FINANCE 7311 - University of Arkansas at Little Rock
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Transcript FINANCE 7311 - University of Arkansas at Little Rock
FINANCE 7311
Review & Financial
Statement Analysis
Dr. Ashvin Vibhakar
Fall 2000
Outline
Review
of Basic Finance
The Corporation
The Accounting Model
Cash Flows
Financial Statement Analysis
Review of Basic Finance
Efficient
Markets
Rates of Return
Time Value of Money
Bond Valuation
Stock Valuation
EFFICIENT MARKETS
Markets are in equilibrium
Expected Returns = Required returns
Expectations are rational
Information is reflected in price
– Information
– Reflected in Price
No Arbitrage
EFFICIENT MARKETS
Why do we care whether or not markets
are efficient?
Prices
direct economic activity
Rates of return (cost of capital)
Valuation (market multiples)
RATES OF RETURN
REQUIRED RETURN
– required by investor
– depends on RISK
EXPECTED RETURN
– given current price & expected future CF’s
REALIZED RETURN
– actual return
RISK
Represents the CHANCE that ACTUAL
returns turn out to be much different
than EXPECTED
Statistically:
Variance
Standard Deviation
TIME VALUE OF MONEY
SINGLE CASH FLOWS
Vn = Vo x (1 + R)n
FV = PV x (1 + R)n
PV = FV x (1 + R)-n
MULTIPLE CASH FLOWS
PERPETUITY
PV = CF / R
TIME VALUE OF $, cont.
ANNUITY
PV = CF X [1/ R (1 - 1/(1 + R)n ]
Calculator:
PV - present value
FV - future value
CF - periodic payment amount
R - discount rate
N - number of CF’s or periods
Ordinary - end of period
Due - beginning of period
BOND VALUATION
CF = coupon rate x par ÷ 2 (semi-ann.)
N = number of semi-annual periods
FV = par amount of bond
R = investor’s required rate of return
PV = price of bond
Solving for R ===> Yield to Maturity
STOCK VALUATION
Present value of future dividends
Assumption about Time Path
More Generally, CF
1) No Growth --> Perpetuity
Vt = CFt+1/R
2) Constant Growth --> Gordon Model
Vt = CFt+1 / (R - g)
THE CORPORATION
REAL ASSETS ----> CASH FLOWS
CLAIMANTS ---->
- EMPLOYEES/CREDITORS
- BONDHOLDERS
- STOCKHOLDERS
MANAGEMENT TEAM
A Picture of the Corporation
Real Assets & Financial Assets
Financing
Investment
CF’s
ASSETS
Bondholders
Shareholders
Business Risk
Financial Risk
3rd Parties
Govt; other
MANAGEMENT
OBJECTIVE: ALLOCATE COPORATE
RESOURCES IN A WAY WHICH:
- Maximizes the value of the firm
- Maximizes current share price
AGENCY PROBLEM
- Management makes decisions which are
inconsistent with the above
MANAGEMENT DECISIONS
INVESTMENT DECISION --> What
should be in the circle
1) Short-term assets --> Working capital
-
inventory policy
A/R and A/P policy
nature and amount of S-T financing
2) L-T Assets --> Capital Budgeting
-
Which assets add most VALUE to the firm?
Mgmt Decisions, cont.
FINANCING DECISION
-
How Should Assets Be Financed?
What is the Proper Mix of Debt and Equity?
How much debt should a company have?
-
Risk
Taxes
Costs of financial distress
Over / Under Investment Problem
-
BUSINESS RISK
Assets are the SOURCE of BUSINESS
RISK
DEMAND & SUPPLY VARIABILITY
COMPETITION (ease of entry)
TECHNOLOGY
REGULATION
MGMT DEPTH & BREADTH
OPERATING LEVERAGE
THE ACCOUNTING MODEL
CONFORMS TO PICTURE:
NWC
L-T ASSETS
LHS = CIRCLE
RHS = RECTANGLES
DEBT
EQUITY
Debt
Interest Bearing - ‘Permanent’ Capital
Reclassify S-T portion of notes payable
Lines of Credit
Include as part of NWC
ACCOUNTING PRINCIPLES
COST PRINCIPLE:
ONLY TRANSACTIONS RECORDED
COST ≠ MARKET IN GENERAL
MATCHING PRINCIPLE
PERFORMANCE MEASUREMENT
ACCRUAL V. CASH BASIS ACCTG.
FINANCIAL STATEMENTS
BALANCE SHEET
- Assets & Liab. as of a point in time
INCOME STATEMENT
- Period of time
- Include effect of accruals
- Not the same as Cash Flow. Why?
BALANCE SHEET
ASSETS -> something owned
- Listed in order of liquidity
- NWC & Long-term
Liability -> something owed
- listed in order of Claim Priority
Retained Earnings -> owned - owed
- Cum. Earnings not paid as dividends
INCOME STATEMENT
GENERAL FORMAT
SALES
- COS
GROSS PROFIT
- OPERATING EXPENSES
EBIT (OPERATING PROFIT)
– EARNINGS W/O REGARD TO DEBT & TAX SITUATION
Income Statement, cont.
EBIT
- INTEREST
EBT (TAXABLE INCOME)
- Taxes
NET INCOME
NET INCOME ≠ CASH FLOW
WHY?
Cash Flow v. Net Income
Non-Cash Expenses
Depreciation
Amortization
Write-offs
Accruals
Timing Differences
CASH FLOW
ASSETS = DEBT + EQUITY
CF FROM ASSETS = CF’S TO D + E
USES:
- CF’S CONSISTENT W/ PICTURE
- SOURCES / USES OF CASH
- VALUATION (PROJECTED CF’S)
CF’S FROM ASSETS
Operating Cash Flow
EBIT
+ DEPRECIATION (NON-CASH ITEMS)
- TAXES
- ∆NWC
- CAPITAL SPENDING
CF’S TO B/H & S/H
CF’S TO B/H:
INTEREST
– NET CHANGE IN DEBT
CF’S TO S/H:
DIVIDENDS
- NET CHANGE IN COMMON STOCK
Taxes and Cash Flow
Historical - Analyzing company’s CF
Use Tax number from Income Stmt
Projections - Free Cash Flow for
valuation purposes
Use Tax Rate x EBIT
RATIO ANALYSIS
FINANCIAL COMPARISON TOOL
RAW FINANCIAL STATEMENTS
- SIZE DIFFERENCES
- DOLLAR AMOUNTS SAY LITTLE
KEY: COMPARABILITY
DEFINITIONS DIFFER
BENCHMARKS
Historical Ratios of Company
- Trend Analysis
- Assumes: Continuation of past
Other Companies / Industry
- RMA, S&P, Hoover
- Industry Publications
Projections (Forecasts)
COMMON SIZE F/S
BALANCE SHEET
EXPRESS EACH ITEM AS % OF ASSETS
INCOME STATEMENT
EXPRESS EACH ITEM AS % OF SALES
COMMON BASE
EXPRESS EACH ITEM AS % OF BASE YEAR
(GROWTH RATE)
RATIO GROUPS
LIQUIDITY
ACTIVITY
LEVERAGE
PROFITABILITY
MARKET
LIQUIDITY
Ability to meet current Obligations
Of Interest to Short-term Creditors
CURRENT RATIO
QUICK RATIO
ACTIVITY RATIOS
Measures Effective Asset Use
Of Interest to management & investors
ASSET TURNOVER
INVENTORY TURNOVER
DAYS SALES IN INVENTORY
DAYS SALES OUTSTANDING
LEVERAGE RATIOS
USE OF DEBT FINANCING
Ability to meet debt payments
Important to long-term creditors
DEBT RATIO
TIMES INTEREST EARNED
DAYS PAYABLE O/S
PROFITABILITY RATIOS
COMBINED USE OF DEBT & ASSETS
IMPORTANT TO MGMT & INVESTORS
PROFIT MARGIN
GROSS MARGIN
OPERATING MARGIN
RETURN ON ASSETS (ROA)
RETURN ON EQUITY (ROE)
DUPONT & ROIC
DUPONT DECOMPOSITION OF ROE
Profitability X Asset Turnover X Leverage
ROIC
EBIT X (1 - T) / (EQUITY + DEBT)
NOT AFFECTED BY LEVERAGE
COMPARE WITH WACC
MARKET RATIOS
P/E RATIO
What investors are willing to pay for a $ of
earnings (Current / Forecast)
What creates a high P/E?
MARKET/BOOK
Usually much different than 1.
EX: S&P 500 CURRENTLY = 6.4 WHY?
LIMITATIONS
NO THEORY TO DEFINE ‘GOOD’
#’S HISTORICAL; NOT ECONOMIC
MOST AS OF SINGLE POINT IN TIME
– SEASONAL OPERATIONS
– ONE-TIME EFFECTS
DESIGNED FOR MANUFACTURERS
ECONOMIC V. ACCTG.
EARNINGS
UNREALIZED GAINS & LOSSES
COST OF EQUITY
‘HIGH’ CORPORATE PROFITS
EVA - attempts to account for cost of equity