11 Cash Flow

0273707310_JACKET-NEW.indd 1 30/11/05 10:37:00 WKMR_A01.QXD 11/24/05 12:53 PM Page i Key management ratios WKMR_A01.QXD 11/24/05 12:53 PM Page ii In an increasingly competitive world, we believe it’s quality of thinking that gives you the edge – an idea that opens new doors, a technique that solves a problem, or an insight that simply makes sense of it all. The more you know, the smarter and faster you can go. That’s why we work with the best minds in business and finance to bring cutting-edge thinking and best learning practice to a global market. Under a range of leading imprints, including Financial Times Prentice Hall, we create world-class print publications and electronic products bringing our readers knowledge, skills and understanding, which can be applied whether studying or at work. To find out more about Pearson Education publications, or tell us about the books you’d like to find, you can visit us at www.pearsoned.co.uk WKMR_A01.QXD 11/24/05 12:53 PM Page iii Key management ratios The clearest guide to the critical numbers that drive your business fourth edition Ciaran Walsh WKMR_A01.QXD 11/24/05 12:53 PM Page iv PEARSON EDUCATION LIMITED Edinburgh Gate Harlow CM20 2JE Tel: +44 (0)1279 623623 Fax: +44 (0)1279 431059 Website: www.pearsoned.co.uk First published 1996 Second edition 1998 Third edition 2003 Fouth edition published in Great Britain 2006 © Ciaran Walsh 2006 The right of Ciaran Walsh to be identified as author of this work has been asserted by him in accordance with the Copyright, Designs and Patents Act 1988. ISBN-13: 978-0-273-70731-8 ISBN-10: 0-273-70731-0 British Library Cataloguing-in-Publication Data A catalogue record for this book is available from the British Library Library of Congress Cataloging-in-Publication Data Walsh, Ciaran. Key management ratios : the clearest guide to the critical numbers that drive your business / Ciaran Walsh.-- 4th ed. p. cm. Includes index. ISBN-13: 978-0-273-70731-8 (alk. paper) ISBN-10: 0-273-70731-0 (alk. paper) 1. Ratio analysis. 2. Management--Statistical methods. 3. Statistical decision. I. Title. HF5681.R25W347 2006 658.4’033--dc22 2005054680 All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without either the prior written permission of the Publishers or a licence permitting restricted copying in the United Kingdom issued by the Copyright Licensing Agency Ltd, 90 Tottenham Court Road, London W1T 4LP. This book may not be lent, resold, hired out or otherwise disposed of by way of trade in any form of binding or cover other than that in which it is published, without the prior consent of the Publishers. 10 9 8 7 6 5 4 3 2 1 09 08 07 06 05 Typeset in Century Schoolbook by 30 Printed and bound by Bell & Bain Limited, Glasgow The Publishers’ policy is to use paper manufactured from sustainable forests. WKMR_A01.QXD 11/24/05 12:53 PM Page v About the author Ciaran Walsh is Senior Finance Specialist at the Irish Management Institute, Dublin. He is trained both as an economist and an accountant (BSc (Econ) London, CIMA) and had 15 years’ industrial experience before joining the academic world. His work with senior managers over many years has enabled him to develop his own unique approach to training in corporate finance. As a consequence, he has lectured in most European countries, the Middle East and Eastern Europe. His main research interest is to identify and computerize the links that tie corporate growth and capital structure into stockmarket valuation. He lives in Dublin and is married with six children. He can be contacted at [email protected] About the author v WKMR_A01.QXD 11/24/05 12:53 PM Page vi To our grandchildren Rebecca Isobel Benjamin Eleanor Sophie Eve Hanna Holly Grace Aaron Alice Zoe Imogen Kate Lei Xiao Shun WKMR_A01.QXD 11/24/05 12:53 PM Page vii Contents Acknowledgments . xii Foreword . xiii Key for symbols . xiv PART I FOUNDATIONS . 1 1 Background . 3 Why do you need this book? . 4 The form and logic . 4 Method . .5 The philosophy . .5 Excitement . .6 Data that makes sense . .6 2 Financial statements . 9 Introduction . .11 The balance sheet . .14 Balance sheet structure – fixed assets . .18 Balance sheet structure – liabilities . .20 Summary . .24 3 Balance sheet terms . 25 Introduction . .26 The terms used . .26 4 Profit and loss account . 35 Introduction . .36 Working data . .42 Contents vii WKMR_A01.QXD 11/24/05 12:53 PM Page viii PART II OPERATING PERFORMANCE . 47 5 Measures of performance . 49 Relationships between the balance sheet and profit and loss account . .50 The ratios ‘return on total assets’ and ‘return on equity’ . .52 Balance sheet layouts . .54 6 Operating performance . 59 Return on investment (ROI) . .61 Return on equity (ROE) . .62 Return on total assets (ROTA) . .64 Standards of operating performance . .66 7 Performance drivers . 81 Operating performance . .82 Operating profit model . .88 PART III CORPORATE LIQUIDITY . 95 8 Cash flow cycle . 97 Corporate liquidity . .99 The cash cycle . 100 Measures of liquidity – long and short analysis . 110 9 Liquidity . 113 Short-term liquidity measures . .115 Current ratio . .116 Quick ratio . .118 Working capital to sales ratio . 120 Working capital days . 122 10 Financial strength . 125 Interest cover . .126 ‘Debt to equity’ ratio (D/E) . .128 Leverage . .134 Summary . .136 viii Contents WKMR_A01.QXD 11/24/05 12:53 PM Page ix 11 Cash flow . 137 The cash flow statement . .139 Sources and uses of funds – method . .140 Opening and closing cash reconciliation . .144 Long and short analysis . .146 Financial reporting standards . .150 PART IV DETERMINANTS OF CORPORATE VALUE . 153 12 Corporate valuation . 155 Introduction . .156 Share values . .158 13 Financial leverage and corporate valuation . 175 Introduction . .176 Financial leverage . .176 V chart . .178 Market to book ratio . .182 14 Growth . 189 Growth . .190 Analysis . .194 Growth equilibrium . .196 Application to acquisitions . .202 PART V MANAGEMENT DECISION-MAKING . 205 15 Cost, volume and price relationships . 207 Introduction . .209 Costing illustration.

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