Exercise 15: Understanding the difference between cashflow and profit

Return to the original model again. Please close the results, switch back to the Editor, close WiMAX-DSL14 and re-open WiMAX-DSL02. Save the model as WiMAX-DSL15.

1. Just press <F5> to run the working model. The pre-defined views are loaded into the Results program.
2. Use the Results tab in the Draw dialog to plot two network results, Operating Profit and Cashflow before Financing, on one graph. You should see that the business makes a profit from 2009 in the working model. Cashflow before Financing is slightly different.

Draw Precedents

3. Select Draw Precedents from the Graphs menu, or press <F2>. The Select Result dialog is displayed.
4. Choose Operating Profit (it’s much simpler!). A graph of the results which contribute to Operating Profit is drawn, and the exact definition appears in the status bar (at the bottom of the screen).

Note the two parallel capabilities: you can press <F1> for an explanation in the help system, or <F2> to see the precise formula in the status bar.

Note: in the following formulae, the items marked * are zero in this model, and can be ignored.

You can see that:

Operating Profit = Revenue
                              – Depreciation and Amortisation
                              – Stock Charge*
                              – Operating Costs.

Note: Depreciation and Amortisation + Operating Costs is referred to as Operating Charge.

5. Close the precedents graph and press <F2> again. This time select Cashflow before Financing.

Now you will see that:

Cashflow before Financing = Cashflow from Operations
                                                – Capital Expenditure
                                                + Proceeds from Sales of Assets*
                                                – Change in investments*

6. Press <F2> again and select Cashflow from Operations.

Then you will see that:

Cashflow from Operations = Pre-Tax Profit
                                                + Depreciation and Amortisation
                                                – Change in Stock*
                                                – Profit on Sale of Assets*
                                                – Change in Debtors less Creditors
                                                – Tax Paid*.

7. If you disregard Change in Investments and Change in Debtors less Creditors, you should see that the cashflow results add back depreciation and subtract capital expenditure. In other words, profitability takes account only of the current-year depreciation, whereas cashflow allows for the actual expenditures being made in a year.

NPV and Discount Rate

8. Draw Network NPV. You will see that it takes somewhat longer for the cashflows to pay back!
9. Press <F1> if you don’t know what NPV means, or what a Discount Rate is.
10. Switch back to the Editor. Open the Financial Data dialog (Data/Financial Data menu). Select Discount Rate, change the value from 0.1 to 0.15.
11. Run the model.

What happens to the payback period? Has the business case changed?

12. Change the Discount Rate back to 0.1.