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A Deep Dive Into Cash Flows


The cheapest and most flexible source of liquidity is internally-generated cash. ... Dow Chemical slashed its dividend by 64% to 15 cents from 42 cents, saving ... – PowerPoint PPT presentation

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Title: A Deep Dive Into Cash Flows

A Deep Dive Into Cash Flows
  • From an academics perspective..

The Current Credit Crisis
  • The current credit crisis has
  • shaken the financial markets.
  • ...undermined the confidence of consumers and
  • caused access to external capital to dry up.
  • sent the cost of capital soaring.
  • led to a renewed focus on liquidity.
  • and reminded us that CASH IS KING!

Cash is King!
  • Success is dependent upon ability to generate
    revenues and earnings, but also cash flow,
    especially free cash flow.
  • Use for acquisitions, debt retirement, dividends,
    stock buybacksor at a more basic level
  • LIQUIDITYto ease the minds of employees,
    customers, suppliers, creditors and investors.
  • Firms with ample liquidity have outperformed
    their cash-strapped industry peers by almost 7.
  • Prior to the credit crisis, cash-rich firm were
    generally underperforming.

8 Keys to Cash Management
Develop Accurate Cash Flow Forecasts
  • Best companies get a clear picture of where they
    are headed, monitor their cash flow forecasts
    closely, and communicate this to key
  • 75 of surveyed finance executives ranked
    forecasting cash flow as top priority in
    liquidity management.
  • Measure and report of the accuracy of forecasts
    and use this to refine future forecasts.
  • Failing to produce accurate forecasts can lead
  • liquidity problems.
  • debt covenant violations.
  • restricted or costly access to capital.
  • earnings volatility.
  • lower returns.

Understand the Risks You Face
  • It is imperative to understand the risks that
    influence a companys performance, as well as
    their impact on forecasts of cash flows.
  • Once you understand the risks, you can take
    proactive steps to manage them.

Understand the Risks You Face
  • 62 of CFOs blame the credit crisis on risk
    managements inability to understand complex
    financial instruments.
  • 75 say risk management now outranks in
    importance such issues as long- and short-term
    debt financing, relationships with financial
    institutions, pension-plan asset allocation, and
    the ability to secure equity financing.

Understand the Risks You Face
  • Only 48 of risk managers report that there is a
    formal document identifying risk management
    purpose and objectives.
  • Only 38 of risk managers report that a risk
    management policy is defined and communicated
  • Only 44 report that the risk management process
    is embedded in company activity.
  • And this is for companies who actually have risk

A Virgin Mobile Story
  • Virgin Mobile CFO, John Feehan, spotted signs of
    looming bankruptcy at Circuit City and took
  • Tightened billing terms
  • Demanded cash payments
  • Adjusted shipments daily
  • Virgin Mobile takes a hands-on approach by
  • perceiving risk management as part of our daily
    life. We dont separate it out as a separate
    function its just part of how we manage every
    aspect of our business.

Understand the Risks You Face
  • Understanding risk is a start, but then companies
    have to develop meaningful data.
  • For every key performance indicator (KPI),
    companies should be tracking a key risk indicator
  • For example, what happens if sales are down 20?
  • How will this affect cash forecasts?
  • What actions will the company take in response?

Understand the Risks You Face
  • Consider communicating this information to key
  • From Starbucks 4th quarter earnings release
  • Starbucks believes that if it were to report a
    two percent decline in consolidated comparable
    store sales in fiscal 2009, the company would
    deliver GAAP EPS of about 0.78 per share, or
    non-GAAP EPS of approximately 0.90 per share. If
    the current environment worsens, the company
    believes even a five percent decrease in
    consolidated comparable store sales would result
    in GAAP EPS of approximately 0.68 per share, or
    non-GAAP EPS of around 0.80 per share. In the
    event of further deterioration in consumer
    spending and its associated impact on traffic,
    Starbucks believes a seven percent decline in
    consolidated same store sales would lead to GAAP
    EPS of approximately 0.59 per share, or non-GAAP
    EPS relatively flat year-over-year.

Ensure Adequate Sources of Liquidity
  • Using cash flow forecasts as a baseline, every
    company should ensure it has access to sufficient
    sources of liquidity to finance its operations
    through a downturn.
  • The cheapest and most flexible source of
    liquidity is internally-generated cash.
  • But given effects of financial crisis on ability
    to generate cash, firms must consider other

Ensure Adequate Sources of Liquidity
  • Consider what others are doing
  • Many private and public firms are working with
    4-5 banks as opposed to 1 bank.
  • Other firms are drawing down credit lines.
  • Ask, do you need this credit to operate on a
    day-to-day basis?
  • If not, analysts argue that this is likely to be
    seen as a black mark against managers who have
    increased leverage for no good reason.
  • Many firms are seeking non-traditional sources
    of funding such as private equity.
  • Some firms are accessing the corporate bond
  • Last week companies raised about 7BCisco
    Systems raised 4B.
  • Prior week Fannie Mae, Harley Davidson, PG, and
    others issued about 17B.

Ensure Adequate Sources of Liquidity
  • Consider what others are doing
  • GM and Ford have sold businesses no longer
    central to their firms strategies.
  • Target and Alcoa have cancelled plans to buy back
  • Sara Lee announced a suspension of buy back
    program, sending share price down by almost 20,
    and then re-instated program (citing the lower
    price for its stock).
  • Sprint Nextel stretched out payments on bank
  • Replaced a 6B revolving credit facility with a
    4.5B loan due in 2010.
  • Debt to Profit ratio increased, decreasing
    probability of violating covenants.
  • Sun Microsystems cut its workforce.

Ensure Adequate Sources of Liquidity
  • Consider what others are doing
  • Dow Chemical and Harley Davidson significantly
    reduced dividends.
  • Dow Chemical slashed its dividend by 64 to 15
    cents from 42 cents, saving an estimated 1B.
  • Harley Davidson slashed its dividend by 70 to 10
    cents from 33 cents, saving an estimated 50M for
    the quarter.
  • In 2008, 62 SP 500 companies decreased dividends
    by an aggregate 40.6 billion, with 48 of the
    decreases coming from financials. Over the
    previous 5 years, only 12 dividend decreases from
    financial sector.
  • Standard Poors expects 2009 SP 500 dividends
    to decline 13.3 percent, the worst decline since
  • Works out to 33B decline in dividend payments
    compared to 2008.

Efficiency in Working Capital
  • One of the best and cheapest sources of liquidity
    comes from reducing the need to finance working
  • Improvements to receivables, payables and
    inventory processes can result in lower operating
    costs, improved forecasting accuracy, and
    improved cash cycles.

Efficiency in Working Capital
  • Receivables
  • Pursue collections more aggressively.
  • Balance desire to limit credit exposure and drive
    cash collection against customer relationship
    management and sales growth.
  • Identify customers worth keeping versus those
    that are not.
  • Pitney Bowes began using a new technology to keep
    on top of its customers via automated phone calls
    to remind them of bills before they are due.

Efficiency in Working Capital
  • Inventory
  • Reduce inventory in supply chain.
  • Consider ways to move excess inventory.
  • Must balance desire to minimize inventory with
    desire to mitigate risk of supply-chain
    disruptions (and risk of not meeting customer
  • Payables
  • Negotiate new terms with suppliers.
  • Must balance desirability of squeezing
    suppliers against long-term cost of damaged
  • PG is shrinking inventory level and also
    squeezing suppliers.

Discipline in Capital Spending
  • Ensure you have a rigorous process in place for
    determining overall capital spending, allocating
    it among business lines, evaluating individual
    projects, and monitoring the efficiency of
    capital expenditures.
  • Starbucks and many other firms are slamming the
    brakes on CAPEX.
  • CAPEX increased 18 in 2006, but only 3 in 2007
    and declines are expected to be reported for 2008
    and 2009.
  • But consider long-term effects of reduced CAPEX
    on competitiveness in marketplace.
  • Decline in CAPEX can lead to a hike in reported
    tax income.
  • Caused by a decrease on deferred liabilities to
    offset current liabilities.

Seize Opportunities Created by Crisis
  • The current financial crisis provides a number of
    opportunities to purchase strategic assets or to
    launch innovative products.
  • The credit crisis will favor those with strong
    balance sheets buying out weaker competitors.
  • Consider Warren Buffett and his purchase of key
    stakes in Goldman Sachs and General Electric on
    favorable terms.
  • Also consider the purchase of Washington Mutual
    by JP Morgan Chase.
  • Be fearful when others are greedy and be greedy
    only when others are fearful. Warren Buffett

Seize Opportunities Created by Crisis
  • Other firms may be building cash.
  • But this can choke off investment in new
  • A recession can be a great time to launch
  • Consumers are reconsidering purchase decisions.
  • Marketplace is less crowded
  • Easier and cheaper to create awareness of new
  • During the dotcom bust Apple launched its first
    version of the iPod.
  • And ten other disruptive innovations were
    launched during the same period.

Monitor Credit Exposures
  • Many companies have begun to monitor the credit
    quality of derivative counterparties, insurance
    carriers and other financial partners more
  • Thereby reducing their exposure and diversifying
    their banking relationships.
  • Many companies are also investing more in
    evaluating the reliability of the links in their
    industry value chains.
  • Such as providing financial assistance to
    vendors, holding excess inventory, and seeking
    alternative sources of supply.

Communicate with Key Stakeholders
  • Serious downturns stem from fear and a loss of
    trust that comes after exuberance.
  • Credible external communications are critical in
    times like these.

Communicate with Key Stakeholders
  • A large body of research in social psychology
    provides evidence that individuals are less
    likely to take information at face value during
    pessimistic periods.
  • Regulators will scrutinize whether both winners
    and losers are being forthcoming in their
    disclosures about liquidity and access to
  • In todays economic environment, changes to
    existing disclosures or incremental disclosures
    may be necessary to comply with the disclosure
    requirements in areas such as risks and
    uncertainties, liquidity, and credit risks, just
    to name a few, Mark Panucci, SEC Associate
    Chief Accountant

Communicate with Key Stakeholders
  • Many companies have already began to bolster
    their MDAs by providing the following types of
  • Will you rely on one bank or a group of banks for
    future financing needs?
  • How do you receive and plan to use cash? How may
    these change due to uncertainties in the
  • What is the status of short-term funds?
    Limitations? Implications if cannot be accessed?
  • What factors could affect credit ratings? Debt

Cash Flow Metrics
  • Credit crisis requires a shift in focus to
    working capital and cash flow (making comparisons
    to peers and industry leaders).
  • The largest 1,000 companies in the U.S. could
    generate an additional 491B of cash flow (4x the
    profits of the largest 10 companies), if they
    matched the Cash Conversion Efficiency of those
    in the top quartile.
  • Managers and other stakeholders may find it
    informative to examine a firms prospects for
    generating cash flow as it grows revenue.

Cash Flow Growth Profile
  • Measures the capacity of a firm to generate cash
    flow as it grows revenue.
  • The metric is forward looking and reports the
    amount of incremental cash flow that can be
    expected for any measured amount of growth in
  • A firm with a positive cash flow growth profile
    will produce increasing amounts of cash flow as
    it grows.
  • A firm with a negative cash flow growth profile
    will require other sources of cash to support

Cash Flow Growth Profile
  • Two separate measures
  • Core Operating Growth Profile
  • Cash flow provided by operations excluding
    non-core sources of cash flow, financing costs
    and taxes.
  • Reflects a combination of its operating cushion
    (operating profit before non-cash depreciation
    and amortization) and operating working capital
    requirements, as a of revenue.
  • It is the amount of core operating cash flow that
    can be expected for any measured amount of growth
    in revenue under the assumption that a firms
    current mix of operating cushion and operating
    working capital remains unchanged.

Cash Flow Growth Profile
  • Two separate measures
  • Free Cash Growth Profile
  • Measures the capacity of the firm to generate
    free cash flow as it grows.
  • Incorporates taxes and capital expenditures, two
    expenditures that are expected to grow with
  • It is the amount of free cash flow that can be
    expected for any measured amount of growth in
    revenue under the assumption that a firms
    current mix of operating cushion, operating
    working capital, income taxes paid and capital
    expenditures, as a of revenue, remain

Cash Flow Growth Profile
  • Four Examples
  • Each firm operates in the Information Technology
    Services Industry
  • Can you match the firm name to the cash flow
    growth profile?
  • Ebay Inc (12.39 15.76B)
  • Yahoo.com (12.08 16.68B)
  • Google (342.70 107.82B)
  • Baidu.com (122.17 4.20B)

(No Transcript)
Are Regulators Responding?
  • Questions posed to The Financial Crisis Advisory
    Group by the FASB and IASB.
  • At whom should general purpose financial
    statements be primarily aimed?
  • Should general purpose financial statements have
    a financial stability objective?
  • With reference to fair value, should financial
    stability or pro-cyclicality be considered even
    if a loss of transparency of information would
  • What principles should determine when financial
    instruments are carried at fair value and when
    change in fair value should be included in

Are Regulators Responding?
  • If U.S. companies are allowed or required to
    shift from reporting under U.S. GAAP to IFRS,
    what will the effect be on your firms
    financials? What will the effect be on your
    firms ability to generate cash?
  • A shift to IFRS will result in more items being
    recognized at fair value.
  • For financial institutions, we have already seen
    the effects during a downturn in the economy.
  • What would be the effect for a troubled real
    estate firm, whose property portfolio is
    currently recorded at historical cost?

Insights from Behavioral Finance
  • Can we be counted on to make sound decisions
    under uncertainty? Are our judgments always
    rational? OR
  • Are we creatures of bounded rationality, driven
    by emotions and desires? Do we confront
    uncertainty with misleading rules of thumb?
  • The answers are No and Yes, respectivelyand the
    way we approach decisions under uncertainty can
    be particularly important during pessimistic

Insights from Behavioral Finance
  • Financial managers would do well to watch out for
    five particular biases and heuristics anchoring
    and adjustment, framing, optimism,
    overconfidence, and self-serving bias.

Anchoring and Adjustment
  • People frequently form estimates by starting with
    a given, easily available reference value which
    could be arbitrary and adjusting from that
  • Most common example in business schools is
    conducting a mock auction by first asking
    students to write down last 2 digits of SSN and
    then submitting a bid for an item.
  • The half of the group with the higher 2-digit
    numbers bid between 60 and 120 more on the item.
  • This has been extended to loan ratings (anchoring
    on current loan ratings) and internal reviews of
    forecasts or proposals (anchoring on the
    proposing groups inflated forecasts).
  • Has direct implications for cash-flow forecasting
    and new capital expenditures.

  • The way a situation is presented, or framed,
    greatly influences the action taken.
  • If a frame is poorly (or strategically)
    constructed, a manager may unwittingly make a
    money-losing choice.
  • For example, if you have to decide whether to
    accept a special order, given fixed capacity, the
    criterion you ought to use is contribution margin
    whereas gross margin could lead to a different
  • Framing combined with loss aversion (reluctance
    to accept a sure loss) can lead managers to frame
    cost as recoverable and tempt them to continue to
    fund a failing project.

  • Individuals systematically think that good events
    are more likely to happen to them, while bad
    events are more likely to happen to others.
  • Optimism can lead to flawed and risky decisions.
  • In a company with marginal investment
    opportunities, managers are likely to perceive
    the opportunities are better than they are and
    think some bad projects are good projectsleading
    to overinvestment.
  • Given liquidity crunch, managers can ill-afford
    overinvestment in negative NPV projects.
  • Optimism can lead managers to overestimate the
    mean of their firms cash flows.

  • If you ask individuals to rate themselves as
    drivers, typically 40 say they are above
    average, 50 average, and only 10 below average.
  • Overconfident CEOs are more prone to engage in
    MA activity.
  • They are more prone to pursue risky deals, or pay
    too much, because they overestimate the returns
    they can produce from an acquisition.
  • Overconfident managers have been shown to
    underestimate the volatility of their firms
    future cash flows.

  • Over a period of six years, researchers collected
    7,000 observations of probability distributions
    provided by top financial executives regarding
    the stock market.
  • Financial executives are miscalibrated realized
    market returns are within the executives 80
    confidence intervals only 38 of the time.
  • Companies with overconfident CFOs use lower
    discount rates to value cash flows, invest more,
    use more debt, are less likely to pay dividends,
    and are more likely to repurchase shares.
  • The overconfident CFOs are also committed more
    heavily to debt, particularly long-term debt,
    because they perceive future cash flows as
    relatively safe.
  • Each of these actions can have exacerbated
    effects during a credit crunch.

Self-Serving Bias
  • The self-serving bias leads people to see data in
    the way they most want to see it, which may
    prompt them to take credit for successes and shun
    blame for failures.
  • This can lead to overinvestment in bad
  • Can also lead to the same mistakes being made
    over and over.
  • Can lead to inaccurate cash flow forecasts period
    after period after period.
  • Mistakes can be extremely costly during times of
    extreme resource constraint.

Key Takeaways
  • Cash is King!
  • 8 Keys to Cash Management
  • Develop Accurate Cash Flow Forecasts
  • Understand the Risks You Face
  • Ensure Adequate Sources of Liquidity
  • Efficiency in Working Capital
  • Discipline in Capital Spending
  • Seize Opportunities Created by Crisis
  • Monitor Credit Exposures
  • Communicate with Key Stakeholders
  • Alternative Cash Flow Metrics
  • Insights from Behavioral Finance
  • Understanding how you think is important!

If All Else Fails
  • Hire a woman as CFO!
  • A new research study finds that investors respond
    more favorably to certain moves by companies
    whose CFOs are women.
  • The stock market reacts more favorably to both
    acquisition announcements and secondary equity
    offerings made by companies with female CFOs.
  • Total growth in assets was 17 lower at companies
    with women CFOs.
  • Female CFOs issued about 13 percent less debt.
  • Why?
  • Psychology research suggests it is due to men
    being more over-confident than women, and women
    being more risk averse than men (scrutinizing
    deals more carefully and thus making fewer poor

Thank You!
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