment: Investment is profitable, if IP is higher than 1.
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Comparing of investment options
If there are more than 2 possibilities for investment of capital:
there is enough capital just for one investment – it is necessary to choose the most profitable option.
there is enough capital for more projects – it is necessary to decide about the sequence of projects according to their profitability.
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1) For each investment we will find out NPV, IRR, IP. 2) According to IRR etc. we decide about the rank .
Disadvantages:
we do not include time, during the time the value of capital changes.