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
Total Assets
Common Stock
Retained Earnings
Total Liabilities and Shareholder’s Equity
Income Statement
Used to figure out how much money we are earning for:
(a)
(b)
(c)
(d)
vendors, employees, etc - Cost of Goods Sold, Operating Expenses
lenders, bondholders - Interest,
government - Taxes,
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
EBT
(-) Taxes
Net Income
to bondholders
earnings before taxes
rate set by government
payout or retain
(-) Dividends
payout
Additions to R/E
retain
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
$10
$15
0
65
Accounts receivable
375
315
Inventories
615
415
Total current assets
$1,000
$810
Gross plant and equip
1,400
1,230
Cash and equivalents
ST investments
Accumulate Depr
Net plant and equip
-400
$1,000
Liabilities and Equity
2008
2007
Accounts payable
$60
$30
Notes payable
110
60
Accruals
140
130
$310
$220
Long-term bonds
754
580
Total liabilities
$1,064
$800
40
40
Common stock (50m shr)
130
130
Retained earnings
766
710
$896
$840
$2,000
$1,680
Total current liabilities
-360 Preferred stock (400k shr)
$870
Total common equity
Total assets
$2,000
$1,680
Liabilities and Equity
footnote - lease payments for 2007 were $42,000,000, and for 2008 were $45,000,000
MicroDrive, Inc: Income Statement (millions of dollars)
2008
2007
$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
$283.8
$263.0
88.0
60.0
$195.8
$203.0
78.3
81.2
$117.5
$121.8
4.0
4.0
$113.5
$117.8
Common dividends
$57.5
$53.0
Additions to retained earnings
$56.0
$64.8
Net sales
Earnings before int. and taxes (EBIT)
Less: Interest
Earnings before taxes (EBT)
Taxes (40%)
Net income before preferred dividends
Preferred dividends
Net income
Calculations of EPS, DPS, BVPS, and CFPS for 2008
(based on 50,000 shares outstanding)
Earnings per share =
EPS =
Net income
Common shares O/S
=
Dividends per share = DPS =
Dividends to C/S
=
Common shares O/S
Book value per share = BVPS =
Total common equity
Common shares O/S
Cash Flow per share = CFPS =
NI + Depr + Amort
Common shares O/S
$113,500,000
50,000,000
$57,500,000
50,000,000
=
=
Stock Price = $23.80
Average analysts expected growth forecast for EPS is 7% per year
=
=
$2.27
$1.15
$896,000,000 =
50,000,000
$17.92
$213,500,000 =
50,000,000
$4.27
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
Adjustments
Noncash adjustments
Depreciation
$117.5
100.0
Due to changes in working capital
Increase in accounts receivable
Increase in inventories
Increase in accounts payable
Increase in accurals
Net cash provided by operating activities
(60.0)
(200.0)
30.0
10.0
($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
Net cash provided by financing activities
$65.0
50.0
174.0
(61.5)
$227.5
Summary
Net change in cash
Cash at beginning of year
Cash at end of year
($5.0)
15.0
$10.0
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
MVAGOOG = $439.2B - $102B = $337.2B
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”
Michael Sullivan
Analyzing Financial Performance using Ratio Analysis
Five major areas to analyze.
(1)
(2)
(3)
(4)
(5)
Liquidity Position
Management of Assets
Management of Debt
Company's Profitability
Market's View of Company
(1)
Liquidity Ratios - use to investigate the relationship between a firm's current (shortterm) assets and current (short-term) liabilities.
(a)
Current Ratio =
Current Assets
Current Liabilities
=
1,000
310
=
3.23x
(b)
Quick Ratio =
Current Assets - Inventory
Current Liabilities
=
1,000 - 615
310
=
1.24x
(2)
Asset Management Ratios - Use to evaluate how efficiently management employs
assets.
(a)
Inventory =
Turnover
(b)
Days
Sales
Outstanding
Cost of Goods Sold
Inventory
=
=
1,284.5
615
= 2.09x
Accounts Receivable =
Credit Sales/day
375
3,000/360
= 45 days
(c)
Fixed Asset =
Turnover
Net Sales
Net Fixed Assets
=
3,000
1,000
= 3.0x
(d)
Total Asset =
Turnover
Net Sales
Total Assets
=
3,000
2,000
= 1.5x
(3)
Debt Management Ratios - use to evaluate riskiness of company (remember higher risk
equates to higher required return)
(a)
Debt Ratio
(b)
(c)
=
Total Liabilities
Total Assets
=
1,064 = 53.2%
2,000
Times-Interest-Earned =
(TIE)
EBIT
Interest
=
283.8 = 3.23x
88
EBITDA
Coverage
EBITDA + Lease Payments
Interest + Principal + Lease Payments
=
=
383.8 + 45
88 + 0 + 45
=
3.22x
(4)
Company's Profitability - Are the owner's earning an adequate return on their
investment.
(a)
Profit Margin
(b)
Return on Assets =
(ROA)
(c)
Return on Equity =
(ROE)
(5)
Market Value Ratios - use to determine how market views company
(a)
PE Ratio =
(b)
PEG Ratio =
(c)
Market to Book =
Ratio
=
Net Income
Net Sales
=
113.5
3,000
= 3.78%
Net Income
Total Assets
=
113.5
2,000
= 5.68%
Net Income
=
Shareholder's Equity
113.5
896
= 12.66%
Price per share
EPS
=
23.80 = 10.48
2.27
PE Ratio
e(gEPS)
=
10.48 = 1.50
7.0
Price
Book Value
=
23.80 = 1.33
17.92
Du Pont Analysis
The DuPont equation provides us a method to evaluate the components that make up ROE.
ROE =
Net Income
=
Shareholder's Equity
113.5 = 12.66%
896
ROE = (ROA)*(Equity Multiplier)
remember:
ROA =
Equity Multiplier =
Net Income
Total Assets
=
113.5
2,000
Total Assets
Shareholder’s Equity
=
=
5.68%
2,000
896
=
2.23
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
Net Sales
=
113.5 = 3.78%
3,000
Total Asset
Turnover
=
Net Sales
Total Assets
=
3,000
2,000
= 1.5
Extended DuPont Equation
may be most beneficial to use as analysis tool.
ROE =
PROFIT *
MARGIN
ROE =
Net Income * Net Sales
Net Sales
Total Assets
12.66% =
3.78%
*
TOTAL
*
ASSET
TURNOVER
1.5
*
*
EQUITY
MULTIPLIER
Total Assets
S/E
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)
(2)
(3)
Compare ratios to industry
Look at trend of ratios over time
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.