Chapter 9
Analyzing Historical
Performance
Presented by Shan Li
Organization of this chapter
• Reorganizing the accounting statements to gain
greater analytical insights and to calculate ROIC
and economic profit
• Calculate free cash flow
• Breaking down ROIC and Developing an
integrated perspective
• Analyzing credit health and liquidity
• Dealing with more advanced issues in analyzing
financial performance
Reorganizing The Accounting
Statements
• The purpose of reorganization of accounting
statements is to calculate Invested Capital,
NOPLAT,ROIC and Economic Profit.
• ROIC and Economic Profit reflect more of an
economic than accounting view of the
company.
For example: distinguish operating from nonoperating assets.
Invested Capital
• Need to reorganize the balance sheet.
• It reflect how much of the capital has been
invested in operating activities and other nonoperating activities.
• Operating invested capital: the amount
invested in the operation of the business.
OIC = operating working capital + net
property, plant and equipment + net other
assets
Invested Capital-9 items
•



Operating current assets
Comprise all current assets used in or
necessary for the operation of the business.
OCA= cash balance + trade accounts
receivables + inventories.
Specifically excluded are cash and
marketable securities greater than the
operational needs of the business.
Invested Capital-9 items
• Non-interest-bearing current liabilities
Such as accounts payable and accrued expense
Net working capital=Operating current assets –
Non-interest-bearing current liabilities
• Net property, plant and equipment
Is the book value of the company’s fixed assets
NPPE=Gross PPE – Accumulated depreciation
Invested Capital-9 items
• Other operating assets, net of other liabilities
 Any other assets or non-interest-bearing liabilities
related to the operation of business
• Non-operating assets
 Any assets not included in operating invested capital
should be added when total investor funds.
 For example: Goodwill, Excess cash and securities,
Non-operating investments.
Invested Capital-9 items
• Equity
 Is the sum of all common equity accounts
 Such as paid-in capital and retain earnings, preferred
shares, and minority interest in consolidated
subsidiaries
• Quasi-equity items
 Accounts recorded as liabilities for accounting
purpose, but should be treated as equity to determine
how much capital the shareholder have invested.
 For example: deferred income taxes
Invested Capital-9 items
• Adjusted equity
Is the sum of all equity accounts plus all quasiequity accounts
• Interest-bearing debt
Includes long-term debt, short-term debt,
current maturities of long-term debt, and
capital lease
NOPLAT
• NOPLAT-Net Operating Profit Less
Adjusted Taxes
• Need to reorganize income statement
• Represents the after-tax operating profits
of the company after adjusting the taxes
to a cash basis
NOPLAT-4 items
• EBITA
 EBITA-Earning Before Interest, Taxes and
Amortization of goodwill
 Is the pretax operating income that a company would
earned if it had no debt and no goodwill amortization
 Includes all types of operating income, including
most revenues and expenses
 Excludes interest income and expense, gain or loss
from discontinued items, extraordinary income or
loss, investment income from non-operating invests
NOPLAT-4 items
• Taxes on EBITA
 Represent the income
taxes that are
attributable to EBITA
 Are taxes the company
would pay if it had no
debt, cash above
operating needs, or nonoperating income or
expenses
Total income tax
provision from
income statement
Tax shield on interest
expense
216
Tax on interest income
0
Tax on non-operating
income
(18)
Taxes on EBITA
231
33
NOPLAT-4 items
• Change in deferred taxes
 Deferred taxes are the difference between the
provision for income taxes in the income statement
and the actual taxes paid in cash.
 Can be made by calculating the change in
accumulated deferred income taxes on the company’s
balance sheet
 For example: accumulated deferred taxes in 1995 was
192, in 1996 was 224. Therefore, change in deferred
taxes is 224-192=32.
NOPLAT-4 items
• Reconciliation to net
income
 To ensure that nothing is
missing in the
calculation of NOPLAT
 To ensure a complete
understanding of the
company’s financial
statements
Net income
282
Add: Increase in
deferred taxes
(1)
Add: Goodwill
amortization
15
Adjusted net income
296
Add: Interest expense
after-tax, net
27
Total income available
to investors
323
After-tax non-operating
income
0
NOPLAT
323
ROIC
• ROIC-Return On Invested Capital
• ROIC= Net operating profit less adjusted taxes
Invested capital
• Invested capital is generally measured at the
beginning of the period or as an average of the
beginning and end of the period.
• ROIC is a better analytical tool because it
focuses on the true operating performance of
the company.
Economic Profit
• It measures the dollars of economic value
created by a company in a single year.
• Economic profit=Invested capital x (ROICWACC) or
• Economic profit=NOPLAT-Capital charge or
• Economic profit=NOPLAT-(Invested capital x
WACC)
• Economic profit combines spread and size of
company into dollar performance
Free Cash Flow
• Free cash flow is a company’s true operating
cash flow.
• It is the total after-tax cash flow generated by
the company that is available to all providers
of the company’s capital, both creditors and
shareholders.
• Free cash flow is before financing and
therefore not affect by the company’s financial
structure.
Free Cash Flow
• FCF=NOPALT-Net investment
=[NOPLAT + Depreciation]-[Net
investment + Depreciation]
=Gross cash flow-Gross investment
Where net investment is the change in
invested capital.
Free Cash Flow-14 items
• Depreciation
 Includes all the noncash charges deducted from
EBITA except goodwill amortization
• Gross cash flow
 Represents the total cash flow thrown off by the
company’s operation
 It is the amount available to reinvest without relying
on additional capital
 GCF=NOPLAT + Depreciation
Free Cash Flow-14 items
• Change in operating working capital
Is the amount the company invested in
operating working capital during the period.
• Capital expenditure
Include expenditures on new and replacement
property, and equipment
Capital expenditure=increase in net property,
plant and equipment + depreciation expenses
Free Cash Flow-14 items
• Increase in other assets, net of liabilities
 Equals the expenditure on all other operating assets
including deferred expense, and net of increases in
non-current, non-interest-bearing liabilities
• Gross investment
 Is the sum of a company’s spending for new capital
 Includes working capital, capital expenditures, and
other assets
 GI=change in working capital + capital expenditure +
change in other assets + foreign currency translation
effect
Free Cash Flow-14 items
• Investment in goodwill
Equals the expenditures to acquire other
companies in excess of the book value of their
net assets
IIG=net changes in goodwill + amortization of
goodwill
Free Cash Flow-14 items
• Non-operating cash flow
Represents the after-tax cash flow from items
not related to operations
Includes cash flow from discontinued
operations, extraordinary gain or loss, and the
cash flow from investments in unrelated
subsidiaries
TV=PV of FCF + PV of After Tax NonOperating CF and Marketable Securities
Free Cash Flow-14 items
• Change in excess marketable securities
Excess marketable securities are the short-term
investments that the company holds above its
target balance to support operation.
The change in excess marketable securities can
be treated as non-operating cash flow or as
financing cash flows.
Free Cash Flow-14 items
• Foreign Currency translation effect
Is driven by the changes in translation rates
applies to both assets and debt
Treat this gain or loss as non-operating cash
flow
• Total funds available to investor
=FCF + all non-operating items
Free Cash Flow-14 items
• Change in Debt
Represents the net borrowing or repayment on
all the company’s interest-bearing debt
Includes short-term debt and capital lease
• After-tax interest expense
=pretax interest expense x (1-marginal tax
rate)
Free Cash Flow-14 items
• Dividends
Includes all cash dividends on common and
preferred shares
• Share issues/repurchases
Includes both preferred and common shares
and the effects of conversions of debt to equity
Breakdown ROIC
• ROIC = NOPLAT
Invested Capital
• NOPLAT=EBITA x (1-Cash tax rate)
• ROIC= EBITA x (1-cash tax rate)
Invested Capital
Breakdown ROIC
EBITA
EBITA
Invested Capital
=
Revenues
Revenues
x
Invested Capital
• Operating Margin (EBITA/Revenues) measures how
effectively the company converts revenues into
profits.
• Capital turnover ( Revenue/Invested capital)
measures how effectively the company employs its
invested capital.
Credit Health and Liquidity
• Interest Coverage
Is the amount of earnings available to pay
interest expense
It provides a sense of how far operating profits
could fall before the company would have
difficulty servicing its debt.
Measures the company’s financial cushion
Interest Coverage= EBIT/Interest expense
Credit Health and Liquidity
• Debt/Total Investor Funds
Measures the company’s reliance on debt
capital
Expressed both at book value (creditors often
use) and at market values
Credit Health and Liquidity
• Investment Rate
Is the ratio of investment to available funds
Net basis : Net investment / NOPLAT
Gross basis: Gross investment / Gross cash
flow
Investment rate > 1 : company is consuming
more funds than it is generating
Credit Health and Liquidity
• Dividend Payout Ratio
Is total common dividends divided by income
available to common shareholders
= Common Dividends / Net Income available
to common
If a company has investment rate >1 and a
high dividend payout ratio, it must be
borrowing money to fund a negative free cash
flow to pay interests and dividends.