Adex Week 04a-Financial Planning.
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Transcript of Adex Week 04a-Financial Planning.
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IV. FINANCIAL PLANNING
I. INTRODUCTION
II. CASH BUDGET
III. FUNDS FLOW STATEMENT
CASES: ENTRAC INCALKA A.S.
MICRODRIVE CORPORATION
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FINANCIAL PLANNING
Value creation is impossible unless the company
has a well articulated plan. Projected financial
statements have three important uses:
1.To Estimate the free cash flows to measurethe current value and to investigate the impact ofproposed changes in strategy and operations.
2. ToPlan for financing that will be required toexecute the operating plans.
3. To provide a basis for a compensation plan
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PLANNING PROCESS
I. Formulating corporate objectivesII. Formation ofcorporate goalsIII. Stating the corporate strategiesIV. Stating corporate policies
a. Marketing
b. Manufacturingc. Finance ( Working capital policy, dividend policy, capital structure policy)
V. Preparing Longterm strategic plansVI. Financial Budgets
a.Projected financial statementsb.Capital budgetc.Cash budgetd.External financing plan
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FINANCIAL PLAN
The financial planning model can be used to test the feasibility of theplanned growth rate.
INGREDIENTS OF A FINANCIAL PLANNING MODEL
I.Macroeconomic Variables : Industry growth, inflation rate, FXforecasts, interest rate forecasts
2.Industry Variables : Industry growth rate, market share, rate ofchange in the industry.
3.Firm variables:a.capacity constraintsb.restrictions on debt policy,current ratio and coverage ratiosc.constraints in funds availabilityd.constraints in skilled personnel
4.Sales forecasts which are converted to sales plans whenjudgements are added.
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SALES PLANS
1.Review sales over the past 5-10 years.2.Estimate the level of economic activity and demand .3.Estimate market share for each product line in each market under
consideration taking into account the firms constraints,
competitors capacities and pricing strategies.So , a combination ofsales units and prices lead to estimation of the growth rate in sales.4.Forecast the exchange rates , government policies on trade etc. for
foreign markets.5. Estimate the need for advertising campaigns, promotions,
determine credit terms.
6.Decide if the firm resources can meet the marketing expensesestimated to reach the forecasted sales levels7.Prepare a sales plan using a breakdown by geographical areas and
by products
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OUTPUTS OF FINANCIALPLANNING:
1. Projected Balance Sheet2. Projected Income Statement3. Cash Flow Statement4. Cash Budget5. Financing Plan
Projected financial statements are used to analyze the effects of the operating plans on the projected profits and financial ratios. to determine the amount of external funds needed to establish a system of controls governing the allocation and use of funds to develop a feedback loop which triggers modification of plans in case of unexpected
changes To establish a performance based compensation system
To determine the value of the company using the free cash flows generated from theforecasted statements.
The projected statements can be analyzed to determine how much value the plancreates for shareholders.The price of the stock as of the end of the forecasted yearshould be estimated. If the statements do not meet the targets,that is, if the value is not
acceptable ,then the elements of the plan should be studied to see if changes shouldbe made.
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Qualitative Factors Analysts ShouldConsider When Evaluating a Companys
Future Financial Performance1. Are the companys revenues tied to one key
customer?2. To what extent are the companys revenues
tied to one key product?
3. To what extent does the company rely on asingle supplier?
4. What percentage of the companys business isgenerated overseas?
5. Competition6. Future Prospects7. Legal and regulatory environment
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CASH BUDGETS
Forecasting future cash needs is called a cash budget.The cash budget is the tabulationof the plans of the firm in terms of their impact on the receipts and disbursements ofcash.The basic aim is to predict when and in what quantity payments of cash will bemade.
In most cash forecasts , receipts and payments are broken down by months.If uneven
inflows and outflows are anticipated within the monthly intervals, it may be necessary tobreak the forecast down into weekly or even daily periods.
The most critical estimate in cash flow forecasting is the forecast of sales.Most cashreceipts and payments are closely related with sales.
Cash budgeting involves projection of cash inflows, outflows and financing needs.Cash
budgeting is directly linked with the lag between transactions and the related cashflows,with cash needs and with excess cash.
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CASH BUDGETS
A cash budget consists of two parts:
1.The planned cash receipts
2.The planned cash disbursements
Evaluation of the cash position may indicate:
1.The need for financing to cover the cash deficit
2.The need for planning to put excess cash to profitableuse.
The cash budget is closely related to the sales plan,
expense budgets, and capital expenditures budget.
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PURPOSES OF THE CASHBUDGET
The purposes of preparing cash budgets may be summarized as:
1.To indicate the probable cash position as a result of plannedoperations.
2. To indicate cash excess and shortages
3.To indicate the need for borrowing or the availability of idle cash forinvestment.4.To coordinate cash with (1) total working capital (2) sales
(3)investment (4) debt5.To establish a sound basis for credit6.To establish a sound basis for control of the cash position.
The cash budget is concerned with timing of cash inflows andoutflows whereas other budgets are concerned with the timing oftransactions.( accrual basis).This is the basic distinction of cashbudgets form other projected statements.
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TIME HORIZONS IN CASHPLANNING
1.Longterm: The timing is in accord (1)with the time dimensions of the capitalexpenditure projects(2) time dimension of
the 5 year plan.
2.Shortterm: The timing is in accord withtha annual profit plan.It forms the basis for
assessing the credit needs and for cashcontrol during the year.
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CONTROL OF THE CASHPOSITION
The deviations of actual cash balance from the budgets may resultfrom:1.variation in factors affecting cash2.unexpected changes influencing operations3.lack of cash control
Cash control can be based on two procedures:
1.A continuous evaluation of both present and probable cash positionon a monthlybasisThis involves reporting monthly actual cash position to date which
helps reprojection of cash flows taking into consideration theunexpected developments.
2.Evaluation of daily cash fluctuations.This is useful in companies having widely fluctuating cash demands.
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INPUTS OF CASH BUDGETS
The main inputs of the cash budgets are:
1. Sales forecasts
2. The percentage of credit sales
3. Receivables collection policy
4. Payments for purchases policy
5. Capital expenditures for the year that are generated fromcapital budgets.
6. Dividend payment policy7. Cash inflows from rent, dividend receipts, sales of assets
8. Outflows revealed by the expense budgets
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BASIC PROBLEMS IN EFFECTIVECASH FORECASTING
1.An important limitation to effective cash forecasting is the needfor comprehensive and detailed planning data.
2.The difficulty of predicting the future due to high variability.
As the degree of uncertainty increases ,
the management should recognize margins for error inherent in itsforecasts
cash budgets can be prepared based on different scenarios withvarying underlying assumptions.
simulation techniques can be used with clear definition of theassumptions upon which forecasts are based.
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Cash Budget: Purpose and Timing
Purpose: Forecasts cash inflows, outflows,and ending cash balances. Usedto plan loans needed or funds
available to invest.Timing: Daily, weekly, or monthly,
depending upon purpose offorecasts. Monthly for annualplanning, daily for actual cashmanagement.
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A. Other Potential Cash Inflows Besides Collections:
1. Proceeds from sale of fixed assets
2. Proceeds from stock and bond sales
3. Interest earned4. Court settlements
B. How can interest earned or paid be incorporated in the
cash budget?1. Interest earned: Add line in the collections section.
2. Interest paid: Add line in the payments section.
3. Calculation: Interest rate x surplus or loan of cash budget for
preceding month.
C. How are bad debts included in cash budget?
Collections would be reduced by the amount of the bad debtlosses.
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III. SOURCES AND USES OFFUNDS STATEMENT
A funds flow statement is a useful aid to a financial manager ora creditor in evaluating the use of funds by a firm and indetermining how these uses are financed.The analyst canevaluate the future flows by means of a projected funds flowstatement which is based on forecasts.Such a statement
provides an efficient method for assessing the growth of thefirm, and its resulting needs and to determine the best way tofinance those needs.
Funds may be defined in several ways depending on the
purpose of analysis.Although they are mostly defined ascash,many analysts treat funds as working capital.
The flow of funds is a continuous process. The assets of thefirm represent net uses of funds; its liabilities and net worth
represent net sources.
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A cash flow cycle for a typical manufacturing company:
EQUITY ASSETS
asset Asset Purchases sales CASHRAW MATERIALSWIP FINISHEDStock repurchases
CASH SALES GOODS
COLLECTIONS CREDIT SALES
(A/R)DEBT
A finished good is produced by a variety of inputs-raw material, net fixedassets, and labor.These inputs are paid in cash. The product is sold eitherfor cash or on credit. A credit sale involves a receivable, when collectedbecomes cash.The reservoir of cash fluctuates over time with theproduction schedule, sales, collections, capital expenditures and financing.
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STATEMENT OF CASH FLOWS
Cash flow statement is a means by which we study the net funds flowbetween two points in time. These two points conform to thebeginning and ending financial statement dates for whatever
examinationperiod is relevanta quarter, a year, or five years.The cash flow
statementrepresents the net rather than gross changes between two comparablestatements at two different dates.
A statement of cash flows is prepared by :
1.Classifying net balance sheet changes that ocur between two pointsin time into changes that increase cash and changes that decreasecash
2.Classifying from the income statement the factors that increase anddecrease cash.
3.Consolidating the changes into a financial statement form.
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SOURCES OF CASH:1.A net decrease in any asset other than cash or fixed
assets
2.A gross decrease in fixed assets3.A net increase in any liability4.Proceeds from sale of common stock5.Funds provided by operations.( Net income+
Depreciation)
USES OF CASH:1.Any net increase in any asset other than cash or fixed
assets.
2.A gross increase in fixed assets.3.A net decrease in any liability4.Dividend payments5.Net losses
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The statement separates the activities into three categories:
1.Operating activities, which include net income,changes in current assets and
current liabilities other than cash,short-term investments and short-term debt.2.Investing activities, which includes investments in or sales of fixed assets3.Financing activities,which includes raising cash by selling short-term
investments, or by issuing short-term debt, long-term debt or stock.Dividendspaid, retirement of bonds are transactions that are included.
When the total sources of cash is subtracted from total uses , the differenceshould be equal to the change in cash between the two statement dates.If itdoes not, the analyst should search for the discrepancy. Frequently, it is due tothe surplus adjustments.
Depreciation is not a source of funds, for funds are generated only fromoperations. Depreciation is a noncash outlay and because it was deducted from
revenues, it should be added back as a source of funds.Accumulateddepreciation account in the balance sheet is treated as a liability account and anincrease in accumulated depreciation is a source of funds.To avoid doublecounting, gross changes in fixed assets are considered.
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Conversion of net income from accrual to cash basis: ( An example)
Reported net income xxxxAdd:
Depreciation
Amortization of intangiblesLosses on sale of assetsDecrease in accounts receivableDecrease in prepaid expensesIncrease in income taxes payable
Deduct:Increase in inventoriesDecrease in accounts payableGains from sale of assets
Equals:Net income on cash basis
An increase in retained earnings account may be the result of:1.Net income only2.Net income minus dividends
3.Net income dividends+/- corrections of prior years earnings4.Some similar combination.
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IMPLICATIONS OF CASH FLOWSTATEMENT
A financial manager may detect imbalances in the use of funds andundertake appropriate action. An out of proportionate growth in one ofthe assets relative to sales, uncovers inefficiencies in assetmanagement.
Another use of cash flow statement is its use in evaluation of
financing.An analysis of the major sources of funds reveals what portionis financed externally.In addition, the kind of financing policy that themanagement adopts is identified and evaluated in terms of its impact oncorporate return and risk.
The cash flow statement also reveals if the company has expanded at a
very fast rate and whether financing is strained.The kind of financingused at present will restrict the future financing policies .
An analysis of forecasted cash flow statement is valuable to the managerin planning intermediate and longterm financing of the firm. It revealsthe firms total prospective need for funds, and the investments for
which they will be used.
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CASES
CASE I : ENTRAC COMPANY
CASE II : ALKA A..
CASE III: MICRODRIVE CORPORATION
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CASH BUDGET : ENTRACCOMPANY
Entrac Company is preparing its cash budget for the first six months of Year 2.The salesdata for Year 1 and the sales forecasts for January through July of Year 2 are :
Actual Sales, Year 1 Sales forecast, Year 2November $350December 400 January $450
February 500March 700
April 800May 600
June 450July 300
All sales are made on credit,with 70% collected in the first month following the sale and30% collected in the second month.Purchases are 60% of the following months sales andare paid in the following month.Monthly expenses equal to 30% of the current monthssales and are paid in the current month.Beginning cash is $ 100 and should not bepermitted to fall below this level in any of the following months.Bank borrowing is used tobring cash to this level when necessary.Whenever cash exceeds $100 level ,the excesscash is used to pay off bank loans outstanding.Prepare the cash budget for this companyfor the first six months of Year 2 .
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SOLUTION
ENTRAC COMPANY
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Cash BudgetEntrac Company
January February March April May June July
Sales 450 500 700 800 600 450 300
Collections:
one month 280 315 350 490 560 420 315
two months 105 120 135 150 210 240 180
Total 385 435 485 640 770 660 495Purchases 300 420 480 360 270 180
Cash Payments
for Purchases270 300 420 480 360 270 180
Expenses 135 150 210 240 180 135 90
Total Payments 405 450 630 720 540 405 270
Net Gain (Loss)(20) (15) (145) (80) 230 255 225
Beginning Cash 100 80 65 -80 -160 70 325
Cumulative Cash 80 65 (80) (160) 70 325 550
Less:Desired Level
of Cash-100 -100 -100 -100 -100 -100 -100
Loans needed (20) (35) (180) (260) (30)
Surplus 225 450
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ALKA A..NAKT BTES
ALKA A.. letmesinin nakit btesine temel tekil eden baz varsaymlarndkm yaplmtr. deiik senaryo iin gelitirilen varsaymlarkullanlarak nakit bteleri hazrlanmaktadr. ncelikle nakit akmlarhesaplanm, bte hazrlanmas srasnda gerekli yerlerde tahsilat, demeplan gibi temel politikalarda baz deiiklikler yaplmtr. letme her aykasada 10,000 TL nakit bulundurmay hedeflemektedir. Bu miktar aannakit menkul kymetlere yatrlacak, bunun altnda kalmas halindebankadan ksa vadeli borlanma yaplacaktr.
KOULLAR
VARSAYIMLAR En kt Normal En iyi
Sat gelirleri %5 azalr Geen yl ile ayn %10 artar
Kredili Satlar Satlarn%95'i Satlarn %90' Satlarn %85'i
Tahsilatlar %80'i 30 gnde %85'i 30 gnde %100' 30 gnde
%10'u 60 gnde %10'u 60 gnde
%10 tahsil edilemeyen %5'i tahsil edilemeyen
Harcamalar %5 artar Geen yl ile ayn %3 der
Yatrm Giderleri 0 100,000 150,000
(ubat'ta) (ubat'ta)
ALKA A
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ALKA A..NAKT BTES*
1.1.20X1 30.6.20X1(Normal Koullar Altnda)
I. GELRLER OCAK UBAT MART NSAN MAYIS HAZRAN
Balang nakit 20,000 16,000 (63,000) (3,000) (5,000) 25,000
Nakit Satlar ve Tahsilatlar 50,000 65,000 75,000 65,000 75,000 65,000
Kira 25,000
Kar Pay ve Faiz 5,000 2,000 5,000 2,000
Toplam Nakit Girii 55,000 67,000 100,000 70,000 75,000 67,000
Mevcut Toplam Nakit 75,000 83,000 37,000 67,000 70,000 92,000
II. NAKT IKILARI
cretler 23,000 25,000 25,000 25,000 25,000 25,000
Maalar 5,000 5,000 5,000 5,000 5,000 5,000
Hammadde demeleri 4,000 16,000 10,000 15,000 15,000 10,000
Kar Pay 2,000 2,000
Gelir Vergisi 25,000 25,000
Yeni Makina 100,000
Toplam Nakit k 59,000 146,000 40,000 72,000 45,000 40,000
Nakit (A) Fazlas 16,000 (63,000) (3,000) (5,000) 25,000 52,000
* Veriler ekonominin normal koullar altnda olduu varsaymna dayaldr.
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ALKA A..DZELTLM NAKT BTES
1.1.20X1 30.6.20X1I. NAKT GRLER OCAK UBAT MART NSAN MAYIS HAZRAN
Balang Nakit 20,000 10,000 10,000 10,000 10,000 10,000
Tahsilat 50,000 65,000 75,000 65,000 75,000 65,000
Kar Pay 25,000
Kar Pay ve Faiz 5,000 2,000 5,000 2,000Vadesi Gelen MenkulKy.* 10,100* 43,531* 498 30,803
Toplam Nakit Girii 55,000 77,100 143,531 70,000 75,498 97,803
Toplam Nakit Mevcudu 75,000 87,100 153,531 80,000 85,498 107,803
II. NAKT IKILARI
cret 23,000 25,000 25,000 25,000 25,000 25,000
Maa 5,000 5,000 5,000 5,000 5,000 5,000
Hammadde 4,000 16,000 10,000 15,000 15,000
Kar Pay 2,000 2,000
Vergi 25,000 25,000
Bor Faizi** 2,506**
Yeni Makina 100,000
Toplam Nakit k 55,000 34,000 146,000 69,506 45,000 45,000
Nakit (A) Fazlas 20,000 53,100 7,531 10,494 40,498 62,803
Minimum Nakit 10,000 10,000 10,000 10,000 10,000 10,000
Nakit (A) Fazlas 10,000 43,100 (2,469) 494 30,498 52,803
*Nakit fazlasnn aylk olarak %1 faizden yatrld varsaylmtr.**Borlanma bir ay iin yaplm ve faiz aylk %1.5 olarak hesaplanarak Nisan aynda geri denmitir.
Bir nceki btedeki baz varsaymlar deitirilmitir.1-Yatrm ubat ayndan Mart ayna alnmtr.
2-Hammadde demeleri 30 gn geciktirilmitir.3-letme her ay en az 10,000 TL kasa bulundurmay hedeflemektedir.
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CASE:
MICRODRIVE CORPORATION
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MICRO DRIVE INC.BALANCE SHEETS ( ml $) ASSETS LIABILITIES AND EQUITY YEAR 2 YEAR 1 YEAR 2 YEAR 1 Cash and Equivalents 10 15 Accounts Payable 60 30 Short Term Investments 0 65 Notes Payable 110 60 Accounts Receivable 375 315 Accruals 140 130 Inventories 615 415 Total Current Liabilities 310 220
Total Current Assets 1000 810 Long Term Bonds 754 580 Total Debt 1064 800 Preferred Stock
(400,000shares) 40 40 Common Stock
(50mil.shares) 130 130 Retained Earnings 766 710 Net Plant and Equipment 1000 870 Total Equity 896 840 Total Assets 2000 1680 Total Liabilities and Equity 2000 1680
MICRO DRIVE INCOME STATEMENTS YEAR 2 YEAR 1
Net Sales 3000.0 2850.0 Costs Excluding Depreciation 2616.2 2497.0 Depreciation 100.0 90.0 Total Operating Costs (2716.2) (2587.0 ) Earnings Before Interest and Taxes 283.8 263.0 Interest (88.0 ) (60.0) Earninge Before Taxes 195.8 203.0
Taxes (40%) (78.3) (81.0) Net Income Before Preferred Dividends 117.5 122.0 Preferred Dividends (4.0) (4.0) Earnings Available to Shareholders 113.5 118.0 Common Dividends (57.5) (53.0) Addition to Retained Earnings 56.0 65.0 Per Share Data Common Stock Price $ 23.00 $26.00 Earnings Per Share 2.27 2.36 Dividends per Share 1.15 1.06 Book Value Per Share 17.92 16.80
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Source Use
Decrease in cash 5Decrease in shortterm investments 65
Increase in receivables 60Increase in inventories 200Gross increase in fixed assets 230Increase in accumulated depreciation 100
Increase in accounts payable 30Increase in notes payable 50Increase in accruals 10Increase in long-term debt 174Increase in retained earnings 56 _______Total $ 490 $ 490
MICRODRIVE STATEMENT OF CASH FLOWSYEAR 2
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YEAR 2
Cash Flow from Operating Activities:
Net Income $ 117.5Additions to net income:
Depreciation 100.0Changes in net working capital:Increase in accounts payable 30.0Increase in accruals 10.0Increase in accounts receivable (60.0)Increase in inventories (200.0)
Net cash provided by operations $ (2.5)
LongTerm Investments:Fixed asset investments (230.0)
Financing Activities:Sale of short-term investments 65.0Increase in notes payable 50.0
Increase in bonds outstanding 174.0Dividend payments (61.5)
Net cash provided by Financing Activities $ 227.5
Summary:Net change in cash (5.0)Cash at the beginning of the year 15.0
Cash at the end of the year 10.0
The most important item in the cash flow statement is the cash fromti A b t fit b ti t ti S
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poperations.A company may boost profits by accounting tactics . So, acompany may report profits until the time it declares bankruptcy. In suchcases , the cash flow from operations start deteriorating much earlier andanalysts can predict trouble by analyzing the trend in cash provided byoperations. Microdrive has $ 2.5 million of cash shortfall from operations.It covered this shortfall by liquidating marketable securities and borrowing
long-term and short-term loans.
Microdrive finances some portion of its fixed assets by long-term debtand some by short-term debt which may be risky if the firm can notgenerate funds in the short run. However, financing with short-term fundsmay reduce costs , assuming short-term interest rates are below long-termrates.
As can be seen in the above statements , the company makes excessiveinvestment in current assets ,especially in inventories, which cause thecash flow from operations to be negative despite the increases in payablesand accruals.
*The company had positive operating profits which increased by 8%, butEVA was negative because of the faster increase (26%) in the cost offinancing . So, the company should improve its ROIC and/or reduce itscost of capital. A reduction in asset investment may reduce TOC andimprove EVA while improving asset turnover and profitability of the firmas well. Lower investment in working capital can help improve the cashflow from operations.