Lecture Series #1

Budget Planning, Implementation and Monitoring

First Step: Understanding Financial Statements – Corporate Approach

Chris Droussiotis

September 2011

Table of Contents

  

Accounting Definitions, Terms and Concepts Using Financial Statements Financial Ratio Analysis

2

These slides could be obtain via the Instructor’s Web page at www.celeritymoment.com

Accounting Definitions and Concepts

3

A = L + NW

A = Assets L = Liabilities NW = Net Worth

Own Owe Keep (Value Creation) How did you pay for the Assets that you own Government

• Deficit or Surplus

Similar Concepts in Other Areas of Finance:

• Consumer finance: Value of the House = Mortgage + Equity • Corporation Value: Enterprise Value = Net Debt + Equity • Investments: Value of the Investment: Margin Loan + Equity

4

Accounting Definitions and Concepts Book Value Vs Market Value

Book Value

 Accounting  Fixed Assets  Corporate Taxation

Market Value

 Finance  Financial Assets  Investment Taxation

5

Accounting Definitions and Concepts

Income Vs Cash

The Perfect World:

Every business is run like a lemonade Stand

Income Statement

Lemonade Sales Sold 100 cups @ $1 each Expenses Box of 100 Cups Lemonade concetrate 4 Gallons of Water Total Expenses Net Income (Profit) $ 100.00

$ 5.00

$ 5.00

$ 10.00

$ 20.00

$ 80.00

Cash Flow Statement

Profit $ 80.00

Plus Money that we owe Less Money owed to us $0.00

$0.00

Net Working Capital Cash $0.00

$ 80.00

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Accounting Definitions and Concepts

Income Vs Cash

Not So Perfect World:

The world of IOUs

Income Statement

Lemonade Sales Sold 100 cups @ $1 each $ 100.00

Expenses Box of 100 Cups Lemonade concetrate 4 Gallons of Water Total Expenses Net Income (Profit) $ 5.00

$ 5.00

$ $ $ 10.00

20.00

80.00

Cash Flow Statement

Profit $ 80.00

Plus Money that we owe Less Money owed to us Net Working Capital Cash $0.00

-$1.00

-$1.00

$ 79.00

7

Income Statement

  

Measurement of Profit and Loss over a Period of Time Top Line to Bottom Line Revenue (Sales) Less Expenses = Profit or Loss

Income Statement

8 Income Statement (000's)

62 63 64 65 66 67 68 69 70 50 51 52 53 54 55 56 57 58 59 60

Revenues by Geography

U.S.

Europe Asia Total Revenue

Cost of Revenues by Geography

U.S.

Europe Asia Total Cost of Revenue Gross Profit

Operating Expenses

Administrative & General Marketing Expenses Other Operating Expenses Total Operating Expenses

EBITDA

72 74 76 78 80 81 82

Depreciation & Amortization EBIT Interest Expense

EBT

Taxes

Net Income

2009

800,000 120,000 40,000 960,000 220,000 100,000 25,000 345,000 615,000 145,000 75,000 10,000 230,000 385,000 60,000 325,000 130,000 40% 195,000 78,000 117,000

2010

1,110,000

9

Balance Sheet Statement

 

It shows us on a snap shot the Wealth of the Company The statement is set-up in Order of Liquidity

Balance Sheet Statement

10 Balance Sheet (000's)

6 7 8 9 10 11

Current Assets

Cash Accounts Receivable Inventories Prepaid Expenses Total Current Assets 13 14 15 16 17 18 19

Property and Equipment

Land Building Furniture & Equipment Total Gross P&E Less Accumulated Depreciaition Net P&E 21 Long-Term Investments 23 Total Assets 25

Liabilities and Owners Equity

27 28 29 30 31 32

Current Liabilities

Accounts Payable Accrued Income Taxes Accrued Expenses Current Portion of Long Term Debt Total Current Liabilities 34 Long-Term Debt: 36 Deferred Income Taxes 38 40 41 42 43 44 Total Liabilties

Owners' Equity

Common Stock Paid-in-Capital Retained Earnings Total Owners' Equity 46 Total Liabilities & Owner's Equity

2009

45,000 45,000 35,000 10,000 135,000 2,500,000 450,000 50,000 3,000,000 2,700,000 200,000 3,035,000

2010

(365,000)

$ Change

20,800 15,000 39,800 100,000 25,000 125,000 60,000 50,000 149,800

% Change

46.2% 33.3% 14.3% -10.0% 29.5% 0.0% 22.2% 50.0% 4.2% 21.7% 2.2% 25.0% 4.9% 35,000 12,000 10,000 20,000 77,000 1,200,000 12,000 1,289,000 1,000,000 746,000 1,746,000 3,035,000 25,000 148,800 173,800 149,800 14.3% -16.7% -20.0% -50.0% -11.7% -1.7% 41.7% -1.9% 0.0% 19.9% 10.0% 4.9%

Cash Flow Statement

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 It shows the Company’s Cash Inflow and Outflow over a period of time  Differences between Income Statement and Cash Flow Statement  Timing Differences (Working Capital Activities)   Capital Expenses Vs Operating Expenses (Investment Activities) Financing Expenses not included in the Income Statement (Financing Activities)  Represents the changes from last Year’s Balance Sheet to this Year’s Balance Sheet       Asset goes Up = Cash Negative Asset goes down = Cash Positive Liability goes up = Cash Positive Liability goes down = Cash Negative Owner’s Equity goes up = Cash Positive Owner’s Equity goes down = Cash Negative

Cash Flow Statement

Adjusting Income to Cash

12 Balance Sheet (000's) Current Assets

Cash Accounts Receivable Inventories Prepaid Expenses Total Current Assets

Property and Equipment

Land Building Furniture & Equipment Total Gross P&E Less Accumulated Depreciaition Net P&E Long-Term Investments Total Assets

Liabilities and Owners Equity Current Liabilities

Accounts Payable Accrued Income Taxes Accrued Expenses Current Portion of Long Term Debt Total Current Liabilities Long-Term Debt:

Deferred Income Taxes

35,000 12,000 10,000 20,000 77,000 1,200,000

12,000

Total Liabilties

Owners' Equity

Common Stock Paid-in-Capital

Retained Earnings

Total Owners' Equity Total Liabilities & Owner's Equity 45,000 45,000 35,000 10,000 135,000 2,500,000 450,000 50,000 3,000,000 (300,000) 2,700,000 200,000 3,035,000 1,289,000

2009

1,000,000 -

746,000

1,746,000 3,035,000

2010 $ Change

20,800 15,000 5,000 39,800 2,500,000 3,125,000 2,760,000 3,184,800 100,000 25,000 125,000 60,000 50,000 149,800 1,180,000 1,265,000 1,000,000 1,919,800 3,184,800 5,000

5,000

25,000

148,800

173,800 149,800

Cash Flow Statement (000's)

Net Income Plus Depreciation Plus Deffered Taxes Cash Income

2010

148,800 65,000 5,000 218,800

Cash Flow Statement

Working Capital Activities

13 Balance Sheet (000's) Current Assets

Cash Accounts Receivable Inventories Prepaid Expenses Total Current Assets

Property and Equipment

Land Building Furniture & Equipment Total Gross P&E Less Accumulated Depreciaition Net P&E Long-Term Investments Total Assets

2009

135,000 450,000 200,000

Liabilities and Owners Equity Current Liabilities

Accounts Payable Accrued Income Taxes Accrued Expenses Current Portion of Long Term Debt Total Current Liabilities Long-Term Debt: Deferred Income Taxes Total Liabilties

Owners' Equity

Common Stock Paid-in-Capital Retained Earnings Total Owners' Equity Total Liabilities & Owner's Equity 746,000

2010 $ Change

65,800 60,000 40,000 9,000 174,800 20,800 15,000 5,000 (1,000) 39,800 2,500,000 550,000 75,000 3,125,000 (365,000) 2,760,000 250,000 3,184,800 100,000 25,000 125,000 (65,000) 60,000 50,000 149,800 40,000 10,000 8,000 10,000 68,000 1,180,000 17,000 1,265,000 1,000,000 25,000 894,800 1,919,800 3,184,800 5,000 (2,000) (2,000) (10,000) (9,000) (20,000) 5,000 (24,000) 25,000 148,800 173,800 149,800

Cash Flow Statement (000's)

Net Income Plus Depreciation Plus Deffered Taxes Cash Income

Working Capital Activities

Change in Accounts Receivable Change in Inventory Change in Prepaid Expenses Change in Accounts Payable Change in Accrued Income Taxes Change in Accrued Expenses Total Change in Working Capital Operating Cash Flow (OCF)

2010

148,800 65,000 5,000 218,800 (15,000) (5,000) 1,000 5,000 (2,000) (2,000) (18,000) 200,800

Cash Flow Statement

Investment Activities

14 Balance Sheet (000's) Current Assets

Cash Accounts Receivable Inventories Prepaid Expenses Total Current Assets

Property and Equipment Land Building Furniture & Equipment Total Gross P&E

Less Accumulated Depreciaition Net P&E

Long-Term Investments

Total Assets

Liabilities and Owners Equity Current Liabilities

Accounts Payable Accrued Income Taxes Accrued Expenses Current Portion of Long Term Debt Total Current Liabilities Long-Term Debt: Deferred Income Taxes Total Liabilties

Owners' Equity

Common Stock Paid-in-Capital Retained Earnings Total Owners' Equity Total Liabilities & Owner's Equity

2009

45,000 45,000 35,000 10,000 135,000

2,500,000 450,000 50,000 3,000,000

(300,000) 2,700,000

200,000

3,035,000 35,000 12,000 10,000 20,000 77,000 1,200,000 12,000 1,289,000 1,000,000 746,000 1,746,000 3,035,000

2010

(365,000)

$ Change

20,800 15,000 5,000 (1,000) 39,800

100,000 25,000 125,000

(65,000) 60,000

50,000

149,800 5,000 (2,000) (2,000) (10,000) (9,000) (20,000) 5,000 (24,000) 25,000 148,800 173,800 149,800

Cash Flow Statement (000's)

Net Income Plus Depreciation Plus Deffered Taxes Cash Income

Working Capital Activities

Change in Accounts Receivable Change in Inventory Change in Prepaid Expenses Change in Accounts Payable Change in Accrued Income Taxes Change in Accrued Expenses Total Change in Working Capital Operating Cash Flow (OCF)

Investment Activities

Capital Expenditures Investments (Change) Total Financing Activities Cash Available for Debt Service (CAFDS)

2010

148,800 218,800 (15,000) (5,000) (2,000) (2,000) (18,000) 200,800 (125,000) (50,000) (175,000)

Cash Flow Statement

Financing Activities

15 Balance Sheet (000's) Current Assets

Cash Accounts Receivable Inventories Prepaid Expenses Total Current Assets

Property and Equipment

Land Building Furniture & Equipment Total Gross P&E Less Accumulated Depreciaition Net P&E Long-Term Investments Total Assets

2009

45,000 45,000 35,000 10,000 135,000 2,500,000 450,000 50,000 3,000,000 (300,000) 2,700,000 200,000 3,035,000

Liabilities and Owners Equity Current Liabilities

Accounts Payable Accrued Income Taxes Accrued Expenses

Current Portion of Long Term Debt

Total Current Liabilities 35,000 12,000 10,000

20,000

77,000

Long-Term Debt: 1,200,000

Deferred Income Taxes Total Liabilties

Owners' Equity

Common Stock Paid-in-Capital Retained Earnings Total Owners' Equity Total Liabilities & Owner's Equity 12,000 1,289,000 1,000,000 746,000 1,746,000 3,035,000

2010 $ Change

(365,000) 20,800 15,000 5,000 (1,000) 39,800 100,000 25,000 125,000 (65,000) 60,000 50,000 149,800 5,000 (2,000) (2,000)

(10,000)

(9,000)

(20,000)

5,000 (24,000) 25,000 148,800 173,800 149,800

Cash Flow Statement (000's)

Net Income Plus Depreciation Plus Deffered Taxes Cash Income

Working Capital Activities

Change in Accounts Receivable Change in Inventory Change in Prepaid Expenses Change in Accounts Payable Change in Accrued Income Taxes Change in Accrued Expenses Total Change in Working Capital Operating Cash Flow (OCF)

Investment Activities

Capital Expenditures Investments (Change) Total Financing Activities Cash Available for Debt Service (CAFDS)

Financing Activities ST Debt Payments LT Payments Equity Contribution

Total Financing Activities

Free Cash Flow 2010

148,800 65,000 5,000 218,800 (15,000) (5,000) 1,000 5,000 (2,000) (2,000) (18,000) 200,800 (125,000) (50,000) (175,000) 25,800

(10,000) (20,000) 25,000

(5,000) 20,800

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Cash Flow Statement

Recap

Cash Flow Statement (000's)

86 Net Income 87 Plus Depreciation 88 Plus Deffered Taxes 89 Cash Income 91

Working Capital Activities

92 Change in Accounts Receivable 93 Change in Inventory 94 Change in Prepaid Expenses 95 Change in Accounts Payable 96 Change in Accrued Income Taxes 97 Change in Accrued Expenses 98 Total Change in Working Capital 99 100 Operating Cash Flow (OCF) 102

Investment Activities

103 Capital Expenditures 104 Investments (Change) 105 Total Financing Activities 106 107 Cash Available for Debt Service (CAFDS) 109

Financing Activities

110 ST Debt Payments 111 LT Payments 112 Equity Contribution 113 Total Financing Activities 115

Free Cash Flow

117 Beginning Cash 119 Ending Cash

2010

148,800 218,800 (15,000) (5,000) (2,000) (2,000) (18,000) 200,800 (125,000) (50,000) (175,000) (10,000) (20,000) (5,000)

Balance Sheet (000's)

Retained Earnings

2009

746,000

2010

894,800

$ Change

148,800 Timing Differences (Working Capital Activities) Investment Activities Financing Activities

Balance Sheet (000's) Current Assets

Cash

2009 2010 $ Change

45,000 65,800 20,800

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Financial Analysis

 Management Discussion and Analysis (MD&A)  Equity & Bond Research – Wall Street Analysts  The Financial Statements could be used by analysts to project the Company’s performance and valuation  For an effective performance of the Company, you need to ask the three following questions: 1.

2.

3.

How is the Company doing versus Last Year How is the Company doing versus its competitors / piers/ market How is the Company doing versus expectations

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Financial Ratio Analysis

 Trend Analysis

Trend Analysis Ratios

U.S. Revenue Growth Europe Revenue Growth Asia Revenue Growth Total Revenue Growth EBITDA Growth

2010 Definition

15.0% 16.7% 25.0% 15.6% (Rev 2010/Rev 2009) -1 12.5% (EBITDA 2010/EBITDA 2009) -1

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Financial Ratio Analysis

 Liquidity Ratio  How well the Company manages

Cash Liquidity Ratios

Current Ratio Quick ratio Accounts Receivable Turnover (ART) Accounts Receivable Days

2010

2.57x

1.85x

21.14x

17.26

Definition

CA/CL (Cash + A/R) / CL Revenue/Avg AR 365 / ART

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Financial Ratio Analysis

 Solvency Ratio  How well the Company manages

Debt Solvency Ratios

LTD / Total Capitalization

EBITDA / Interest (Coverage Ratio) LTD / EBITDA (Leverage Ratio) 2010

38.1% 3.61x

2.73x

Definition

LTD / (LTD + Equity) EBITDA / Interest LTD / EBITDA

Financial Ratio Analysis

 Activity and Operating Ratios  It measures productivity and efficiency for running the business

Activity Ratios / Operating Ratios

Inventory Ratio (IR) Inventory Ratio - Days

2010

11.20x

32.59

Definition

Cost of Revenues/Avg Inventory 365 / IR

21

Please note that there are a lot of ratios establish by specialization (i.e. for a Hotel company is Occupancy Rate or for a Cable company is revenue per subscriber)

22

Financial Ratio Analysis

 Profitability Ratio  How profitable is the company

Profitability Ratios

Gross Margin EBITDA Margin EBIT Margin Return on Assets (ROA) Gross Return on Assets Return on Equity (ROE)

2010

62.2% 39.0% 33.2% 4.8% 11.8% 8.1%

Definition

Gross Margin / Revenues EBITDA / Revenue EBIT / Revenue NI / Avg Assets EBIT / Avg Assets NI / Avg Equity