Financial Analysis - Rationale

Who needs it? – Investors, Suppliers, Customers, Others

Basis for Analysis– Financial statements– External information

Industry Economy Market

Financial Statements

The Four Financial Statements Statement of Earnings (Income)

– Profit and Loss

Balance Sheet– What is Owned & What is owed– Assets - Liabilities - Preferred = Equity

Statement of Changes in Equity Statement of Cash Flows

Statement of Cash Flows Three Parts

– Operating/ Investing /Financing Activities CFOA = Net Income + Adjustments +

Changes in NWC What is a good cash flow number?

– CFOA– CFIA– CFFA

Analysis of Financial Statements Ratios

– Liquidity– Profitability– Efficiency (Asset Utilization)– Leverage– Market Value

Common Size Statements Growth Rates

Some Terms and Ratios Net Operating profit

– EBIT(1-T) EBIT adjusted for cash charges and taxes

Operating Income Return on Investment (OIROI)– EBIT/Total Assets

EBITDA/SALES Free Cash flow

– Net cash flow available to investors = EBIT(1-T) - Net investment in Operating capital

Sustainable Growth Rate– ROE (1-Payout)

MVA and EVA Market Value Added

– MVA = Market value of equity - capital supplied

EVA – Cost of capital included– EVA = (r – k) C

r = OIROI k = Total cost of capital C = Invested capital

Comparative Analysis & Some Issues Historical Comparison Industry Benchmark Peer Company Comparison Quality of Earnings and Balance Sheet FASB, SEC, Other standards

– REG FD

Financial Planning

Financial Planning– Ensure funds when needed– Manage Sources of funds– Part of overall planning process– Analysis and feedback

Long-term, Short-term & medium-term

Short-Term Forecasting and Planning Planning Requires Forecasts Main Forecasting/Planning Tools

– Cash Budget Short-term

– Projected Financial Statements Medium-term

Cash Budget

Short-term forecast– Forecasting, planning and management

of cash balances– No business can do without it!

Forecast of cash flows, not earnings– Receipts and Disbursements

Cash Budget - (Contd.)

Key Steps– Forecasting Period

daily, weekly, monthly

– Forecasting Horizon 1 year, 18 months

– Key Forecasting assumptions Sales, Collections, Costs, Major outflows

Cash Budget Format

Collection and Payments Worksheet Receipts Disbursements Surplus/Deficit for the Period Cash Balances

– Beginning, Ending, Target Loan/Investment

Projected Financial statements Direct Projections Forecasts from Cash Budget Key assumptions

– Sales, Costs, Key Ratios– Variability of sales, ratios

Discretionary Funds Needed (DFN)– Sources of financing– Analysis and Feedback

DFN: Formula Approach

DFN = (A*/S0)S - (L*/S0)S - MS1(1 - d)– A* = Assets increasing in proportion to sales– L* = Liabilities increasing in proportion to

sales – M = Net profit margin– S0,S1 = Sales for last year, forecast year

– S = (S1/S0) - 1

– d = Payout ratio

Managing Growth

Sustainable growth rate– g = ROE (1-d)/(1 - ROE (1-d))

Financial implications Special case projections Computerized planning models

Forecasting Financial Statements - Check and Evaluation Historic Comparisons Key assumptions

– Sensitivity Analysis– Scenarios: Good, Bad, and Indifferent

Other Factors– Currency effect