Cash Flow Patterns Research Articles

Business Life Cycle and Capital Structure: Evidence from Chinese Manufacturing Firms

AbstractThis paper uses a panel data‐fixed effect approach and data collected from Chinese public manufacturing firms between 1999 and 2011 to investigate the impacts of business life cycle stages on capital structure. We find that cash flow patterns capture more information on business life cycle stages than firm age and have a stronger impact on capital structure decision‐making. We also find that the adjustment speed of capital structure varies significantly across life cycle stages and that non‐sequential transitions over life cycle stages play an important role in the determination of capital structure. Our study indicates that it is important for policy‐makers to ensure that products and financial markets are well‐balanced.

Impending Bankruptcy: Examining Cash Flow Pattern of Distress and Healthy Firms

Abstract Studies have proven that information on earnings has become less relevant to measure company performance during distressed situation. A relatively simple and convenient way to analyze a company's financial status is by using cash flow information. The present study examines eight types of cash flow patterns used as an alternative tool to predict financial distress incidence. The cash flow patterns derived from positive and negative signs of cash flow components which consist of operating, investing and financing activities. The data collected consists of 124 Malaysian public listed companies covering the period of 2006 until 2013. The main objective of the study is to find out whether there is any significant relationship between cash flow patterns and financial distress incidence. The results found that companies are more likely to experience financial distress situation when the company generates positive cash inflow from daily operation activities and use the cash generated to finance future investment and long term debt. Besides, the companies are also more likely in distressed situation when they are unable to cover its short term obligation due to insufficient cash inflows generated from the main operating activities. Distressed companies are more likely to acquire external financing since the excess of cash generated from operating activities is insufficient. When the company experienced outflows in all operating, investing and financing activities, there is high tendency for the company to go bankrupt. The results also revealed that there is a significant difference between distressed and healthy companies in incidence of different patterns of cash flow.

On the efficient utilisation of duration

In this article we present a new approach to estimate the change of the present value of a given cashflow pattern caused by an interest rate shift. Our approximation is based on analysing the evolution of the present value function through a linear differential equation. The outcome is far more accurate than the standard approach achieved by a Taylor expansion. Furthermore, we derive an approximation formula of second order that produces nearly accurate results. In particular, we prove that our method is superior to any known alternative approximation formula based on duration. In order to demonstrate the power of this improved approximation we apply it to coupon bonds, level annuities, and level perpetuities. We finally generalise the approach to a non-flat term structure. As for applications in insurance, we estimate the change of the discounted value of future liabilities due to a proportional shift in the set of capital accumulation factors. These findings are of particular importance to capital adequacy calculations with respect to interest rate stress scenarios that are part of regulatory solvency requirements.

Are Credit Default Swaps Credit Default Insurances?

No, they are not. Although they exhibit similar cash flow patterns (economic perspective) this article argues that from a legal, accounting and regulatory perspective credit default swaps (CDS) are not considered to be an insurance contract. The protection buyer of a CDS is eligible to obtain the compensation without suffering any loss (and potentially realizing a gain) whereas insurance policies only pay out to compensate a loss (and not potentially realizing a gain). This disconnect between protection and exposure is the source for potential over-coverage. Furthermore, the concentrated set of reference entities and (interbank) counterparties as well as their tradeability make CDSs highly systemically significant products. Our conclusion is that CDSs are not default insurance policies. We propose to use default protection instead of credit default insurance to avoid the mislabelling. Furthermore, CDS have a substantial systemic risk potential which sharply contrasts to the limited systemic risk in the insurance industry. The legal classification of CDS as insurance contracts would have an enormous impact on the liquidity of CDS, as the ability of counterparties to issue and participate in CDS contracts would be limited.

The Analysis of Business Operation Pattern of E-Commerce Cash Flow

In the rapid development of e-commerce, cash flow plays an important role in a company's operation. Stable cash flow can effectively improve operational efficiency. It reduces investment costs and further acceleration transaction speed. The procurement cycle trade can effectively reduce the problem of inventories and other aspects of the occupation. Management of cash flow is extremely important for the survival and development of e-commerce enterprises. The role of e-coomerce cash flow was analyzed. At last the e-commerce operation pattern and management of cash flow was summed up.

Corporate life cycle as determinant of capital structure in companies of Czech automotive industry

The issue of capital structure choice belongs to fundamental strategic financial decisions. A variety of potential determinants was suggested by theoreticians; however, the corporate life cycle was considered of peripheral importance, and thus the relationship between corporate life stages and capital structure was investigated only exceptionally. Both concepts were in the meantime developed separately. Recently, it has appeared that the aforementioned relation has become a subject of increased interest of the researches as a way to better understanding of how the corporate funding is changing in the course of time. The main objective of this paper is to investigate the impact of corporate life cycle on the capital structure of companies. For the purpose of the article quantitative research is used. The sample consists of fifty companies belonging to NACE division 29, manufacture of motor vehicles, trailers and semi-trailers. The data come from financial statements of the chosen companies and mostly cover a period since their start-up till year 2010. First, the method based on cash flow patterns is applied for the identification of firm’s life cycle. Next, the methods of descriptive statistics and the hypothesis test about a population proportion are used. The paper explores the relationship between capital structure and corporate life cycle. The empirical study is performed to support theoretical findings.

Managing uncertainty: A case for using real options with option pricing model (OPM) to evaluate capital investment

The pulp and paper industry relies heavily on the traditional discounted cash flow-based net present value (DCF-NPV) for making capital investment decisions. The deficiency of the DCF-NPV model is that it is static; once a pattern of cash flow is established, management does not have the option to change the direction when new information is available. However, flexibility to alter the investment decision is a powerful strategic and capital investment tool. Abundant research has established strong precedence for applications of “real options” in operational and strategic settings to provide useful insights in the evaluation of irreversible investments under uncertainty. The binomial or Black-Scholes option pricing model (OPM) for strategic planning and capital investment has been used in many other industries but not in the pulp and paper industry. The pulp and paper industry, though very capital intensive, has provided poor to moderate return on investment or return on capital and has never used the OPM and the flexibility it offers for capital investment decisions. This paper makes a case for using OPM for capital investment decisions by using the example of a hypothetical North American mill considering investments to modernize its papermaking operation.

A study on effects of cash flow patterns and auditors’ opinions in predicting financial distress

Article history: Received May 12, 2013 Received in revised format 25 June 2013 Accepted 27 June 2013 Available online June 29 2013 Bankruptcy has been one of the most important issues among investors in stock market and there are literally different techniques for predicting bankruptcy. In this paper, we study on effects of cash flow patterns and auditors’ opinions in predicting financial distress on some 80 selected firms traded on Tehran Stock Exchange over the period 2005-2011. In this study, the combination of cash flow patterns represent firm’s resource allocations and operational capabilities interacted with their strategy choices. In additions, predictions about each individual cash flow components, operational, investment, financial, are derived from economic theory, which forms a basis for the life proxy. We use cash flow patterns in the decline stage and compare the results with auditors’ opinions. The results indicate that cash flow patterns could predict financial distress companies in Iran. In addition, the effective cash flow patterns in predicting financial distress is more than auditors’ feedbacks. © 2013 Growing Science Ltd. All rights reserved.

Illustrating Non-Constant Marginal Cost of Capital and the Interdependency of Independent Projects

The simple mechanics of capital budgeting decision techniques are complicated by presence of mutual exclusion, project contingencies, differing risk levels, and unequal lives. This paper examines another such complexity virtually ignored by financial management textbooks but present in virtually all capital budgeting scenarios: project interdependency caused by a non-constant marginal cost of capital (MCC) schedule, a cost schedule representing the reality for business firms. Any capital budgeting decision method using the cost of capital as an input is affected. An example of this complexity is presented in this paper. An expositional exercise concerning the role of cashflow pattern and scale differences in creating differences in total net present value for a capital budgeting decision is presented as well. Finally, an explanation of the isolated role of the non-constant MCC is presented and a proof offered in the paper's appendix.

Relationship Characteristics and Cash Flow Variability

Service firms seek customers with high revenues, profits, or lifetime value. However, they frequently ignore variations in consumption that lead to cash flow variability and adversely influence service operations and financial performance. This study shows that variation in individual customers' consumption or spending on services can be decreased in ways that are actionable by most managers, without decreasing revenues or profits. First, customer satisfaction has a ``double-whammy'' effect: lower cash flow variability and higher cash flow levels. This finding is important because firms can increase satisfaction in many ways. Second, customers who participate in loyalty programs have more variable cash flows, but not higher average cash flows. Hence, firms should design loyalty programs to improve customer satisfaction or intangible benefits (e.g., membership recognition), rather than offering economic incentives. Third, customers who purchase many different offerings, or allocate a large share of their purchases to the firm, have higher cash flow variability and higher average cash flows. Firms can optimize the customer portfolio by combining customers with high variability with customers who have different, offsetting cash flow patterns. Fourth, personal characteristics, such as age and income, also influence cash flow variability. Empirical findings are robust across two settings: telecommunications and financial services. The study describes sensitivity analyses of how different service and relationship marketing strategies influence a firm's business outcomes. The article concludes with insights into how to integrate service management principles, which emphasize consistency or low variability in processes, with customer relationship management principles that emphasize growing relationships and cash flows.

Harmonic Mean as an Approximation for Discounting Intraperiod Cash Flows

We examine the possible errors of various present value approximations that center on the widely used end-of-period convention in cases of intraperiod cash flows. We suggest a new formula for adjusting the end-of-period present value based on the harmonic mean of the end-of-period and beginning-of-period present values. This approximation minimizes the maximum possible error in general. We give useful nomograms for several cash flow patterns to assess and correct for the errors of the different approximation methods. We find that the harmonic approximation has acceptable errors for most of these patterns. The findings are illustrated in a realistic example.

Contractual Structures and Payoff Patterns of Sukūk Securities

This paper is about the six different Sukūk securities, which originated in 1990s, and are now traded in some 11 markets as the new debt-like securities classed under Islamic finance. The outstanding value of these contracts is estimated to be US $850 billion. This paper proposes a classification for Sukūk contracts as pure debt, equity-based, and asset-backed based on the intrinsic nature and purpose of fund-raising. This classification has more practical use compared to existing classification. Futher, the contract peculiarities of the six instruments (mudārabah, mushārakah, murābahah, ijārah, salam and istisnāh) are carefully specified for the first time. To start a discussion on how the economic behaviour may be modeled for theory building, the potential cash flow pattern of each type of Sukūk contracts is specified. The paper aims to contribute to advanced studies by specifying the basic behavioural characteristics.

Axiomatization of residual income and generation of financial securities

This paper presents an axiomatization of residual income, also known as excess profit, and illustrates how it can univocally give rise to fixed-income or variable-income assets. In the first part it is shown that, depending on the relations between excess profit and the investor's excess wealth, a well-specified theory of residual income is generated: one is the standard theory, which historically traces back to Hamilton and Marshall and is a deep-rooted notion in economic theory, finance, and accounting. Another is the systemic value added or lost-capital paradigm: first introduced by Magni, the theory is enfolded in Keynes's notion of user cost and is naturally generated by an arbitrage-theory perspective. In the second part, the paper inverts the usual analysis: instead of computing residual incomes from a pattern of cash flows, residual incomes are fixed first to derive vectors of cash flows. It is shown that variable- or fixed-income assets may be constructed on the basis of either theory starting from pre-determined growth rates for residual income. In particular, zero-coupon bonds and coupon bonds traded in a capital market are shown to be deduced as equilibrium vectors of residual-income-based assets.

Convex order approximations in the case of cash flows of mixed signs

In Van Weert et al. (2010), results are obtained showing that, when allowing some of the cash flows to be negative, convex order lower bound approximations can still be used to solve general investment problems in a context of provisioning or terminal wealth. In this paper, a correction and further clarification of the reasoning of Van Weert et al. (2010) are given, thereby significantly expanding the scope of problems and cash flow patterns for which the terminal wealth or initial provision can be accurately approximated. Also an interval for the probability level is derived in which the quantiles of the lower bound approximation can be computed. Finally, it is shown how one can move from a context of provisioning of future obligations to a saving and terminal wealth problem by inverting the time axis.

Analyzing the Impact of Negative Cash Flow on Construction Performance in the Dubai Area

AbstractCash flow impacts all aspects of the construction project implementation process. Cash shortages can lead to project failure and business bankruptcy. Researchers have studied cash flow in the context of scheduling, project delay, business failure, and forecasting. However, negative cash flow trends and patterns themselves have not been closely examined. This paper investigates negative cash flow trends and patterns and their impact on construction performance. To this end, the study reviews financial and scheduling data for 40 ongoing projects in the Dubai area and selects four projects for in-depth analysis. These projects represent the main categories of the Dubai construction industry in terms of type, budget, and business. Three elements of project cash flow are analyzed: (1) actual cash disbursements; (2) cash receipts; and (3) accumulated cash flow. Results of data analysis indicate that there was negative cash flow for 30 to 70% of project duration in each of the selected subject projects. ...

Parameter Stability and the Valuation of Mortgages and Mortgage‐Backed Securities

The recent financial crisis was triggered by large and unexpected losses on mortgages and mortgage‐related securities. Here we examine model risk arising from innovations in mortgage markets and the effect on asset values. In particular, we examine the effect of parameter instability in the prepayment function. Using carefully constructed microdata, we find that the refinancing propensity was greater in 1998 for a 1997 issue given the same incentives, compared to the 1993 performance of a 1992 issue. The associated change in cash flow patterns produces economically significant changes in asset prices. Results are robust to alternative term structure models.

Bias And Random Measurement Error In Accounting-Based Surrogates For Internal Rate Of Return

<span>Limitations inherent in alternative profitability measures as estimates of internal rate of return (IRR) often require that managers and researchers employ accounting-based profitability measures. Using published accounting and stock market data, this study models accounting rate of return (ARR) and conditional estimate of internal rate of return (CIRR) as functions of product market risk; growth (g) inventory cost flow assumption (INV), and depreciation method (DE). The models support inferences about the bias and efficiency (i.e. systematic and random error) in the relationships between the two accounting-based profitability measure and IRR, as estimated by the bias and efficiency in their relationships with a factor that is suggested in the finance literature as a determinant of systematic risk (product market risk). The results indicate that ARR estimates IRR with bias attributable to g; however, ARR is unaffected by INV and DEP. Whether g, INV, or DEP affect CIRRs ability to estimate IRR depends on the interval over which CIRR is estimated and the assumed cash flow pattern. On the other hand, CIRR generally estimates IRR with significantly greater efficiency. These results have research design implications, as well as implications for both accounting policy formulation and anti-trust policies.</span>

Cash Flow Patterns as a Proxy for Firm Life Cycle

ABSTRACT This study develops a firm life cycle proxy using cash flow patterns. The patterns provide a parsimonious indicator of life cycle stage that is free from distributional assumptions (i.e., uniformity). The proxy identifies differential behavior in the persistence and convergence patterns of profitability. For example, return on net operating assets (RNOA) does not mean-revert (spread of 7 percent after five years between mature and decline firms) when examined by life cycle stage, which has implications for growth rates and forecast horizons. Further, determinants of future profitability such as asset turnover and profit margin are differentially successful in generating increases in profitability conditional on life cycle stage. Finally, investors do not fully incorporate the information contained in cash flow patterns and, as a result, undervalue mature firms. The cash flow proxy is a robust tool that has applications in analysis, forecasting, valuation, and as a control variable for future research. Data Availability: All data are available from public sources identified in the paper.

INDIFFERENCE VALUATION OF MORTGAGE-BACKED SECURITIES IN THE PRESENCE OF PREPAYMENT RISK

We present a utility-based methodology for the valuation and the risk management of mortgage-backed securities subject to totally unpredictable prepayment risk. Incompleteness stems from its embedded prepayment option which affects the security's cash flow pattern. The prepayment time is constructed via deterministic or stochastic hazard rate. The relevant indifference price consists of a linear term, corresponding to the remaining outstanding balance, and a nonlinear one that incorporates the investor's risk aversion and the interest payments generated by the mortgage contract. The indifference valuation approach is also extended to the case of homogeneous mortgage pools.

A Method of Evaluating Profitability and Risk of Multiple Investments Applying Internal Rate of Return

In todays uncertain economic environment, economic risk is inherent in making large investments on manufacturing facilities. It is, therefore, practically meaningful to divide investment over multiple periods, reducing the risk of investment. Then, the cash-flow over the entire planning horizon would comprise positive inflow and negative outflow. In this case, in general, evaluation by internal rate of return (IRR) is not feasible, because multiple IRRs are involved. This paper deals with a problem of evaluating profitability, as well as risk, of investment alternatives made in multiple times of investment over the entire horizon. Typically, an additional investment is required after the initial one, for expanding manufacturing capacity or other reasons. The paper pays attention to a unit cash-flow over two periods, decomposing the total cash-flow into a series of unit cash-flow patterns. It is easy to evaluate profitability of a unit cash-flow by using IRR. The total cash-flow can be decomposed into the series of two types of unit cash-flows: an investment type one (negative-positive) and the borrowing type one (positive-negative). This paper, therefore, proposes a method in which only the borrowing type unit cash-flow is eliminated in the series by converting total cash-flow using capital interest rate. Then, a unique IRR can be obtained and the profitability is evaluated. Thus, the paper extends the method of IRR so that it may help decision making in complicated cash-flow pattern observed in practice.