Transcript Cash Flows
Financial Statements
The Big Three Accounting
Statements
1.
2.
3.
The Balance Sheet
The Income Statement
The Statement of Cash Flows
2
1) The Balance Sheet
LHS
A snapshot of the firm
Assets ≡ Liabilities +
Stockholder’s Equity
Current
Assets
Left Hand Side must
balance with the Right
Hand Side
Fixed
Assets
Tangible
Intangible
RHS
Current
Liabilities
Long-Term
Debt
Shareholder
Equity
3
Balance Sheet Analysis
When analyzing a balance sheet, the Finance
Manager should be aware of three concerns:
1.
2.
3.
Liquidity
Debt versus Equity
Value versus Cost
4
Liquidity
Refers to the ease & quickness that an assets can be
converted to cash without a significant loss in value
Generally the
more liquid the asset the lower the rate of
return
The more liquid a firm’s assets, the less likely the
firm is to experience problems meeting short-term
cash obligations (Ex. payroll)
A
profitable but illiquid firm will experience financial
distress
Current assets are more liquid than fixed assets
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Debt versus Equity
Debt → Liability
Promise
Equity is the residual
Assets
to payout cash, an IOU
– Liabilities ≡ Equity
Debt represents a senior claim on firm assets
If
the firm goes bankrupt debt holders get paid
before equity holders
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Value versus Cost
Cost: What did we pay for it
Accountants
are historians
GAAP requires assets be recorded at cost
Book value
Market value: What would it cost TODAY
Cost and Market Value are two completely
different concepts
What
did we pay for it, versus what can we sell it for
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2) The Income Statement
Income ≡ Revenue – Expenses
Measure how the company has performed over
some period of time
Generally comprised of four parts:
Operating
2. Non-Operating
3. Taxes
4. Bottom Line
1.
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U.S.C.C. Income Statement
Total operating revenues
Cost of goods sold
Selling, general, and administrative expenses
Depreciation
Operating income
Other income
Earnings before interest and taxes
Interest expense
Pretax income
Taxes
Current: $71
Deferred: $13
Net income
$2,262
1,655
327
90
$190
29
$219
49
$170
84
$86
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Income Statement Analysis
There are several things to keep in mind
when analyzing an income statement:
INCOME IS NOT CASH
2. Matching Principal
3. Non-Cash Items
1.
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Matching
GAAP requires that revenues be recorded
along with the expenses incurred to produce
them
Thus, income may be reported even though
no cash has changed hands
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Non-Cash Items
The income statement will also record
expenses, where no money is exchanged
Depreciation is the simplest example
No firm ever writes a check for “depreciation.”
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Taxes
“In this world nothing is certain but death and
taxes.” Ben Franklin
Taxes represent a major cost to the firm
Taxes are subject to political, not economic forces
Therefore
taxes do not need to make economic sense
Companies are subject to two different tax rates
Marginal – the percentage paid on the next
Average – the tax bill / taxable income
dollar earned
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Marginal versus Average Rates
Suppose your firm earns $4 million in taxable
income.
What is the firm’s tax liability?
.15(50,000) + .25(75,000 – 50,000) + .34(100,000 – 75,000) +
.39(335,000 – 100,000) + .34(4,000,000 – 335,000) = $1,356,100
Rate from table 2.3
What
is the average tax rate?
What
is the marginal tax rate?
If you are considering a project that will increase the
firm’s taxable income by $1 million, what tax rate
should you use in your analysis?
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3) The Statement of Cash Flows
The three components are:
Cash
flow from operating activities
Cash flow from investing activities
Cash flow from financing activities
Attempts to change Net Income to a Cash
number
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U.S.C.C. Cash Flow from Operations
Start with net
income, and
then add back
non-cash
expenses , and
changes in
accounts
Operations
Net Income
Depreciation
Deferred Taxes
Changes in Assets and Liabilities
Accounts Receivable
Inventories
Accounts Payable
Accrued Expenses
Notes Payable
Other
Total Cash Flow from Operations
$86
90
13
-24
11
16
18
-3
-8
$199
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U.S.C.C. Cash Flow from Investing
Cash flows from the acquisition sales of fixed
assets (i.e., net capital expenditures).
The cash from sales of our fixed assets minus
the cost of fixed assets we bought
Acquisition of fixed assets
Sales of fixed assets
Total Cash Flow from Investing Activities
-$198
25
-$173
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U.S.C.C. Cash Flow from Financing
Cash flows to
and from equity
and debt
investors in the
firm
Retirement of debt (includes notes)
Proceeds from long-term debt sales
Dividends
Repurchase of stock
Proceeds from new stock issue
Total Cash Flow from Financing
-$73
86
-43
-6
43
$7
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Finance and the Accounting
Finance is concerned with:
Market Values and Cash Flows
Accounting:
Care
about historical costs
Accounting numbers (NOT CASH)
But Accounting is often called the language of
finance
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Quick Quiz
1.
2.
3.
4.
What is the difference between book value and
market value? Which should we use for decision
making purposes?
What is the difference between accounting
income and cash flow? Which do we need to use
when making decisions?
What is the difference between average and
marginal tax rates? Which should we use when
making financial decisions?
How do we determine a firm’s cash flows? What
are the equations, and where do we find the
information?
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Financial Statements
Analysis and LongTerm Planning
Chapter 3
Financial Statement Analysis
Attempts to compare different companies
and/or to track how a company is developing
Relies of their financial statements
Generally follows 1 of 2 methods
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1) Common-Size Statements
Report
everything as a percent the top
number
Total
assets for the Balance Sheet
Sales for the Income Statement
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2) Ratio Analysis
Ratio of one financial number to another
Ask yourself:
How
is the ratio computed?
What is the ratio trying to measure and why?
What does the value indicate?
How can we improve the company’s ratio?
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Categories of Financial Ratios
Short-term solvency (liquidity ratios)
Long-term solvency (financial leverage ratios)
Asset management (turnover ratios)
Profitability ratios
Market value ratios
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Liquidity Ratios
How easily can the firm meet its short term obligations
Why
Current Ratio = CA / CL
708
/ 540 = 1.31 times
Quick Ratio (Acid Test) =(CA – Inventory) / CL
(708
is this important?
- 422) / 540 = 0.53 times
Cash Ratio = Cash / CL
98
/ 540 = 0.18 times
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Leverage Ratios
How easily can the firm meet its long term obligations
Why
is this important?
Total Debt Ratio = (TA – TE) / TA
(3588
Debt/Equity = TD / TE
(3588
- 2591) / 3588 = 28%
– 2591) / 2591 = 38.5%
Equity Multiplier = TA / TE = 1 + D/E
1
+ .385 = 1.385
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Coverage Ratios
How easily can the firm payoff its debt holders
Why
Times Interest Earned = EBIT / Interest
691
is this important?
/ 141 = 4.9 times
Cash Coverage= (EBIT + Depreciation)/Interest
(691
+ 276) / 141 = 6.9 times
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Inventory Ratios
How efficiently is the firm managing inventory
Why
Inventory Turnover = Cost of Goods Sold /
Inventory
1344
is this important?
/ 422 = 3.2 times
Days’ Sales in Inventory = 365 / Inventory
Turnover
365
/ 3.2 = 114 days
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Receivables Ratios
How quickly does the firm get paid
Why
Receivables Turnover = Sales / Accounts
Receivable
2311
is this important?
/ 188 = 12.3 times
Days’ Sales in Receivables = 365 /
Receivables Turnover
365
/ 12.3 = 30 days
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Total Asset Turnover
How efficient is the firm turning assets into sales
Why
Total Asset Turnover = Sales / Total Assets
2311
is this important?
/ 3588 = 0.64 times
It is not unusual for TAT < 1, especially if a firm
has a large amount of fixed assets. Why?
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Profitability Measures
How efficient is the firm’s operations
Why
Profit Margin = Net Income / Sales
363
/ 2311 = 15.7%
Return on Assets (ROA) = Net Income / Total Assets
363
is this important?
/ 3588 = 10.1%
Return on Equity (ROE) = Net Income / Total Equity
363
/ 2591 = 14.0%
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Breaking Down ROE
If we break down ROE we can see how firms
generate returns for investors
ROE = NI / TE →PM * TAT * EM
Aside: Algebra
ROE
= NI / TE
ROE = (NI / TE) (TA / TA)
ROE = (NI / TA) (TA / TE) = ROA * EM
ROE = (NI / TA) (TA / TE) (Sales / Sales)
ROE = (NI / Sales) (Sales / TA) (TA / TE)
ROE = PM * TAT * EM
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Where are returns generated
ROE = PM * TAT * EM
Profit
margin: How well does the firm controls costs
Total asset turnover: How well does the firm
manages its assets
Equity multiplier: How levered is the firm
The better the managers handle these aspects of
the firm the greater the return generated
34
Market Value Measures
How do people feel about the firm
Why
PE Ratio = Price per share / Earnings per share
88
is this important?
/ 11 = 8 times
Market-to-book ratio = market value per share /
book value per share
88
/ (2591 / 33) = 1.12 times
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Using Financial Statement Analysis
Ratios by themselves are not very useful
Is
a profitability ratio of 9% good?
Time-Trend Analysis
Compare
this years ratios to prior ratios
Peer Group Analysis
Compare
your ratios to other firms in the industry
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Issues with Financial Statement Analysis
There is no definitive way to run the analysis
It’s hard to find the right benchmarking
Especially
for diversified firms
Firms use different accounting procedures, and
year ends
Extraordinary, or one-time, events
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Long-Term Financial Planning
These are the big decisions, planning where the
company is going
Capital
budgeting: Does Nike start a magazine?
Capital structure: Do we issue stock or bonds?
Generally these decisions are based on pro forma
financial statement
Financial
statements based on what we think will
happen in the future
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External Financing and Growth
At low levels of growth a company can use the cash
it generates to meet its investment requirements
At higher levels of growth the company’s cash on
hand will not be enough to finance all the
investments the company wants, it now has to go to
the capital market
Sell
Stock or Bonds
External financing helps a firm grow faster than relying
on internal funds alone
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The Internal Growth Rate
This is how fast the company can grow using
only the money it makes
IGR = (ROA * b )/ (1 – ROA * b)
b is the plowback ratio
Measure how much of net income is reinvested in
the firm
b = Addition to Retained Earnings / Net Income
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Calculating the Internal Growth Rate
Using the information from the Hoffman Co.
ROA
= 66 / 500 = 0.132
b = 44/ 66 = .66700
Internal Growth Rate
* b )/ (1 – ROA * b)
(0.132 * 0.667) / (1 – 0.132 * 0.667 )= 0.0965
Hoffman Co. can grow at 9.65% using only internal funds
(ROA
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The Sustainable Growth Rate
This is how fast the firm can grow using
internal funds and external funds, but leaving
the D/E ratio the same
Will
this be higher or lower than the IGR?
SGR = (ROE * b )/ (1 – ROE * b)
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Calculating the Sustainable Growth
Rate
Using the Hoffman Co.
ROE
= 66 / 250 = 0.264
b = 0.667
Sustainable Growth Rate
* b )/ (1 – ROE * b)
(0.264 * 0.667) / (1 – 0.264 * 0.667 )= 0.214
Hoffman Co. can grow at 21.4% without changing
its capital structure
(ROE
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Long-term Planning Caveats
Our financial planning models cannot tell us
what is the best policy to follow
Our models are simplifications of the real
world, and as such can miss important aspects
of a situation
However, firms need to have a long-term plan
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Quick Quiz
1.
2.
3.
4.
5.
How do you standardize balance sheets and
income statements?
Why is standardization useful?
What are the major categories of financial ratios?
How do you compute the ratios within each
category?
What are some of the problems associated with
financial statement analysis?
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Quick Quiz
6.
7.
8.
9.
10.
11.
What is the purpose of long-range planning?
What are the major decision areas involved in
developing a plan?
What is the percentage of sales approach?
What is the internal growth rate?
What is the sustainable growth rate?
What are the major determinants of growth?
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