Chapters 3 and 13
Financial Statement and Cash Flow Analysis
Balance Sheet
Assets Liabilities and Shareholder’s Equity Cash Inventory Accounts Receivable Accounts Payable Notes Payable Accrued Wages Property Plant Equipment Bank Loans Bonds Common Stock Retained Earnings
Total Assets Total Liabilities and Shareholder’s Equity
Income Statement
Used to figure out how much money we are earning for:
(a) vendors, employees, etc - Cost of Goods Sold, Operating Expenses (b) lenders, bondholders - Interest,
(c) government - Taxes,
(d) owners/stockholders - Dividends/Retained Earnings Sales revenues
(-) Cost of Goods Sold cost to manufacture product (-) Operating Expenses general expenses
(-) Depreciation expensing fixed assets EBIT earnings before int. and
taxes
(-) Interest to bondholders EBT earnings before taxes (-) Taxes rate set by government Net Income payout or retain (-) Dividends payout
Statement of Cash Flows Cash Flow from Operations:
Net income (I/S) + depreciation (I/S)
- increases in current assets (B/S) + increases in current liabilities (B/S) Cash Flow from Investments:
- investments in PPE (B/S) + sale of assets (B/S) Cash Flow from Financing:
+ proceeds from issues of common stock or debt (B/S) - payment of dividends (I/S)
- repurchase of common stock (B/S) - repayment of debt (B/S)
Net increase/decrease in Cash Account
MicroDrive, Inc: Balance Sheet (millions of dollars)
Assets 2008 2007 Liabilities and Equity 2008 2007 Cash and equivalents $10 $15 Accounts payable $60 $30
ST investments 0 65 Notes payable 110 60
Accounts receivable 375 315 Accruals 140 130
Inventories 615 415 Total current liabilities $310 $220 Total current assets $1,000 $810 Long-term bonds 754 580 Gross plant and equip 1,400 1,230 Total liabilities $1,064 $800 Accumulate Depr -400 -360 Preferred stock (400k shr) 40 40 Net plant and equip $1,000 $870 Common stock (50m shr) 130 130 Retained earnings 766 710 Total common equity $896 $840 Total assets $2,000 $1,680 Liabilities and Equity $2,000 $1,680
MicroDrive, Inc: Income Statement (millions of dollars)
2008 2007Net sales $3,000.0 $2,850.0
Cost of goods sold 1,284.5 1,211.6
Administration expenses 1,331.7 1,285.4
Earnings before int., taxes, depr., amort., (EBITDA) $383.8 $353.0
Depreciation 100.0 90.0
Amortization 0.0 0.0
Earnings before int. and taxes (EBIT) $283.8 $263.0
Less: Interest 88.0 60.0
Earnings before taxes (EBT) $195.8 $203.0
Taxes (40%) 78.3 81.2
Net income before preferred dividends $117.5 $121.8
Preferred dividends 4.0 4.0
Net income $113.5 $117.8
Common dividends $57.5 $53.0
Additions to retained earnings $56.0 $64.8
Calculations of EPS, DPS, BVPS, and CFPS for 2008 (based on 50,000 shares outstanding)
Earnings per share = EPS = Net income = $113,500,000 = $2.27 Common shares O/S 50,000,000
Dividends per share = DPS = Dividends to C/S = $57,500,000 = $1.15 Common shares O/S 50,000,000
Book value per share = BVPS = Total common equity = $896,000,000 = $17.92 Common shares O/S 50,000,000
Cash Flow per share = CFPS = NI + Depr + Amort = $213,500,000 = $4.27 Common shares O/S 50,000,000
Stock Price = $23.80
MicroDrive, Inc: Statement of Retained Earnings (millions of dollars)
Balance of retained earnings, 12/31/07 $710.0
Add: Net income, 2008 113.5
Less: Dividends to common stockholders (57.5) Balance of retained earnings, 12/31/08 $766.0
MicroDrive, Inc: Statement of Cash Flows (millions of dollars)
Cash provided or uses Operating Activities
Net income before preferred dividends $117.5 Adjustments
Noncash adjustments Depreciation
100.0 Due to changes in working capital
Increase in accounts receivable Increase in inventories
Increase in accounts payable Increase in accurals
(60.0) (200.0) 30.0 10.0 Net cash provided by operating activities ($2.5)
Long-Term Investing Activities
Cash used to acquire fixed assets ($230.0)
Financing Activities
Sale of short-term investments Increase in notes payable Increase in bonds outstanding Payment of P/S and C/S dividends
$65.0 50.0 174.0 (61.5) Net cash provided by financing activities $227.5
Summary
Net change in cash ($5.0)
Cash at beginning of year 15.0
Cash Flow Analysis
Earnings before Interest, Taxes, Depreciation, and Amortization (EBITDA)
Cash Flow available to bondholders, to pay government, and to fund asset purchase. Adds back in noncash items.
Net Operating Working Capital = Operating Current Assets - Operating Current Liabilities Operating = those flows from normal operations
Operating Current Assets = Cash, A/R, Inv Operating Current Liabilities = A/P, Accruals
Net Operating Profit after Taxes (NOPAT) = EBIT ( 1 - tax rate )
Free Cash Flow (FCF) = NOPAT - Net investment in operating capital
Net investment in operating capital = - change in current assets (operating) + change in current liabilities (operating) - change in net capital assets
Current asset increase represents an investment Current liability increase represents borrowing Net capital assets = Increase in PPE - Depreciation
Market Value Added (MVA)
Consistent with shareholder wealth maximization
MVA = market value of common stock - initial value of equity capital
example: Google, Inc.
Google went public (IPO) on August 19, 2004 at $85 per share Google stock value on June 16, 2008 was $366.00
Shares Outstanding = 1.2B
GOOG
Economic Value Added (EVA)
EVA = NOPAT - (After-tax dollar cost of capital used to support operations) After-tax dollar cost of capital used to support operations =
(net operating working capital + net plant and equipment) * WACC = (amount spent on B/S) * (cost of raising money)
“EVA is net operating profit minus an appropriate charge for the opportunity cost of all capital invested in an enterprise”
http://www.sternstewart.com/
“EVA is the actual return from the company’s assets in place less the cost of raising the money to purchase those assets. In other words, the actual net dollar return from the assets reported on the balance sheet”
Analyzing Financial Performance using Ratio Analysis
Five major areas to analyze. (1) Liquidity Position (2) Management of Assets (3) Management of Debt (4) Company's Profitability (5) Market's View of Company
(1) Liquidity Ratios - use to investigate the relationship between a firm's current (short-term) assets and current (short-(short-term) liabilities.
(a) Current Ratio = Current Assets = 1,000 = 3.23x Current Liabilities 310
(b) Quick Ratio = Current Assets - Inventory = 1,000 - 615 = 1.24x Current Liabilities 310
(2) Asset Management Ratios - Use to evaluate how efficiently management employs assets.
(a) Inventory = Cost of Goods Sold = 1,284.5 = 2.09x
Turnover Inventory 615
(b) Days
Sales = Accounts Receivable = 375 = 45 days
Outstanding Credit Sales/day 3,000/360
(c) Fixed Asset = Net Sales = 3,000 = 3.0x
Turnover Net Fixed Assets 1,000
(d) Total Asset = Net Sales = 3,000 = 1.5x
(3) Debt Management Ratios - use to evaluate riskiness of company (remember higher risk equates to higher required return)
(a) Debt Ratio = Total Liabilities = 1,064 = 53.2% Total Assets 2,000
(b) Times-Interest-Earned = EBIT = 283.8 = 3.23x
(TIE) Interest 88
(c) EBITDA = EBITDA + Lease Payments Coverage Interest + Principal + Lease Payments
= 383.8 + 45 = 3.22x
88 + 0 + 45
(4) Company's Profitability - Are the owner's earning an adequate return on their investment.
(a) Profit Margin = Net Income = 113.5 = 3.78% Net Sales 3,000
(b) Return on Assets = Net Income = 113.5 = 5.68%
(ROA) Total Assets 2,000
(c) Return on Equity = Net Income = 113.5 = 12.66%
(ROE) Shareholder's Equity 896
(5) Market Value Ratios - use to determine how market views company (a) PE Ratio = Price per share = 23.80 = 10.48
EPS 2.27
(b) PEG Ratio = PE Ratio = 10.48 = 1.50 EPS
e(g ) 7.0
(c) Market to Book = Price = 23.80 = 1.33
Du Pont Analysis
The DuPont equation provides us a method to evaluate the components that make up ROE. ROE = Net Income = 113.5 = 12.66%
Shareholder's Equity 896 ROE = (ROA)*(Equity Multiplier)
remember: ROA = Net Income = 113.5 = 5.68% Total Assets 2,000
Equity Multiplier = Total Assets = 2,000 = 2.23 Shareholder’s Equity 896
shows the asset base supported by common equity; high equity multiplier shows a lot of risk or may be due to low market value relative to book value.
ROE = (ROA) * (Equity Multiplier) ROE = Net Income * Total Assets
Total Assets S/E
12.66% = 5.68% * 2.23
ROA = (profit margin)*(total asset turnover), where:
Profit Margin = Net Income = 113.5 = 3.78% Net Sales 3,000
Total Asset = Net Sales = 3,000 = 1.5
Extended DuPont Equation may be most beneficial to use as analysis tool.
ROE = PROFIT * TOTAL * EQUITY MARGIN ASSET MULTIPLIER
TURNOVER
ROE = Net Income * Net Sales * Total Assets Net Sales Total Assets S/E 12.66% = 3.78% * 1.5 * 2.23
ROE is separated into profitability of each $ of sales (profit margin), efficiency of asset management (total asset turnover), and company risk (equity multiplier).
Can now get insight into whether company's return is due to high profitability, good management, or compensation for risk.
Keys
to using Ratio Analysis (1) Compare ratios to industry (2) Look at trend of ratios over time(3) Be aware of the limitations in using ratio analysis
LIMITATIONS TO RATIO ANALYSIS
(1) Difficult to fit conglomerate into specific industry - or company make-up may change over time.
(2) Focus on some 'important' ratios may adversely effect overall firm performance. (3) Timing of cash flows affect balances in accounts.
(4) Window Dressing Techniques - make ratios appear better than they are to improve appearance of the company (fool investors).
(5) Different Accounting Methods
(6) No absolutes - high/low does not always mean good/bad or bad/good.
(7) Industry averages may be distorted if all company's in industry very good or very bad.
