Cash Flow Model

Abstract

Cash flows are one of the main indicators of liquidity of the company. In practice, the statements of cash
flows are often done as „following document“ to Balance sheet and Income statement.This is wrong. The
statement of cash flows can give the information to its users about the ability of the company to make
cash. The balance sheet and Income statement, due to their accrual basis, are not saying anything about
the cash flows of the accounting period, and that is why the Statement of cash flows is very important. A
good analysis of this statement can be the basis and support to the process of decision making both for
internal and external users of financial information. In this paper we are presenting the methodology of
the Statement of cash flows report analysis. The subject of this paper is the analysis of the Cash Flow
statement.

The aim of this paper is to point out the importance of reporting on cash flows and its information
capabilities to users of accounting information.

Cash flow refers to the net cash and cash equivalents moving in and out of a business, generated from a
company's core business activities, taking into account money spent on expenses related to producing the
business goods and services.
Cash flow, measured over a specific time period, can be positive or negative. Positive cash flow indicates
that a company's liquid assets are increasing, enabling it to cover obligations, reinvest in its business,
return money to shareholders, pay expenses, and provide a buffer against future financial needs. Negative
cash flow, on the other hand, means that a company's cash position is deteriorating, which can lead to
financial difficulties if not addressed.
Cash flow is the lifeblood of a business and helps keep business operations running smoothly. It measures
the cash coming in and money paid out, assessed over a specified period, lasting from a day to a fiscal
year or any time within. Cash flow measures the cash available to meet obligations, invest in growth, and
sustain operations; hence, it is a more important gauge of a business's health than profit.
After covering all operating expenses and capital investments, the remaining cash available for
distribution to shareholders or reinvestment in the business is referred to as free cash flow. Free cash flow
is a subset of cash flow that represents the cash a company generates after accounting for its Capital
Expenditures (CapEx).
Cash flow is a critical indicator of a company's financial health, revealing its liquidity position, financial
flexibility, and overall operating efficiency. A solid financial health (i.e., a consistent and stable flow of
cash in and out) equips businesses with resilience to withstand economic downturns.
A cash flow statement is a financial roadmap that charts this cash movement. It clearly shows where a
company's cash comes from (inflows) and where it goes (outflows). The cash flow statement offers
invaluable insights into a company's financial health by meticulously tracking these transactions,
providing a blueprint for fiscal year-end income tax preparation.
 Introduction
A cash flow model is a financial tool used to forecast and analyze the inflows and outflows of cash and
cash equivalents over a specific period. This report provides an overview of a cash flow model, its
components, and its importance in business decision-making.

Cash flow is the amount of cash and cash equivalents, such as securities, that a business generates or
spends over a set time period. Cash on hand determines a company’s runway, the more cash on hand and
the lower the cash burn rate, the more room a business has to maneuver and, normally, the higher its
valuation.
Cash flow differs from profit. Cash flow refers to the money that flows in and out of your business. Profit,
however, is the money you have after deducting your business expenses from overall revenue.

Cash Flow Analysis:

Cash flow is a measure of how much cash a business brought in or spent in total over a period of time.
Cash flow is typically broken down into cash flow from operating activities, investing activities, and
financing activities on the statement of cash flows, a common financial statement.
While it’s also important to look at business profitability on the income statement, cash flow analysis
offers critical information on the financial health of a company. It tells you if cash inflows are coming
from sales, loans, or investors, and similar information about outflows. Most businesses can sustain a
temporary period of negative cash flows, but can’t sustain negative cash flows long-term.

Newer businesses may experience negative cash flow from operations due to high spending on growth.
That’s okay if investors and lenders are willing to keep supporting the business. But eventually, cash flow
from operations must turn positive to keep the business open as a going concern.
Cash flow analysis helps you understand if a business’s healthy bank account balance is from sales, debt,
or other financing. This type of analysis may uncover unexpected problems, or it may show a healthy
operating cash flow. But you don’t know either way until you review your cash flow statements or
perform a cash flow analysis.

In addition to looking at the standard cash flow statement and details, it’s often also useful to calculate
different versions of cash flow to give you additional insights. For example, free cash flow excludes
non-cash expenses and interest payments and adds in changes in working capital, which gives you a
clearer view of operating cash flows. Unlevered free cash flow shows you cash flow before financial
obligations while levered free cash flow explains cash flow after taking into account all bills and
obligations.
Why Is Cash Flow Analysis Important?
A cash flow analysis determines a company’s working capital — the amount of money available to run
business operations and complete transactions. That is calculated as(opens in new tab)current assets (cash
or near-cash assets, like notes receivable) minus current liabilities (liabilities due during the upcoming
accounting period).

Cash flow analysis helps you understand if your business is able to pay its bills and generate enough cash
to continue operating indefinitely. Long-term negative cash flow situations can indicate a potential
bankruptcy while continual positive cash flow is often a sign of good things to come.

Cash Flow Analysis Basics

Cash flow analysis first requires that a company generate cash statements(opens in new tab) about
operating cash flow, investing cash flow and financing cash flow.

● Cash from operating activities represents cash received from customers less the amount spent on
operating expenses. In this bucket are annual, recurring expenses such as salaries, utilities,
supplies and rent.
● Investing activities reflect funds spent on fixed assets and financial instruments. These are
long-term, or capital investments, and include property, assets in a plant or the purchase of stock
or securities of another company.
● Financing cash flow is funding that comes from a company’s owners, investors and creditors. It
is classified as debt, equity and dividend transactions on the cash flow statement.

Key Takeaways
● Cash flow analysis helps you understand how much cash a business generated or used during a
specific accounting period.
● Understanding cash sources and where your cash is going is essential for maintaining a
financially sustainable business.
● A business may be profitable and still experience negative cash flow or lose money and
experience positive cash flow.
● Complementary measurements, such as free cash flow and unlevered free cash flow, offer unique
insights into a company’s financial health.
Components of a Cash Flow Model

1. Operating Cash Flows: Cash generated from core business operations, such as sales and production.
2. Investing Cash Flows: Cash used for investments in assets, such as property, plant, and equipment.
3. Financing Cash Flows: Cash generated from financing activities, such as debt issuance or equity
financing.
4. Net Change in Cash: The net increase or decrease in cash and cash equivalents.

Key examples of a cash flow model

1. Revenue Growth Rate*: 10% annual growth rate.

2. Cost of Goods Sold*: 30% of revenue.
3. Operating Expenses*: 20% of revenue.
4. Tax Rate*: 25%.
5. Discount Rate*: 10%.

Cash Flow Projections

| Year | Operating Cash Flows | Investing Cash Flows | Financing Cash Flows | Net Change in Cash |
| --- | --- | --- | --- | --- |
| 2024 | $100,000 | ($50,000) | $20,000 | $70,000 |
| 2025 | $110,000 | ($60,000) | $30,000 | $80,000 |
| 2026 | $121,000 | ($70,000) | $40,000 | $91,000 |

Analysis
The cash flow model indicates a positive net change in cash over the three-year period, with a cumulative
total of $241,000. The operating cash flows are the primary driver of the company's cash generation.
However, investing activities, such as capital expenditures, are expected to increase in the future.
Types of cash flow models

● Discounted cash flow:

Discounted cash flow (DCF) is a valuation method that estimates the value of an investment using its
expected future cash flows. Analysts use DCF to determine the value of an investment today, based on
projections of how much money that investment will generate in the future.Discounted cash flow analysis
finds the present value of expected future cash flows using a discount rate. Investors can use the present
value of money to determine whether the future cash flows of an investment or project are greater than the
value of the initial investment

Why is discounted cash flow Important?

Discounted cash flow models are used to estimate the value of an asset. It is considered a fundamental
analysis technique, meaning it is both quantitative and qualitative in nature.
DCF models require detailed assumptions that are used to forecast future cash flows. In drafting these
assumptions analysts put a great deal of effort into identifying economic, environmental, and social issues
that impact future free cash flow.
Because of this, Discounted cash flow analysis is seen as comprehensive and is widely viewed as an
industry standard in estimating the fair value of an investment.
Discounted cash flow calculations also rely on a wide variety of data, including cost of equity, the
weighted average cost of capital (WACC), and tax-rates.
WACC is, “A calculation of a firm’s cost of capital in which each category of capital is proportionately
weighted. All sources of capital, including common stock, preferred stock, bonds, and any other
long-term debt, are included in a WACC calculation”
The DCF model relies on free cash flow (FCF), which is a reliable metric that reduces the noise created
by accounting policies and financial reporting.
One key benefit of using Discounted cash flow valuations over a relative market comparable approach is
that the calculation is not influenced by marketwide over or under-valuation.
It’s critical that the assumptions that are being input into a discounted cash flow model are
accurate—otherwise, the model tends to lose its effectiveness.
How to Calculate Discounted Cash Flows
Because Discounted cash flow models depend on free cash flow, calculating a DCF is both a progressive
and cumulative process.

● Undiscounted cash flow:

The concept of “Undiscounted Future Cash Flows” refers to the projections of cash flows that an
investment or business is expected to generate in the future, without adjusting for the time value of
money. In financial analysis, cash flows are usually “discounted” to account for the time value of money,
meaning that future cash flows are worth less than immediate cash flows because of the opportunity cost
of not having that money available for investment elsewhere.
However, in some contexts, you may want to look at the raw, or “undiscounted,” future cash flows. These
are the nominal amounts of money that are expected to be received or paid at various future points in
time, without any adjustment for the effect of inflation, risk, or the opportunity cost of capital.
Here are some scenarios where you might consider using undiscounted future cash flows:
 ● Initial Screening: As a preliminary step, you might evaluate an investment project using
undiscounted cash flows to quickly judge its feasibility or attractiveness before diving into more
detailed analysis.
● Risk-Free or Short-Term Analysis: In cases where risk is considered negligible or the time frame
is very short, you might use undiscounted cash flows for simplicity.
● Regulatory or Contractual Requirements: Sometimes legal or regulatory
requirements mandate the use of undiscounted cash flows for specific
reporting purposes.
● Sensitivity Analysis: You might use undiscounted cash flows as part of a
sensitivity analysis to understand how sensitive an investment’s
attractiveness is to the discount rate used.
● Comparing to Current Cost: For projects with a relatively short time span,
the undiscounted cash flows can be directly compared to the current cost of
investment to get a rudimentary idea of profitability.

Although straightforward, it is essential to remember that using undiscounted future cash

flows ignores the important economic principle of the time value of money, potentially
leading to inaccurate or suboptimal investment decisions. Therefore, in most cases, it’s
better to use discounted cash flow (DCF) techniques for a more accurate assessment of an
investment’s worth.

Example of Undiscounted Future Cash Flows

Let’s consider a simple example involving a small investment in a vending machine

business.
Scenario:

● You are considering purchasing a vending machine that costs $5,000.

● You estimate that the vending machine will generate the following cash
inflows over the next 5 years:
○ Year 1: $1,200
○ Year 2: $1,400
○ Year 3: $1,600
○ Year 4: $1,800
○ Year 5: $2,000

Using Undiscounted Future Cash Flows:

● Calculate Total Undiscounted Future Cash Flows: Add up all the future
cash inflows.$1,200 + $1,400 + $1,600 + $1,800 + $2,000 = $8,000
● Compare to Initial Investment: The total undiscounted future cash
inflows are $8,000, and the initial investment is $5,000.
● Initial Evaluation: Since the total undiscounted cash inflows ($8,000) are
greater than the initial investment ($5,000), the investment looks attractive
on the surface.
Limitations:

● Time Value of Money: This approach does not account for the time value
of money. A dollar received in the future is not worth the same as a dollar
today.
● Risk and Opportunity Cost: This approach does not account for the risk
or the opportunity cost of using the $5,000 for some other investment.
 Conclusion

The cash flow model provides a comprehensive view of the company's financial performance and helps
identify areas for improvement. The model's assumptions and projections can be refined as new data
becomes available. This report recommends:

1. Monitoring revenue growth and operating expenses.

2. Optimizing investing activities to minimize cash outflows.
3. Exploring financing options to support business growth.

A cash flow statement is a financial statement that allows you to track money coming in and out of
business. It is an integral part of the business and a great tool for managers,investors and other
stakeholders that shows how changes in the balance sheet and income statement affect cash.The
Statement of Cash Flows explains what all during the reporting period affected the cash balance presented
in the balance sheet at the beginning of the reporting period to arrive at a new cash balance at the end of
the accounting period.Without information on the company's cash flows,it is not possible to make
adequate business decisions and thus maximize the success of the activities undertaken. Good
methodology for analysing of the Cash flows is very important .Without that, information from the cash
flows are more valuable. Just visual analysis is not enough for period of turbulent and uncertain
conditions. The presented methodology can be used together with analyisng of balance sheet and Income
statements.

Recommendations

1. Review and update the cash flow model quarterly.

2. Conduct sensitivity analysis to test assumptions.
3. Develop a contingency plan for potential cash flow shortfalls.