Cash flow calculation formula cf. Cash flow: formula and calculation methods

It can be represented as a cash flow characterizing the income and expenses generated by this activity. Making decisions related to capital investments is an important stage in the activity of any enterprise. For effective use funds raised and maximizing return on invested capital requires a thorough analysis of future cash flows associated with the sale developed operations, plans and projects.

Estimated cash flows carried out by discount methods, taking into account the concept of the time value of money.

The task of the financial manager is to select such projects and ways of their implementation that will provide a cash flow that has the maximum present value compared to the amount of required capital investments.

Investment project analysis

There are several methods for evaluating attractiveness. investment projects and, accordingly, several main indicators of the effectiveness of cash flows generated by projects. Each method basically has the same principle: as a result of the project, the enterprise should receive a profit(should increase equity enterprises), while various financial indicators characterize the project from different angles and may meet the interests of various groups of people related to this enterprise (owners, creditors, investors, managers).

First step analysis of the effectiveness of any investment project - calculation of the required capital investments and forecast of the future cash flow generated by this project.

The basis for calculating all indicators of the effectiveness of investment projects is the calculation net cash flow, which is defined as the difference between current income (inflow) and expenses (outflow) associated with the implementation of the investment project and measured by the number of monetary units per unit of time ( currency unit/ unit of time).

In most cases, capital investments occur at the beginning of the project at the zero stage or during the first few periods, followed by cash inflows.

From a financial point of view, current income and expense flows, as well as net cash flow, fully characterize an investment project.

Cash flow forecasting

When forecasting cash flow, it is advisable to forecast the data of the first year by months, the second year by quarters, and for all subsequent years by total annual values. This scheme is recommended and in practice should correspond to the conditions of a particular production.

A cash flow for which all negative elements precede positive ones is called standard(classic, normal, etc.). For non-standard flow, alternating positive and negative elements are possible. In practice, such situations most often occur when the completion of the project requires significant costs (for example, the dismantling of equipment). Additional investments may also be required in the process of project implementation related to environmental protection measures.

• cash flows exactly correspond to the theory of the value of money in time - the basic concept of financial management;
• cash flows - a precisely defined event;
• using real cash flows avoids the problems associated with memorial accounting.

When calculating cash flows, take into account all those cash flows that change due to this decision:

• costs associated with production (building, equipment and equipment);
• changes in receipts, income and payments;
• taxes;
• changes in the amount of working capital;
• the opportunity cost of using scarce resources that are available to the firm (although this need not be directly related to cash costs).

should not be taken into account those cash flows that do not change in connection with the adoption of this investment decision:

• past cash flows (costs incurred);
• cash flows in the form of costs that would be incurred regardless of whether the investment project is implemented or not.

There are two types of costs that make up the total required capital investment.

1. direct costs, necessary to launch the project (construction of buildings, purchase and installation of equipment, investments in working capital, etc.).
2. Alternative costs. Most often, this is the cost of the premises used or land plots, which could be profitable in another operation ( alternative income) if they were not busy for the implementation
   project.

When forecasting future cash flow, it must be borne in mind that the reimbursement of costs associated with the necessary increase in the working capital of the enterprise (cash, inventory or accounts receivable) occurs at the end of the project and increases the positive cash flow related to the last period.

The final result of each period, which forms the future cash flow, is the amount of net profit, increased by the amount of accrued depreciation and accrued interest on borrowed funds(Interest has already been taken into account in calculating the cost of capital and should not be counted twice).

AT general view the cash flow generated by an investment project is a sequence of elements INV t , CF k

• INV t are negative values ​​corresponding to cash outflows(for this period, the total costs of the project exceed the total income);
• CF k are positive values ​​corresponding to cash inflows(revenues exceed expenses).

Since planning for the future cash flow is always carried out under conditions of uncertainty (it is necessary to predict future prices for raw materials and materials, interest rates, wages, volume of sales, etc.), it is desirable to consider, in order to take into account the risk factor, according to at least, three possible implementation options - pessimistic, optimistic and most realistic. The smaller the difference in the resulting financial indicators for each option, the more stable this project to changes in external conditions, the lower the risk associated with the project.

Key indicators related to cash flow estimation

An important step in assessing cash flows is analysis financial opportunities enterprises, the result of which should be the value of the cost of capital of the enterprise with different volumes required.

WACC value is the basis for the adoption of financial investment decisions, since in order to increase the capital of the enterprise, the condition must be met: the cost of capital is less than the return on investment.

The value of the weighted average cost of capital WACC in most cases is chosen as the discount rate when estimating future cash flows. If necessary, it can be adjusted for indicators possible risk related to the implementation specific project and the expected rate of inflation.

If the calculation of the WACC indicator is associated with difficulties that cast doubt on the reliability of the result obtained (for example, when evaluating equity), you can choose the value of the average market return, adjusted for the risk of the analyzed project, as the discount rate.

In some cases, the value of the discount rate is taken equal to that of the Central Bank.

Payback period of the investment project

The calculation of the payback period of investments is often the first step in the process of deciding on the attractiveness of a particular investment project for an enterprise. This method can also be used to quickly screen out projects that are unacceptable in terms of liquidity.

Most of all, creditors of the enterprise are interested in calculating this indicator, for which the fastest payback is one of the guarantees for the return of the funds provided.

In the general case, the desired value is the value !!DPP??, for which !!DPP = min N??, for which ∑ INV t / (1 + d) t more or equal ∑ CF k / (1 + d) k, where is the discount rate.

The decision criterion when using the payback period calculation method can be formulated in two ways:

• the project is accepted if the payback as a whole takes place;
• the project is accepted if the found DPP value lies within the specified limits. This option is always used when analyzing projects with a high degree of risk.

When choosing projects from several possible options projects with a shorter payback period will be preferred.

Obviously, the value of the payback period is the higher, the more rate discounting.

A significant disadvantage this indicator as a criterion for the attractiveness of the project is ignoring positive cash flow values beyond the calculated period . As a result, the project, which as a whole would bring more enterprise over the entire implementation period, may turn out to be less attractive according to the criterion !!DPP?? compared to another project that brings a much lower final profit, but more quickly recovers the initial costs. (By the way, this circumstance does not worry the creditors of the enterprise at all.)

This method also does not distinguish between projects with the same value!!DPP??, but with different distribution income within the calculated period. Thus, the principle of the time value of money is partially ignored when choosing the most preferred project.

Net present (discounted) income

NPV indicator reflects a direct increase in the capital of the company, therefore, for the shareholders of the enterprise, it is the most significant. The calculation of net present value is carried out according to the following formula:

NPV = ∑ CF k / (1 + d) k - ∑ INV t / (1 + d) t.

The project acceptance criterion is a positive valueNPV. In the case when it is necessary to make a choice from several possible projects, preference should be given to the project with a larger value of net present value.

At the same time, it should be taken into account that the ratio of NPV indicators various projects is not invariant with respect to a change in the discount rate. A project that was more preferable by the NPV criterion at one rate value may turn out to be less preferable at another value. It also follows from this that PP and NPV indicators can give conflicting estimates when choosing the most preferred investment project.

To make an informed decision and take into account possible changes in the rate (usually corresponding to the cost of invested capital), it is useful to analyze the graph of NPV versus d. For standard cash flows, the NPV curve is monotonically decreasing, tending with increasing d to a negative value equal to the present value of invested funds (∑ INV t / (1 + d) t). The slope of the tangent at a given point on the curve reflects the sensitivity of the NPV indicator to a change in d. The larger the slope, the more risky this project is: a slight change in the market situation that affects the discount rate can lead to major changes in the predicted results.

For projects that have large incomes in the initial periods of implementation, the possible changes in net present value will be less (obviously, such projects are less risky, since the return on investment is faster).

When comparing two alternative projects, it is advisable to determine the value barrier the rate at which the net present value of the two projects are equal. The difference between the discount rate used and the barrier rate will represent a margin of safety in terms of the advantage of a project with a larger NPV. If this difference is small, then an error in the choice of rate d can lead to the fact that a project will be accepted for implementation, which in reality is less profitable for the enterprise.

Internal rate of return

The internal rate of return corresponds to the discount rate at which present value future cash flow coincides with the amount of invested funds, i.e. satisfies the equality

∑ CF k / (1 + IRR) k = ∑ INV t / (1 + IRR) t.

Finding this indicator without the help of special tools (financial calculators, computer programs) in the general case implies the solution of an equation of degree n, therefore it is quite difficult.

A graphical method can be used to find the IRR corresponding to normal cash flow, given that the NPV value turns to 0 if the discount rate matches the IRR value (this can be easily seen by comparing the formulas for calculating NPV and IRR). This fact is based on the so-called graphical method for determining the IRR, which corresponds to following formula approximate calculation:

IRR = d 1 + NPV 1 (d 2 - d 1) / (NPV 1 - NPV 2),

where d 1 and d 2 are rates corresponding to some positive (NPV 1) and negative (NPV 2) values ​​of net present value. The smaller the interval d 1 - d 2, the more accurate the result. With practical calculations, a difference of 5 percentage points can be considered sufficient to obtain a fairly accurate value of the IRR value.

The criterion for accepting an investment project is the excess of the IRR indicator of the selected discount rate. When comparing several projects, projects with large IRR values ​​will be more preferable.

In the case of a normal (standard) cash flow, the condition IRR > d is fulfilled simultaneously with the condition NPV > 0. Decision-making according to the NPV and IRR criteria gives the same results if the question of the possibility of implementing a single project is considered. If several different projects are compared, these criteria may give conflicting results. It is believed that in this case the indicator of net present value will be a priority, since, reflecting an increase in the equity capital of the enterprise, it is more in the interests of shareholders.

Modified internal rate of return

For non-standard cash flows, the solution of the equation corresponding to the definition of the internal rate of return, in the vast majority of cases (non-standard flows with a single IRR value are possible) gives several positive roots, i.e., several possible values ​​of the IRR indicator. In this case, the IRR > d criterion does not work: the IRR value may exceed the discount rate used, and the project under consideration turns out to be unprofitable.

To solve this problem in the case of non-standard cash flows, an analogue of IRR is calculated - a modified internal norm MIRR yield (it can also be calculated for projects that generate standard cash flows).

MIRR is interest rate, with the accumulation of which during the project implementation period n the total amount of all discounted investments at the initial moment, a value equal to the sum of all cash inflows accrued at the same rate d at the end of the project implementation is obtained:

(1 + MIRR) n ∑ INV / (1 + d) t = ∑ CF k (1 + d) n - k .

Decision criterion MIRR > d. The result is always consistent with the NPV criterion and can be used to evaluate both standard and non-standard cash flows.

Rate of return and index of profitability

Profitability - important indicator investment efficiency, since it reflects the ratio of costs and income, showing the amount of income received for each unit (ruble, dollar, etc.) of invested funds.

P = NPV / INV 100%.

Profitability index (profitability ratio) PI - the ratio of the present value of the project to the costs, shows how many times the invested capital will increase during the implementation of the project:

PI = [∑ CF k / (1 + d) k ] / INV = P / 100% + 1.

The criterion for making a positive decision when using profitability indicators is the ratio P > 0 or, equivalently, PI > 1. Of several projects, those with higher profitability indicators are preferable.

The profitability criterion can give results that contradict the criterion of net present value if projects with different amounts of invested capital are considered. When making a decision, it is necessary to take into account the financial and investment capabilities of the enterprise, as well as the consideration that the NPV indicator is more in the interests of shareholders in terms of increasing their capital.

At the same time, it is necessary to take into account the influence of the projects under consideration on each other, if some of them can be accepted for implementation simultaneously and on projects already being implemented by the enterprise. For example, the opening of a new production facility may lead to a reduction in sales of previously manufactured products. Two projects implemented at the same time can give a result that is both greater (synergy effect) and less than in the case of a separate implementation.

Summing up the analysis of the main indicators of cash flow efficiency, we can highlight the following important points.

Advantages of the PP method (a simple method for calculating the payback period):

• simplicity of calculations;
• accounting for the liquidity of the project.

By cutting off the most dubious and risky projects in which the main cash flows come at the end of the period, the PP method is used as a simple method for assessing investment risk.

It is suitable for small firms with little money turnover, as well as for express analysis of projects in conditions of lack of resources.

Disadvantages of the RR method:

• the choice of the barrier value of the payback period can be subjective;
• the profitability of the project beyond the payback period is not taken into account. The method cannot be applied when comparing options with the same payback periods, but different lifetimes;
• the time value of money is not taken into account;
• not suitable for evaluating projects related to fundamentally new products;
• the accuracy of calculations using this method largely depends on the frequency of dividing the life of the project into planning intervals.

Advantages of the DPP method:

• takes into account the time aspect of the value of money, gives more long term return on investment than RR and takes into account more cash flows from capital investments;
• has a clear criterion for the acceptability of projects. When using the DPR, the project is accepted if it pays for itself within its lifetime;
• the liquidity of the project is taken into account.

The method is best used to quickly screen low-liquid and high-risk projects under conditions
high level inflation.

Disadvantages of the DPP method:

• does not take into account all cash flows received after the completion of the project period. But, since DPP is always greater than PP, DPP excludes a smaller amount of these cash receipts.

Advantages of the NPV method:

• focused on increasing the welfare of investors, therefore, is fully consistent with the main goal of financial management;
• takes into account the time value of money.

Disadvantages of the NPV method:

• it is difficult to objectively estimate the required rate of return. Its choice is crucial in NPV analysis, as it determines the relative value of the cash flows attributable to different periods time. The rate used in estimating NPV should reflect the required risk-adjusted rate of return;
• it is difficult to assess such uncertain parameters as the moral and physical depreciation of fixed capital; changes in the activities of the organization. This may lead to an incorrect assessment of the useful life of fixed assets;
• The NPV value does not adequately reflect the result when comparing projects:
  • with different initial costs for the same value
    pure real;
  • with a higher net present value and a long payback period and projects with a lower net present value and a short payback period;
• may give conflicting results with other indicators of cash flows.

The method is most often used when approving or rejecting a single investment project. It is also used in the analysis of projects with uneven cash flows to assess the value of the internal rate of return of the project.

Advantages of the IRR method:

• objectivity, informativeness, independence from the absolute size of investments;
• gives an estimate of the relative profitability of the project;
• can be easily adapted to compare projects with different levels risk: projects with a high level of risk should have a large internal rate of return;
• does not depend on the discount rate chosen.

Disadvantages of the IRR method:

• complexity of calculations;
• possible subjectivity of the choice of normative return;
• greater dependence on the accuracy of estimates of future cash flows;
• implies the mandatory reinvestment of all income received, at a rate equal to IRR, for a period until the end of the project;
• not applicable for estimating non-standard cash flows.

The most frequently used method due to the clarity of the results obtained and the possibility of comparing them with the profitability of various market financial instruments often used in conjunction with the payback method

Advantages of the MIRR method:

• gives a more objective assessment of the return on investment;
• less likely to conflict with the NPV criterion;

Disadvantages of the MIRR method:

• depends on the discount rate.

MethodMIRRused in the same cases as the methodIRRin the presence of uneven (non-standard) cash flows that cause a problem of multiplicityIRR.

Advantages of the methodPandPI:

• the only one of all indicators reflects the ratio of income and costs;
• gives an objective assessment of the profitability of the project;
• applicable to the evaluation of any cash flows.

Disadvantages of the methodPandPI:

• may give conflicting results with other indicators.

The method is used when the payback method and the methodNPV (IRR) give inconsistent results, and also if the value of the initial investment is important for investors.

Analysis of criteria for the effectiveness of investment projects. Comparison of NPV and IRR.

1. If the NPV and IRR criteria are applied to such a single project in which only cash receipts occur after the initial cash outlay, then the results obtained by both methods are
   agree with each other and lead to identical decisions.
2. For projects with other cash flow schedules, the value of the internal rate of return IRR can be as follows:

• no IRR:
  • a project in which there is no cash flow always has a positive NPV value; in this regard, there is no IRR in the project (where NPV = 0). In this case, IRR should be discarded and NPV should be used. Since NPV > 0, this project should be accepted;
  • a project with no cash flow always has a negative NPV, and such a project has no IRR. In this case, IRR should be discarded and NPV should be used; because NPV< 0, то данный проект следует отвергнуть;
• opposite IRR. A project that first has cash inflows and then cash outflows has an IRR that is never consistent with NPV ( low rate IRR and positive NPV will be observed simultaneously);
• multiple IRRs. A project that alternates between incoming and then outgoing cash will have as many internal rates of return as there are reversals in the direction of cash flows.

3. Project ranking is necessary if:

• projects are alternative to be able to choose one of them;
• the amount of capital is limited, and the company is not able to raise enough capital to implement all good projects;
• there is no agreement between NPV and IRR. In the case of using two methods simultaneously: NPV and IRR, different rankings often occur.

Causes of discrepancy between the results of the IRR and NPV methods for several projects

Project lead time – Long term projects may have a low IRR, but over time their net present value may be higher than short term projects. high stake profitability.

Choice between IRR and NPV:

• if we use the NPV method as a criterion for choosing an investment project, then it leads to the maximization of the amount of cash, which is equivalent to the maximization of the cost. If this is the goal of the firm, then the net present value method should be used;
• if the IRR method is used as a selection criterion, it leads to the maximization of the firm's growth percentage. When a firm's goal is to increase its value, the most important characteristic of investment projects is the degree of return, the ability to earn cash to reinvest them.

Estimation of cash flows of different duration

In cases where there is doubt about the correctness of the comparison using the considered indicators of projects with different implementation periods, one of the following methods can be resorted to.

Chain repeat method

When using this method, find the least common multiple of the implementation time and estimated projects. They build new cash flows resulting from several project implementations, assuming that costs and incomes will remain at the same level. The use of this method in practice can be associated with complex calculations if several projects are considered, and in order to match all the deadlines, each will need to be repeated several times.

Equivalent annuity method

This method means more simple calculations carried out in the following stages for each of the considered projects:

Projects with a higher value are preferred.

At the same time, the re-implementation of the project is not always possible, especially if it is long enough or relates to areas where there is a rapid technological renewal of manufactured products.

In addition to the considered quantitative indicators of the effectiveness of capital investments, when making investment decisions, it is necessary to take into account the qualitative characteristics of the attractiveness of the project, corresponding to the following criteria:

• compliance of the project under consideration with the general investment strategy of the enterprise, its long-term and current plans;
• possible impact on other projects implemented by the enterprise;
• the prospects of the project in comparison with the consequences of refusing to implement alternative projects;
• compliance of the project with the accepted regulatory and planned indicators in relation to the level of risk, financial stability, economic growth organizations, etc.;
• ensuring the necessary diversification of the financial and economic activities of the organization;
• compliance of the project implementation requirements with the available production and human resources;
• social consequences of the project implementation, possible impact on the reputation, image of the organization;
• compliance of the project under consideration with environmental standards and requirements.

The main disadvantage of the considered methods is the assumption that the conditions for the implementation of projects, and hence the required costs and revenues will remain at the same level, which is almost impossible in the current market situation.

Many people believe that the measure of a company's performance is its profitability. However, many items of expenditure and income that are recorded on the balance sheet are not tied to real money. It's about on depreciation and exchange rate revaluation of assets. Also, part of the profit goes to capital expenditures and current activities. A real understanding of the amount of money you make gives you free cash flow.

The place of free cash flow among other financial indicators

There are several types of cash flows in the course of a business. The total (gross) amount of money is fixed in the NCF indicator (net cash flow), which is formed on the basis of the summation of all positive and negative financial transactions from the investment, financial and operating activities of the company. However, another indicator is much more expressive.

Free cash flow (FCF - free cash flow) is the amount of money that remains at the disposal of owners and investors after deducting all taxes, as well as capital investments. In fact, it is cash that increases the company's shareholder value and expands its asset base. If FCF has a good positive indicator, then the enterprise can develop and produce new products, pay increased dividends, acquire assets, therefore, becomes more attractive to its shareholders.

How free cash flow is calculated

In the activities of any enterprise, there are two main types of free cash flows:

• Enterprise Free Flow (FCFF) is money after capital expenditures and taxes have been deducted, but before settlement of credit interest. It is used to understand the real value of the enterprise itself and is important for lenders and investors.
• Free flow on equity (FCFE) is the funds left after deducting interest on loans, taxes and operating expenses. The indicator is important for owners and shareholders, as it assesses the shareholder value of the company.

• net investment in working capital;
• net investment in fixed capital;
• money from the operating activities of the enterprise after taxes.

The first two positions are taken from the balance sheet.

To search for an indicator free flow enterprise The most commonly used formula is:

wherein:

• Tax - the amount of income tax;
• DA is the depreciation rate of assets (intangible and tangible);
• EBIT - profit before all taxes;
• ∆WCR - the amount of capital expenditures, the term CAPEX can also be used;
• CNWC - dynamics of working net capital (expenses for the purchase of new assets). It is calculated in the following way: (Zi + ZDi - ZKi) - (Zo + ZDo - ZKo), where З - stocks, ЗД - receivables, ЗК - accounts payable. From the sum of these indicators for current period(index i) the sum of similar values ​​for the previous time interval is subtracted (indexo).

There are also other payment options. For example, in 2001 the following methodology was proposed:

wherein:

• CFO stands for the amount of money from a company's operating activities;
• Tax - income tax (interest rate);
• Interest expensive - interest costs;
• CFI - funds from investment activities.

Some use the most simple formula to calculate the value of the desired indicator:

FCFF=NCF-CAPEX , where

• NCF - net cash flow;
• CAPEX - capital expenditures.

The FCFF flow is created by the company's assets (operating and production) and directed to investors, so its value is equal to the total amount of payments, this rule also works in reverse. This rule is called the identity of cash flows and is written graphically as follows: FCFF=FCFE (finance to owners) +FCFD (finance to creditors)

Index free flow on your capital(FCFE) indicates the amount remaining at the disposal of shareholders and owners after settlements for all tax liabilities and mandatory investments in the operating activities of the enterprise. The most important criteria here are:

• NI (Net Income) - the net profit of the company, its value is taken from the accounting report;
• DA (Depletion, Depreciation & Amortization) - depreciation, depletion and depreciation, accounting indicator;
• ∆WCR (CAPEX) is the cost of current activities (capital expenditures), they can be found in the investment activity report.

Ultimately general formula looks like this:

In addition to the abbreviations explained above, some more apply here:

• Investment - the volume of investments made by the company in short-term assets, the source is the balance sheet;
• Net borrowing is the delta between already repaid and newly received loans, the source is financial statements.

However, some "expenditure" items (for example, depreciation) do not lead to real spending, so a slightly different system for calculating this indicator is often used. Here, the value of the cash flow from production operations is used, which already takes into account changes in working capital, net profit, the indicator is also adjusted for depreciation and other non-cash transactions:

FCFE=CFFO- ∆WCR + Net borrowing

In fact, the main difference between the considered types of free cash flows is that the calculation of FCFE is made after the receipt (payment) of debts, and FCFF - before that.

Billionaire Warren Buffett uses the most conservative method of estimating this indicator, which he calls Owner`s earnings. In his calculations, in addition to the usual indicators, he also takes into account the average annual amount of funds that should be invested in fixed assets in order to maintain a competitive market position and production volumes in long term.

How FCF is applied in practice

Ideally, a stable operating enterprise in a normal economic situation should have a positive FCF at the end of a year or other reporting period. This state of affairs enables the company to repay all its obligations in a timely manner, as well as expand (produce new products, modernize equipment, diversify sales markets, open new facilities).

In other words, the owner can withdraw the amount of FCF from circulation, without the risk of lowering the company's capitalization and losing its market position.

If the FCF is above zero, then this means the following:

• timely payment of dividends to shareholders;
• cost increase valuable papers companies;
• opportunity to additional emission shares;
• the owners and management of the enterprise are effective managers.

If free cash flow is negative, then this may indicate two possible options for the state of the company:

• the enterprise is unprofitable;
• company management invests large funds in its development, which can give a return in the long term due to a high level of profitability.

To understand the real state of the company, it is necessary, in addition to current position, also study the strategy of its development. To increase the value of the company, you need to use growth levers, which include:

• tax optimization;
• revision of the direction of capital investments;
• increase in revenue and reduce costs to increase EBIT;
• bringing assets to an acceptable minimum by increasing their efficiency.

Investors often use the free cash flow indicator to calculate a number of statistical and dynamic coefficients that evaluate the performance and profitability of an enterprise, including IRR (internal rate of return), DPP (discounted payback period), ARR (profitability of an investment project), NV (current cost ).

The profit of the company, which is shown in the income statement, is supposed to be an indicator of the effectiveness of its work. However, in reality, net income is only partly related to the money that the company receives in real terms. How much money a business actually makes can be found from the cash flow statement.

The fact is that net profit does not fully reflect the money received in real terms. Some of the items in the income statement are purely “paper”, for example, depreciation, revaluation of assets at the expense of exchange differences, and do not bring real money. In addition, the company spends part of the profit on maintaining its current activities and on development (capital costs) - for example, the construction of new workshops and factories. Sometimes these costs can even exceed the net profit. Therefore, a company on paper can be profitable, but in reality suffer losses. To assess how much money a company actually makes, cash flow helps. The company's cash flows are reflected in the cash flow statement.

Company cash flows

There are three types of cash flows:

• from operating activities - shows how much money the company received from its core activities
• from investment activity - shows the cash flow aimed at the development and maintenance of current activities
• from financial activities- Shows cash flow financial transactions: raising and paying debts, paying dividends, issuing or repurchasing shares

The summation of all three items gives a net cash flow - Net Cash Flow. It is reported in the report as Net increase/decrease in cash and cash equivalents. Net cash flow can be both positive and negative (negative is indicated in brackets). It can be used to judge whether a company earns money or loses it.

Now let's talk about what cash flows are used to value the company.

There are two main approaches to business valuation - in terms of the value of the entire company, taking into account both equity and debt capital, and taking into account the cost of equity only.

In the first case, the cash flows generated by all sources of capital — equity and borrowed — are discounted, while the discount rate is taken as the cost of attracting total capital (WACC). The cash flow generated by all capital is called the firm's free cash flow FCFF.

In the second case, the value of not the entire company is calculated, but only its own capital. To do this, free cash flow is discounted to equity FCFE - after payment of debt payments.

FCFE - free cash flow to equity

FCFE is the amount of money left over from profits after taxes, debt payments, and expenses to maintain and grow a company's operations. The calculation of free cash flow to equity FCFE starts from the company's net income (Net Income), the value is taken from the income statement.

Depreciation, depletion and amortization is added to it from the income statement or from the cash flow statement, since in fact this expense exists only on paper, and in reality no money is paid.

Further, capital expenditures are subtracted - these are the costs of servicing current activities, upgrading and purchasing equipment, building new facilities, and so on. CAPEX is taken from the investment activity report.

Something the company invests in short-term assets - for this, the change in the amount of working capital (Net working capital) is calculated. If working capital increases, cash flow decreases. Working capital is defined as the difference between current (current) assets and short-term (current) liabilities. In this case, it is necessary to use non-monetary working capital, that is, to adjust the value of current assets by the amount of cash and cash equivalents.

For a more conservative estimate, non-cash working capital is calculated as (Inventory + Accounts Receivable - Accounts payable last year) - (Inventory + Accounts Receivable - Accounts Payable of the previous year), figures are taken from the balance sheet.

In addition to paying off old debts, the company attracts new ones, which also affects the amount of cash flow, so it is necessary to calculate the difference between payments on old debts and obtaining new loans (net borrowings), the figures are taken from the financial performance report.

The general formula for calculating free cash flow to equity is:

FCFE= Net profit+Depreciation-Capital cost+/-Change in working capital - Repayment of loans + Obtaining new loans

However, depreciation is not the only “paper” expense that reduces profits, there may be others. Therefore, you can use a different formula using cash flow from operations, which already includes net income, adjustment for non-cash transactions (including depreciation), and changes in working capital.

FCFE = Net cash flow from operating activities – Capital expenditures – Loan repayments + New borrowings

FCFF is the firm's free cash flow

A firm's free cash flow is the cash that remains after paying taxes and capital expenditures, but before deducting interest and debt payments. To calculate FCFF, operating profit (EBIT) is taken, taxes and capital expenditures are deducted from it, as is done when calculating FCFE.

FCFF = After tax operating income (NOPAT) + Depreciation - Capital cost +/- Change in working capital

Or here's a simpler formula:

FCFF = Net cash flow from operating activities - Capital expenditures

FCFF for Lukoil will be 15568-14545=1023.

Cash flows can be negative if the company is unprofitable or if capital expenditures exceed profits. The main difference between these values ​​is that FCFF is calculated before paying / receiving debts, and FCFE after.

Owner's earnings

Warren Buffett uses what he calls owner profit as his cash flow. He wrote about this in his 1986 address to Berkshire Hathaway shareholders. Owner's profit is calculated as net income plus depreciation and amortization and other non-cash transactions minus the average annual capital expenditure on property, plant and equipment that is required to maintain a long-term competitive position and volume. (If a business requires additional working capital to maintain its competitive position and volume, its growth should also be included in capital expenditures.)

It is believed that the owner's profit is the most conservative method of estimating cash flow.

Owner Profit = Net Income + Depreciation and Depreciation + Other Non-Cash Operations - Capital Costs (+/- Additional Working Capital)

In essence, free cash flow is the money that can be completely painlessly withdrawn from a business without fear that it will lose its position in the market.

If we compare all three parameters of Lukoil over the past 4 years, then their dynamics will look like this. As can be seen from the graph, all three indicators are falling.

Cash flow is the money that is left with the company after all necessary expenses. Their analysis allows you to understand how much the company actually earns, and how much money it actually has left for free disposal. DP can be both positive and negative if the company spends more than it earns (for example, it has a large investment program). However, a negative DP does not necessarily indicate a bad situation. Current large capital expenditures can return many times more profit in the future. A positive DP indicates the profitability of the business and its investment attractiveness.

Free cash flow (in English. Free Cash FloworFCF), is an indicator of profitability, efficiencymanagementand liquidity, which calculates how much cash a company generatesafter payment of operating expenses and investments for business expansion. FCFcalculated by subtracting capex from operating cash flow. In other words, FCF is the surplus that a corporation earns after paying all its operating expenses and Capex. This is an important concept because it shows:

1) how effectivebutbusiness generates cash 2) canwhether the company deliver incometo its investors after payment of all expenses,given the expansion of business activities.

What is withfreecash flow?

Investors and lenders use this metric to assess the value of a company. FCF- exponential metric, reflecting the real profitability of the company. Other financial ratios can be adjusted or changed by management principles accounting. Such manipulation is not possible when calculating FCF. Thus, analysts look at FCFs to assess how well a business is performing and, more importantly, whether a company can deliver a return on its investment.On the other hand, lenders also use this measurement to analyze a company's cash flows and assess its ability to meet its debt obligations.

Now that we know why this ratio is important, let's answer the question, what is FCF?

Formula

To calculate FCF, you need to find operating cash flow (also called “cash flow”).th streamfrom operating activities”) from the statement of cash flows and deduct from it the capital expenditures required for current operations.

Example. At the end of the reporting year 2017, operating cash flowAlphabetreached $37. 091 billion., capital expenditures amounted to$13.184 billion. Thus, according to the report10 K on site company free cash flowAlphabetin 2017:

FCF=$37.091 – $13.184 = $23.907 billion.

Alternative calculation methodFCF

To calculate FCF differently, you would need an income statement and a balance sheet. Start with net income and add back depreciation and amortization costs. Make an additional adjustment for changes in working capital, which is made by subtracting current liabilities from current assets. Then subtract the capital cost:

Interpretation

We can see that Alphabet had a lot of free cash flow that can be used to pay dividends, expand operations and reduce the balance sheet, i.e.e. debt reduction.

When calculating the FCFkeep in mindthat meansreceived from a one-time sale of propertyandequipment are not included in the calculation,and marked in section “Cash flow from investing activities”,because thethis is a one-time event and not part of the day-to-day cash flow operations.

The growth of free cash flows is often a signal to increase profits. Companies that experience explosive FCF growth—due to revenue growth, efficiency gains, cost reductions, share repurchases, dividend distributions, or debt elimination—can reward investors. This is why many analysts rate a positive FCF as a positive factor. When a firm's stock price is low,afree cash flow is rising, it is likely that earnings and share prices will rise soon.On the contrary, a reduction in FCF could mean that companies cannot sustain earnings growth. Insufficient FCF to boost earnings can force a company to increase its debt levels or operate on the brink of liquidity.

Analysis

It is important to note that excess cash does not always mean that the company is doing well or that it will grow in the future. For example, a company may have a positive FCF because it does not spend money on new equipment. Eventually, the equipment will be destroyed and the business may have to shut down until the equipment can be replaced. For example, a trucking company may need to replace a truck. If the truck is not running, the Company will lose orders.

Conversely, negative free cash flow may simply mean that the business is investing heavily in new equipment and other fixed assets, causing excess cash to disappear. As with all financial metrics, FCF is one of the key financial metrics for business valuation. You should review the statements in detail, including footnotes, to understandwhere is the company now and where is it heading.

Free Cash Flow to Equity

FCFE measures how muchMoneygenerated by the company for its shareholders and calculated after taxes,interest on loans, capitalX costs and payments/attractionsdebt loans.

FCFE= FCF - Interest

FCFE= EBIT - Interest - Taxes + Depreciation - Change in NWC - Capex – Repayment of debts + New debts

FCFE = Net income + Amortization–Change in NWC–Repayment of debts + New debts

Definition: Net cash flow. net cash flow)the difference between the cash inflow and outflow of a company certain period. In a strict sense, net cash flow refers to the change in a company's cash balance as reflected in the cash flow statement.. cash flow statement).

NCF is reflected inchanges in cash and cash equivalents. It is very important to keep in mind that net cash flow is not equal to net income, FCF or EBITDA. An analyst can estimate a company's net cash flow by comparing the cash balance at the beginning of the period and at the end. However, the cash flow statement provides more detail on the calculationnet cash flow. Net cash flow is the sum of cash flows from

1) operating activities (CFO)

2) investment activity (CFI)

3) financial activity (CFF).

Net Cash Flow = Cash Flow from Operating Activities + Cash Flow from Investing Activities + Cash Flow from Financing Activities

Net Cash Flow = CFO + CFI + CFF

Example

ABC is the largest manufacturer of well drilling equipment and a leader in the sector. CompanyABCseeks to expand its operations and invested in the construction of a second plant for a total of $20 million. As a result, the company suffered negative NCF in 2013.

Below are the company's cash flows from operating, investment and financial activities:

Year 2013 = $18,000 - $18,500 - $1,050 = -$1,550

Year 2014 = $6,000 – $7,000 + $1,500 = $500

Year 2015 = $7,000 - $9,000 + $1,300 = -$700

Although the investment in the 2013 production plan justifies the negative cash flow, the company cannot maintain a stable negative cash flow for many years, as such signs may indicate the financial instability of the enterprise.

A company may have a negative net cash flow for 2 years because it invests heavily in new expensive equipment. In these cases, the potential increase in profits after the installation of equipment can significantly outweigh the disadvantage of a temporarily negative balance.

However, a net cash flow that is decreasing every year may indicate a drop in sales or a decline in profits, which is obviously not a good sign for a business.