00:00:10
hello everyone hi welcome to the channel
of WallStreetmojo
00:00:13
watch the video till the end and if
you're new to this channel then you can
00:00:18
subscribe us by clicking the bell icon
today we have a topic with asset cash
00:00:22
flow returns on investments it's as
simple as that I know how much cash flow
00:00:26
as a part of the return that goes with
your investment that you have piston as
00:00:30
a part of your money this is the example
of Starbucks corp capital employed and
00:00:34
the cash from operations so the capital
employed was 18.47 billion
00:00:38
cash flow from the operation goes around
11.94B there was
00:00:42
a significant rise in both the scenario
and the jump has been taken but there's
00:00:47
a huge jump that has been seen from 2018
itself so what exactly this all ratio is
00:00:53
all about we are trying to understand
first what is the CFROI okay the CFROI
00:00:59
or cash flow or it is also known as your
IRR of the company as it is compared
00:01:05
with the hurdle rate it is compared with
the hurdle rate to the understand
00:01:09
whether the profit or the investment is
doing well or not like it was designed
00:01:12
by hold value associates you know the
measure all all allows the investor to
00:01:18
go into the internal structure of the
company to find out how cash is created
00:01:24
in the organization it helps you to
understand know how company finances its
00:01:29
operations and how financial providers
are being paid more ever you know the
00:01:32
cash flow returns on investments also
takes inflation into account so CFROI
00:01:37
is a valuation model
it's a valuation model and at the same
00:01:45
time it does not take into account the
performance of the earnings of the
00:01:48
company right so we'll try and
understand the formula for this
00:01:53
particular concept the CFROI is equal
to the OCF divided by the capital
00:02:03
employed
so to be able to calculate the CFROI we
00:02:10
need to understand both the OCF and CE
right so let's understand them one by
00:02:17
one first is OCF that is operating cash
flow in simple terms the operating cash
00:02:22
flow is the amount of the cash that
comes in after paying operating expenses
00:02:26
for the company so well we will first
look at the net income and do following
00:02:32
adjustments according to the indirect
method of cash flow OCF is equal to
00:02:37
your net income plus your non-cash
expenses plus changes in walking cap
00:02:47
again now capital employed C let's look
at the capital employed or part rate it
00:02:52
is okay I will again say it it is net
income OCF operating cash flow is your
00:02:57
net income plus non-cash expenditure
plus changes in working capital and CFROI
00:03:01
formula is operating cash flow divided
by the capital employed now we'll discuss
00:03:05
see the CEO of the company used to
method two usual means of measures to
00:03:11
calculate the capital employed there are
the two ways to find out the capital
00:03:14
employed no matter which we use we need
to remain consistent in to approach the
00:03:18
capital employed is equal to your fixed
assets plus your working capital right
00:03:22
and second your capital employed is
equal to your total assets less your
00:03:28
current liabilities right the second
method is easier and and in the example
00:03:34
section we'll use the second method to
ascertain the capital employed back on
00:03:38
the Starbucks example the chart that we
saw over here you know the operating
00:03:43
cash flow standing at 11.94B and the capital employed
00:03:47
standing at 18.47B so the CFROI will be is equal to
00:03:52
the CFROI is going to be is equal to
11.94 divided by
00:03:57
18.47 that's going
to be 64.67%
00:04:00
65
okay so we have got the percentage but
00:04:04
how to interpret so that is our next
topic of disparate discussion that is
00:04:08
the interpretation part interpret the CFROI cannot be interpreted
00:04:15
without comparing it to the hurdle rate
so usually the hurdle rate is the
00:04:18
weighted average
weighted
00:04:20
average cost of capital the WACC okay
now once the CFROI is calculated it is
00:04:27
compared with the CFROI is compared
with the WACC and then the net CFROI
00:04:39
is calculated so here's how we can
calculate CFROI the cash flow from return
00:04:45
on investment less the weighted average
cost of capital right so if the net CF
00:04:50
ROI if the net CFROI is let's say
positive that as the CFROI is greater
00:04:59
than the WACC then it increases the
value of the shareholders and if the net
00:05:03
CFROI is let's say negative that is the
CFROI is less than the WACC
00:05:09
then it decreases the value of the
shareholders now let's understand the
00:05:14
example see let's say Ms.Shweta has been thinking of investing in Q company but
00:05:20
before investing she wants to know
whether Q company would be able to
00:05:23
appreciate our value as a as a
shareholder so she decided to find out
00:05:27
the cash flow return on investment and
the net CFROI right so she has
00:05:34
some of the following details something
like this details are something like
00:05:38
this net income depreciation deferred
tax account receivables inventories and
00:05:43
so on and so forth it goes around with a
couple of details we have in we have the
00:05:48
above information available and first
will try to calculate over here the OCF
00:05:52
that is the operating cash flow so we
will try and incorporate this first so
00:05:56
let's try and incorporate the numbers
we'll start with OCF here we'll start
00:06:01
with net income so net income over here
is 6,00,000 plus any non-cash
00:06:09
expenditures
00:06:14
just add over here okay non-cash
expenditure will be depreciation
00:06:21
amortization deferred tax both of them
above so we'll take down all those
00:06:26
numbers here okay and now we will have
to add any increase in the or the
00:06:33
changes in the working capital okay
which will be increasing account racer
00:06:40
will decrease in inventory accounts
payable and all of this about let's take
00:06:44
down the numbers here increase in
account receivable has to be deducted
00:06:47
this will be decrease in inventory has
to be added increase in account payable
00:06:51
decrease in ability should be deducted
and this will be added okay now any
00:06:57
increase in the accrued the profit on
the sale of property will be deducted so
00:07:02
we'll take down that number here 12000
so now we'll get from this
00:07:06
above cash flow from operating
activities okay so that will be just
00:07:14
take down all the numbers just sum it up
everything is equal to sum all these
00:07:18
numbers out here so it's 646700
so we have the component
00:07:22
of the CFR we need to calculate the
another one that is capital M so for
00:07:26
capital employed we need total assets that is e right then current liability that's
00:07:32
B and then there will be capital
employed that is A - right let's get the
00:07:38
total assets here 32 lack current
liabilities 4 lakh and capital
00:07:44
employed will be 32 lakh - 4 lakh that is 28 lakh so here's the cash flow
00:07:49
return on investment of Q company that
is the cash flow return on the
00:07:53
investment formula CFROI is equal to
just get the numbers out here see if ROI
00:08:01
6.4700 divided by
28 lakh and that gives us 23.1%
00:08:05
so - no hurdle rate total rate and
to compare the cash flow rate or
00:08:09
investment method we need to first
compute the WACC and find out the same
00:08:13
if you calculate over here the WACC it's
long process but it comes down to
00:08:18
4.06 then the net cash flow
rate on an investment is twenty
00:08:22
23.10 as for CFROI and WACC so
the net cash flow or return
00:08:27
on investment is going to be 23-4.6
this is percentage so it's gonna
00:08:36
be 0.06 that is 19.04 so from the
00:08:43
above share is now confident that Q
company will be able to appreciate the
00:08:47
investment should be making as a as a
result she would go ahead and invest
00:08:51
into the company so in the final
analysis CFROI is one of the best
00:08:55
measure if you want to know an accurate
picture of how company is doing other
00:08:58
accounting ratio work but there are
based on the flawed idea that more
00:09:02
profit means you know better resources
management and better returns but in
00:09:06
actual sense how much cash is coming and
how much is going out is what is
00:09:13
important and will always decide how a
company is doing in terms of the
00:09:16
performance in the market and every
investor should calculate the CF ROI and
00:09:20
the net cash flow or returns on
investment before investing into any
00:09:24
company so that's it for this particular
topic I think if you have learned and
00:09:29
you know liked the video if you think
that you know if you have enjoyed and
00:09:33
learned watching this video please like
comment on this video and subscribe to
00:09:37
our channel for all the latest updates
thank you everyone
00:09:40
Cheers
