Corporate Finance
Interpreting Financial Statements
Dr. Markus R. Neuhaus
Dr. Marc Schmidli, CFA
Autumn Term 2013
Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch
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Corporate Finance: Course overview 2013
20.09. Fundamentals
M. Neuhaus & M. Schmidli
27.09. No lecture
04.10. Interpreting Financial Statements
M. Neuhaus & M. Schmidli
11.10.
Mergers & Acquisitions I & II (4 hours)
M. Neuhaus & S. Beer
18.10
Investment Management
M. Neuhaus & P. Schwendener
25.10
Business Valuation (4 hours)
M. Neuhaus & M. Bucher
01.11
Value Management
M. Neuhaus, R. Schmid & G. Baldinger
08.11
No lecture
15.11
Legal Aspects
Ines Pöschel
22.11
Turnaround Management
M. Neuhaus & R. Brunner
29.11
No lecture
06.12
Financial Reporting
M. Neuhaus & M. Jeger
13.12
Taxes (4 hours)
M. Neuhaus & M. Marbach
20.12
Summary Repetition
M. Neuhaus
Autumn Term 2013
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Markus R. Neuhaus
PricewaterhouseCoopers AG, Zürich
Phone:
Email:



Grade
Qualification
Career Development

Subject-related Exp.

Lecturing

Published Literature

Other professional roles:
Autumn Term 2013
+41 58 792 40 00
markus.neuhaus@ch.pwc.com
Chairman
Doctor of Law (University of Zurich), Certified Tax Expert
Joined PwC in 1985, became Partner in 1992 and CEO from 2003 –
2012, became Chairman in 2012
Corporate Tax
Mergers & Acquisitions
SFIT: Executive in Residence, lecture: Corporate Finance
Multiple speeches on leadership, business, governance, commercial
and tax law
Author of commentary on the Swiss accounting rules
Publisher of book on transfer pricing
Author of multiple articles on tax and commercial law, M&A, IPO, etc.
Member of the board of économiesuisse, member of the board
and chairman of the tax chapter of the Swiss Institute of
Certified Accountants and Tax Consultants
Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch
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Marc Schmidli
PricewaterhouseCoopers AG, Zürich
Phone:
Email:




Grade
Qualification
Career Development
Lecturing

Published Literature
+41 58 792 15 64
marc.schmidli@ch.pwc.com
Partner
Dr. oec. HSG, CFA charterholder
Corporate Finance PricewaterhouseCoopers since July 2000
Euroforum – Valuation in M&A situations
Guest speaker at ZfU Seminars, Uni Zurich, ETH, etc.
Finanzielle Qualität in der schweizerischen Elektrizitätswirtschaft
Various articles in „Treuhänder“, HZ, etc.
Autumn Term 2013
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Contents





Learning targets
Pre-course reading
Lecture „Interpreting Financial Statements“
Pre-course reading case studies / questions
Solutions to case studies
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Learning targets

Framework for financial statement analysis
 Understanding the need for financial statement analysis
 Understanding the financial reporting system
 Refreshing principal elements of financial statements (Balance sheet, income and
cash flow statements)

Analysis of financial statements
 Understand the purpose and use of ratio analysis
 Being able to apply the various ratio analyses
 Being able to evaluate corporate performance by the integrated analysis of ratios
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Contents





Learning targets
Pre-course reading
Lecture „Interpreting Financial Statements“
Pre-course reading case studies / questions
Solutions to case studies
Autumn Term 2013
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Pre-course reading

Books
 Mandatory reading:
 Brigham, Houston (2012): Chapter 4 (pp. 96-130)
 White, Sondhi, Fried (2003): Chapter 3 (pp. 74-99)
 Optional reading:
 Brigham, Houston (2012): Chapter 3 (pp. 56-95)

Slides
 Slides 1 to 11 – mandatory reading
 Other Slides – optional reading, will be dealt within the lecture
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Contents





Learning targets
Pre-course reading
Lecture „Interpreting Financial Statements“
Pre-course reading case studies / questions
Solutions to case studies
Autumn Term 2013
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Agenda I
1. Introduction

Financial analysis

Classes of users

Need for financial statement analysis
2. Ratio analysis

Significance of ratio analysis

Sources

Financial reporting systems and standards

Important groups of ratio analysis
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Agenda II
3. Case study
Beans Incorporation vs. Garlic Incorporation
4. Q&A and discussion
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Agenda: Introduction

Financial analysis

Classes of users

Need for financial statement analysis
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Financial analysis

Evaluation of a firm‘s performance and development mainly by
 identifying the key drivers of a firm‘s performance and financial position
 calculating and interpreting important ratios of the firm
 Balanced Scorecard (soft – hard)

A well rounded financial analysis takes into account not only the financials alone but also
surrounding factors which can have significant influence on the firm’s development.
Financial management does not operate in a vacuum.
Environment
Macroeconomic situation,
industry, market
Business
Management, products, margins,
technology, knowledge base, competition
Financial Statements
Balance sheet, income statement,
cash flow, stockholders’ equity, budget
Financial
Analysis
Source: White, Sondhi, Fried (2003), 2ff.
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Classes of users

Internal users (such as managers or board members)

External users of financial information encompass a wide range of interests but can be
classified into three general groups:
 Credit and equity investors
 Government, regulatory bodies, tax authorities
 General public and special interest groups, labor unions and consumer groups
Source: White, Sondhi, Fried (2003), 4.
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Need for financial statement analysis


Internal:
External:
Financial statements provide the
company with information on its
performance and development over
time and are a crucial basis for most
financial decisions (i.e. investment,
financing)
Financial statements facilitate the
interaction between the company
and its business environment by
providing third parties with essential
information on the company’s
development

Costs

Creditors

Efficiency

Investors

Profitability

Shareholders

Investments

Government

Financing (needs)
Financial analysis has great significance and impact
on a company‘s development as it influences
expectations on the capital markets
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Agenda: Ratio analysis

Significance of ratio analysis

Sources

Financial reporting systems and standards

Important groups of ratio analysis
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Ratio analysis

Financial statements help predict the future development of a company
Firm A has total debt of $ 1’060m and $ 88m interest charges whereas firm B has total
debt of $ 52m and $ 4m interest charges. Which firm is stronger, better financed? Or
which firm is more liquid or more likely to generate higher cash flows?
 Figures standing alone, such as total debt or interest charges, are not really helpful
 By putting debt into perspective with other appropriate figures, we are able to
predict which firm is more likely to succeed
 such comparisons are ratio analysis
The debt burden can be evaluated
(a) by comparing each firm‘s debt with its assets and
(b) by comparing the interest the company has to pay with the income
it has available
Source: Brigham, Houston (2012), 98f.
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Significance of ratio analysis

„help predict the
future development
of a company”
As a company’s value is determined by its ability to generate cash today and in
the future, ratio analysis has great importance

Share price development

Credit rating

However, there is no generally used list of ratios that could be applied to any company

Groups of ratios1):
 Liquidity ratios
 Asset management ratios
 Debt or financing ratios
 Profitability ratios
 Market value ratios
1)
Details later: see page 25ff.
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Principal elements of financial statements as primary
source for financial analysis




Balance sheet
Income statement
Statement of cash flows
Statement of stockholders‘ equity

Further sources: Broker/analyst reports, Bloomberg, Reuters, Factset etc.
Collectively, these interrelated financial statements provide
relevant and timely information about the past and are
essential for making crucial business decisions about
investment or financing activities today and in the future.
Financial statements are a key component to build trust in the
financial community.
Source: White, Sondhi, Fried (2003), 5.
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Financial reporting systems and standards

Reporting systems and standards compel the company to meet a great number of
requirements in order to ensure that the financial statements are, above all, transparent
and comparable

The two most commonly used standards are:

IFRS (International Financial Reporting Standards)

US GAAP (United States Generally Accepted Accounting Principles)

Differences are found mainly in the classification of certain events (e.g. whether an
interest payment is reported under operating costs or financing costs etc.) or with regard
to financial instruments. Both aim to provide a “true and fair view”of the company’s
performance.

In addition, there are local GAAPs (Generally Accepted Accounting Principles). In
Switzerland we have rules in the Code of Obligation which permit hidden reserves and
the FER (Fachempfehlung für Rechnungslegung) which is a light form of IFRS.
Source: White, Sondhi, Fried (2003), 5ff.
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Balance sheet


Snapshot of the company‘s assets
and liabilities at a certain reporting
date
Assets = Liabilities + Equity
Balance Sheet
(chf m)
USD
m
2008
2011
2007
2010
Assets
Cash and cash equivalents
Accounts receivable
Inventories
Current assets
10
375
615
1'000
80
315
415
810
Net plant and equipment
Non-current assets
1'000
1'000
870
870
Total assets
2'000
1'680
60
110
140
310
30
60
130
220
750
1'060
580
800
130
810
940
130
750
880
2'000
1'680
Liabilities and Equity
Accounts payable
Notes payable
Accruals
Total current liabilities
Long-term bonds
Total debt
Common stock (50'000'000 shares)
Retained earnings
Total equity
Total liabilities and equity
Source: Brigham, Houston (2012), 62.
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Income statement


Reports on the performance of a firm, the results of its operating activities
Matching principle = revenues and related costs must be accounted for during the same
period of time. This requires the recognition of expenses incurred to generate revenues
in the same period as the related revenues (revenue recognition, accrual method).
Income Statement
(chf in
USD
m millions)
2011
2008
2010
2007
Net Sales
Operating Costs
3'000.0
(2'616.2)
2'850.0
(2'497.0)
383.8
(100.0)
353.0
(90.0)
EBIT
Interest
Taxes
283.8
(88.0)
(78.3)
263.0
(60.0)
(81.2)
Net Income
117.5
121.8
57.5
60.0
53.0
68.8
EBITDA
Amortization
Depreciation
Common dividends
Addition to retained earnings
Source: Brigham, Houston (2012), 67.
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Statement of cash flow






The cash flow statement represents the cash
generated by a company during the given
accounting period
Separated into three categories: (I) operating
activities, (II) investing activities, (III) financing
activities
The investment section illustrates how cash was
spent whereas section III, financing shows how
those investments were financed
In the long run, cash flows from operating activities
should considerably increase; investments should
be equal to depreciation (plus a bit more to
support stable growth)
In this example, the company has an operating
problem as the cash flow from operating activities
is negative
CAPEX = capital expenditures
Statement of Cash Flow
(chf
USDinmmillions)
2008
2011
Operating activities
Net Income
Additions
Depreciation and Amortization
Increase in accounts payable
Increase in accruals
Substractions
Increase in accounts receivable
Increase in inventories
Net cash provided by operating activities
(60.0)
(200.0)
(2.5)
Long-term investing activities
Cash used to acquire fixed assets (CAPEX)
(230.0)
117.5
100.0
30.0
10.0
Financing activities
Increase in notes payable
Increase in bonds
payments of dividens
Net cash provided by financing activities
50.0
170.0
(57.5)
162.5
Net decrease in cash and equivalents
(70.0)
Cash and equivalents at beginning of the year
Cash and equivalents at end of the year
80.0
10.0
Source: Brigham, Houston (2012), 69.
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Statement of retained earnings


Changes in retained earnings occur because stockholders allow the management to
retain and invest funds that otherwise would be paid out as dividend
Thus, the retained earnings position is not cash and is not available for spending
Statement of retained earnings
(chf
USDinmmillions)
2008
2011
Balance of retained earnings as of 2007
2010
Add: Net income 2008
2011
Less: Dividend to common stockholders
Balance of retained earnings as of 2008
2011
750.0
117.5
(57.5)
810.0
Source: Brigham, Houston (2012), 72.
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Important groups of financial ratios

Liquidity ratios
Is the company able to pay its debts as they become due this year?

Asset management ratios
Does the amount of assets seem to be reasonable in relation to current and projected sales? And
how efficiently does the company use its assets?”

Debt or financing ratios
To what extent is the company using financial leverage? Risk from capital structure?

Profitability ratios
How profitable is the company? How much output does the company generate in relation to a
certain input?

Market value ratios
How do the earnings and results appear in relation to the stock price?
Be aware – the definition of ratios may vary between different authors or users!
Source: Brigham, Houston (2012), 99ff.
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Liquidity ratios
Current ratio 


If a company is getting into financial difficulties, it will pay its bills more slowly, borrowing money from
banks and from suppliers. This leads to increased current liabilities which causes the current ratio to
decrease. If current liabilities grow faster than current assets, this is a an indication of financial
difficulties.
The current ratio is also known as liquidity ratio 3.
Quick ratio 


Current assets
1000

 3.2x
Current liabilities 310
Current assets - inventories 1000 - 615

 1.2x
Current liabilities
310
Inventories are a firm’s least liquid current asset and therefore most likely to suffer losses if they have
to be sold in liquidation. A company should be able to pay current liabilities with current assets less
inventories.
The quick ratio is also known as liquidity ratio 2.
Source: Brigham, Houston (2012), 99f; Volkart (2011), 161f.
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Balance sheet and income statement
Balance Sheet
(chf m)
USD
m
Income Statement
2008
2011
2007
2010
Assets
Cash and cash equivalents
Accounts receivable
Inventories
Current assets
10
375
615
1'000
80
315
415
810
Net plant and equipment
Non-current assets
1'000
1'000
870
870
Total assets
2'000
1'680
Liabilities and Equity
Accounts payable
Notes payable
Accruals
Total current liabilities
Long-term bonds
Total debt
Common stock (50'000'000 shares)
Retained earnings
Total equity
Total liabilities and equity
60
110
140
310
30
60
130
220
750
1'060
580
800
130
810
940
130
750
880
2'000
1'680
(chf in
USD
m millions)
2008
2011
2007
2010
Net Sales
Operating Costs
3'000.0
(2'616.2)
2'850.0
(2'497.0)
383.8
(100.0)
353.0
(90.0)
EBIT
Interest
Taxes
283.8
(88.0)
(78.3)
263.0
(60.0)
(81.2)
Net Income
117.5
121.8
57.5
60.0
53.0
68.8
EBITDA
Amortization
Depreciation
Common dividends
Addition to retained earnings
Source: Brigham, Houston (2012), 67.
Source: Brigham, Houston (2012), 62.
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Liquidity ratios
Current ratio 


If a company is getting into financial difficulties, it will pay its bills more slowly, borrowing money from
banks and from suppliers. This leads to increased current liabilities which causes the current ratio to
decrease. If current liabilities grow faster than current assets, this is a an indication of financial
difficulties.
The current ratio is also known as liquidity ratio 3.
Quick ratio 


Current assets
1000

 3.2x
Current liabilities 310
Current assets - inventories 1000 - 615

 1.2x
Current liabilities
310
Inventories are a firm’s least liquid current asset and therefore most likely to suffer losses if they have
to be sold in liquidation. A company should be able to pay current liabilities with current assets less
inventories.
The quick ratio is also known as liquidity ratio 2.
Source: Brigham, Houston (2012), 99ff; Volkart (2011), 161f.
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Balance sheet and income statement
Balance Sheet
(chf m)
USD
m
Income Statement
2008
2011
2007
2010
Assets
Cash and cash equivalents
Accounts receivable
Inventories
Current assets
10
375
615
1'000
80
315
415
810
Net plant and equipment
Non-current assets
1'000
1'000
870
870
Total assets
2'000
1'680
Liabilities and Equity
Accounts payable
Notes payable
Accruals
Total current liabilities
Long-term bonds
Total debt
Common stock (50'000'000 shares)
Retained earnings
Total equity
Total liabilities and equity
60
110
140
310
30
60
130
220
750
1'060
580
800
130
810
940
130
750
880
2'000
1'680
(chf in
USD
m millions)
2008
2011
2007
2010
Net Sales
Operating Costs
3'000.0
(2'616.2)
2'850.0
(2'497.0)
383.8
(100.0)
353.0
(90.0)
EBIT
Interest
Taxes
283.8
(88.0)
(78.3)
263.0
(60.0)
(81.2)
Net Income
117.5
121.8
57.5
60.0
53.0
68.8
EBITDA
Amortization
Depreciation
Common dividends
Addition to retained earnings
Source: Brigham, Houston (2012), 67.
Source: Brigham, Houston (2012), 62.
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Asset management ratios
Inventory turnover ratio 


Sales
3000

 4.9x
Inventory 615
Inventory turnover indicates whether a company (compared with peer companies) holds too much
inventory, which is very unproductive and represents an investment with a low return
The inventory turnover ratio can also be calculated by using “Cost of Goods Sold” instead of “Sales”
Receivables
Receivables 375


 46 days
Averagesales per day Sales / 365 3000
365
DSO shows the “average collection period” or how long customers usually take to pay their bills. The
higher the DSO, the more money is lost, because the company has to finance the gap with
expensive loans etc.
Days sales outstanding 

Fixed asset turnover ratio 

Sales
3000

 3.0x
Net fixed assets 1000
The fixed assets turnover ratio indicates how effectively the company is using its fixed assets
compared with peer companies.
Source: Brigham, Houston (2012), 102ff; Volkart (2011), 163f.
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Balance sheet and income statement
Balance Sheet
(chf m)
USD
m
Income Statement
2008
2011
2007
2010
Assets
Cash and cash equivalents
Accounts receivable
Inventories
Current assets
10
375
615
1'000
80
315
415
810
Net plant and equipment
Non-current assets
1'000
1'000
870
870
Total assets
2'000
1'680
Liabilities and Equity
Accounts payable
Notes payable
Accruals
Total current liabilities
Long-term bonds
Total debt
Common stock (50'000'000 shares)
Retained earnings
Total equity
Total liabilities and equity
60
110
140
310
30
60
130
220
750
1'060
580
800
130
810
940
130
750
880
2'000
1'680
(chf in
USD
m millions)
2008
2011
2007
2010
Net Sales
Operating Costs
3'000.0
(2'616.2)
2'850.0
(2'497.0)
383.8
(100.0)
353.0
(90.0)
EBIT
Interest
Taxes
283.8
(88.0)
(78.3)
263.0
(60.0)
(81.2)
Net Income
117.5
121.8
57.5
60.0
53.0
68.8
EBITDA
Amortization
Depreciation
Common dividends
Addition to retained earnings
Source: Brigham, Houston (2012), 67.
Source: Brigham, Houston (2012), 62.
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Asset management ratios
Inventory turnover ratio 


Sales
3000

 4.9x
Inventory 615
Inventory turnover indicates whether a company (compared with peer companies) holds too much
inventory, which is very unproductive and represents an investment with a low return
The inventory turnover ratio can also be calculated by using “Cost of Goods Sold” instead of “Sales”
Receivables
Receivables 375


 46 days
Averagesales per day Sales / 365 3000
365
DSO shows the “average collection period” or how long customers usually take to pay their bills. The
higher the DSO, the more money is lost, because the company has to finance the gap with
expensive loans etc.
Days sales outstanding 

Fixed asset turnover ratio 

Sales
3000

 3.0x
Net fixed assets 1000
The fixed assets turnover ratio indicates how effectively the company is using its fixed assets
compared with peer companies.
Source: Brigham, Houston (2012), 102ff; Volkart (2011), 163f.
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Balance sheet and income statement
Balance Sheet
(chf m)
USD
m
Income Statement
2008
2011
2007
2010
Assets
Cash and cash equivalents
Accounts receivable
Inventories
Current assets
10
375
615
1'000
80
315
415
810
Net plant and equipment
Non-current assets
1'000
1'000
870
870
Total assets
2'000
1'680
Liabilities and Equity
Accounts payable
Notes payable
Accruals
Total current liabilities
Long-term bonds
Total debt
Common stock (50'000'000 shares)
Retained earnings
Total equity
Total liabilities and equity
60
110
140
310
30
60
130
220
750
1'060
580
800
130
810
940
130
750
880
2'000
1'680
(chf in
USD
m millions)
2008
2011
2007
2010
Net Sales
Operating Costs
3'000.0
(2'616.2)
2'850.0
(2'497.0)
383.8
(100.0)
353.0
(90.0)
EBIT
Interest
Taxes
283.8
(88.0)
(78.3)
263.0
(60.0)
(81.2)
Net Income
117.5
121.8
57.5
60.0
53.0
68.8
EBITDA
Amortization
Depreciation
Common dividends
Addition to retained earnings
Source: Brigham, Houston (2012), 67.
Source: Brigham, Houston (2012), 62.
Autumn Term 2013
Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch
33
Asset management ratios
Inventory turnover ratio 


Sales
3000

 4.9x
Inventory 615
Inventory turnover indicates whether a company (compared with peer companies) holds too much
inventory, which is very unproductive and represents an investment with a low return
The inventory turnover ratio can also be calculated by using “Cost of Goods Sold” instead of “Sales”
Receivables
Receivables 375


 46 days
Averagesales per day Sales / 365 3000
365
DSO shows the “average collection period” or how long customers usually take to pay their bills. The
higher the DSO, the more money is lost, because the company has to finance the gap with
expensive loans etc.
Days sales outstanding 

Fixed asset turnover ratio 

Sales
3000

 3.0x
Net fixed assets 1000
The fixed assets turnover ratio indicates how effectively the company is using its fixed assets
compared with peer companies.
Source: Brigham, Houston (2012), 102ff; Volkart (2011), 163f.
Autumn Term 2013
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34
Balance sheet and income statement
Balance Sheet
(chf m)
USD
m
Income Statement
2008
2011
2007
2010
Assets
Cash and cash equivalents
Accounts receivable
Inventories
Current assets
10
375
615
1'000
80
315
415
810
Net plant and equipment
Non-current assets
1'000
1'000
870
870
Total assets
2'000
1'680
Liabilities and Equity
Accounts payable
Notes payable
Accruals
Total current liabilities
Long-term bonds
Total debt
Common stock (50'000'000 shares)
Retained earnings
Total equity
Total liabilities and equity
60
110
140
310
30
60
130
220
750
1'060
580
800
130
810
940
130
750
880
2'000
1'680
(chf in
USD
m millions)
2008
2011
2007
2010
Net Sales
Operating Costs
3'000.0
(2'616.2)
2'850.0
(2'497.0)
383.8
(100.0)
353.0
(90.0)
EBIT
Interest
Taxes
283.8
(88.0)
(78.3)
263.0
(60.0)
(81.2)
Net Income
117.5
121.8
57.5
60.0
53.0
68.8
EBITDA
Amortization
Depreciation
Common dividends
Addition to retained earnings
Source: Brigham, Houston (2012), 67.
Source: Brigham, Houston (2012), 62.
Autumn Term 2013
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35
Debt management ratios
Total debt to total assets 

Total debt
1060

 53.0%
Total assets 2000
Creditors prefer a low debt to equity ratio whereas stockholders may want more leverage as it can
magnify expected earnings ( pecking order theory). The optimal ratio between debt and assets is
highly dependent on the firm’s business and industry.
Times - interest - earned ratio 

EBIT
284

 3.2x
Interest
88
The TIE ratio measures the extent to which operating profit can decline before the firm is unable to
meet its interest costs. Not being able to pay interest costs will bring legal troubles and can result in
bankruptcy.
Source: Brigham, Houston (2012), 105ff.
Autumn Term 2013
Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch
36
Balance sheet and income statement
Balance Sheet
(chf m)
USD
m
Income Statement
2008
2011
2007
2010
Assets
Cash and cash equivalents
Accounts receivable
Inventories
Current assets
10
375
615
1'000
80
315
415
810
Net plant and equipment
Non-current assets
1'000
1'000
870
870
Total assets
2'000
1'680
Liabilities and Equity
Accounts payable
Notes payable
Accruals
Total current liabilities
Long-term bonds
Total debt
Common stock (50'000'000 shares)
Retained earnings
Total equity
Total liabilities and equity
60
110
140
310
30
60
130
220
750
1'060
580
800
130
810
940
130
750
880
2'000
1'680
(chf in
USD
m millions)
2008
2011
2007
2010
Net Sales
Operating Costs
3'000.0
(2'616.2)
2'850.0
(2'497.0)
383.8
(100.0)
353.0
(90.0)
EBIT
Interest
Taxes
283.8
(88.0)
(78.3)
263.0
(60.0)
(81.2)
Net Income
117.5
121.8
57.5
60.0
53.0
68.8
EBITDA
Amortization
Depreciation
Common dividends
Addition to retained earnings
Source: Brigham, Houston (2012), 67.
Source: Brigham, Houston (2012), 62.
Autumn Term 2013
Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch
37
Debt management ratios
Total debt to total assets 

Total debt
1060

 53.0%
Total assets 2000
Creditors prefer a low debt to equity ratio whereas stockholders may want more leverage as it can
magnify expected earnings ( pecking order theory). The optimal ratio between debt and assets is
highly dependent on the firm’s business and industry.
Times - interest - earned ratio 

EBIT
284

 3.2x
Interest
88
The TIE ratio measures the extent to which operating profit can decline before the firm is unable to
meet its interest costs. Not being able to pay interest costs will bring legal troubles and can result in
bankruptcy.
Source: Brigham, Houston (2012), 105ff.
Autumn Term 2013
Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch
38
Balance sheet and income statement
Balance Sheet
(chf m)
USD
m
Income Statement
2008
2011
2007
2010
Assets
Cash and cash equivalents
Accounts receivable
Inventories
Current assets
10
375
615
1'000
80
315
415
810
Net plant and equipment
Non-current assets
1'000
1'000
870
870
Total assets
2'000
1'680
Liabilities and Equity
Accounts payable
Notes payable
Accruals
Total current liabilities
Long-term bonds
Total debt
Common stock (50'000'000 shares)
Retained earnings
Total equity
Total liabilities and equity
60
110
140
310
30
60
130
220
750
1'060
580
800
130
810
940
130
750
880
2'000
1'680
(chf in
USD
m millions)
2008
2011
2007
2010
Net Sales
Operating Costs
3'000.0
(2'616.2)
2'850.0
(2'497.0)
383.8
(100.0)
353.0
(90.0)
EBIT
Interest
Taxes
283.8
(88.0)
(78.3)
263.0
(60.0)
(81.2)
Net Income
117.5
121.8
57.5
60.0
53.0
68.8
EBITDA
Amortization
Depreciation
Common dividends
Addition to retained earnings
Source: Brigham, Houston (2012), 67.
Source: Brigham, Houston (2012), 62.
Autumn Term 2013
Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch
39
Profitability ratios
Net income 118

 3.9%
Sales
3000
The profit margin on sales shows the profit per unit of sales
Profit margin 

Return on total assets 

Stockholders want to earn a return on their money invested. This ratio indicates the profitability of a
stockholders’ invested money from an accounting perspective
Basic earning power 

Net income
118

 5.9%
Total assets 2000
EBIT
284

 14.2%
Total assets 2000
This ratio shows the raw earning power of the firm’s assets excluding potential influence from interest
payments or leverage effects.
Return on common equity 

Net income
118

 12.5%
Common equity 940
Stockholders want to earn a return on their money invested. This ratio indicates the profitability of a
stockholders’ invested money from an accounting perspective
Source: Brigham, Houston (2012), 108ff.
Autumn Term 2013
Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch
40
Balance sheet and income statement
Balance Sheet
(chf m)
USD
m
Income Statement
2008
2011
2007
2010
Assets
Cash and cash equivalents
Accounts receivable
Inventories
Current assets
10
375
615
1'000
80
315
415
810
Net plant and equipment
Non-current assets
1'000
1'000
870
870
Total assets
2'000
1'680
Liabilities and Equity
Accounts payable
Notes payable
Accruals
Total current liabilities
Long-term bonds
Total debt
Common stock (50'000'000 shares)
Retained earnings
Total equity
Total liabilities and equity
60
110
140
310
30
60
130
220
750
1'060
580
800
130
810
940
130
750
880
2'000
1'680
(chf
USD in
m millions)
2008
2011
2007
2010
Net Sales
Operating Costs
3'000.0
(2'616.2)
2'850.0
(2'497.0)
383.8
(100.0)
353.0
(90.0)
EBIT
Interest
Taxes
283.8
(88.0)
(78.3)
263.0
(60.0)
(81.2)
Net Income
117.5
121.8
57.5
60.0
53.0
68.8
EBITDA
Amortization
Depreciation
Common dividends
Addition to retained earnings
Source: Brigham, Houston (2012), 67.
Source: Brigham, Houston (2012), 62.
Autumn Term 2013
Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch
41
Profitability ratios
Net income 118

 3.9%
Sales
3000
The profit margin on sales shows the profit per unit of sales
Profit margin 

Return on total assets 

Stockholders want to earn a return on their money invested. This ratio indicates the profitability of a
stockholders’ invested money from an accounting perspective
Basic earning power 

Net income
118

 5.9%
Total assets 2000
EBIT
284

 14.2%
Total assets 2000
This ratio shows the raw earning power of the firm’s assets excluding potential influence from interest
payments or leverage effects.
Return on common equity 

Net income
118

 12.5%
Common equity 940
Stockholders want to earn a return on their money invested. This ratio indicates the profitability of a
stockholders’ invested money from an accounting perspective
Source: Brigham, Houston (2012), 108ff.
Autumn Term 2013
Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch
42
Balance sheet and income statement
Balance Sheet
(chf m)
USD
m
Income Statement
2008
2011
2007
2010
Assets
Cash and cash equivalents
Accounts receivable
Inventories
Current assets
10
375
615
1'000
80
315
415
810
Net plant and equipment
Non-current assets
1'000
1'000
870
870
Total assets
2'000
1'680
Liabilities and Equity
Accounts payable
Notes payable
Accruals
Total current liabilities
Long-term bonds
Total debt
Common stock (50'000'000 shares)
Retained earnings
Total equity
Total liabilities and equity
60
110
140
310
30
60
130
220
750
1'060
580
800
130
810
940
130
750
880
2'000
1'680
(chf
USD in
m millions)
2008
2011
2007
2010
Net Sales
Operating Costs
3'000.0
(2'616.2)
2'850.0
(2'497.0)
383.8
(100.0)
353.0
(90.0)
EBIT
Interest
Taxes
283.8
(88.0)
(78.3)
263.0
(60.0)
(81.2)
Net Income
117.5
121.8
57.5
60.0
53.0
68.8
EBITDA
Amortization
Depreciation
Common dividends
Addition to retained earnings
Source: Brigham, Houston (2012), 67.
Source: Brigham, Houston (2012), 62.
Autumn Term 2013
Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch
43
Profitability ratios
Net income 118

 3.9%
Sales
3000
The profit margin on sales shows the profit per unit of sales
Profit margin 

Return on total assets 

Stockholders want to earn a return on their money invested. This ratio indicates the profitability of a
stockholders’ invested money from an accounting perspective
Basic earning power 

Net income
118

 5.9%
Total assets 2000
EBIT
284

 14.2%
Total assets 2000
This ratio shows the raw earning power of the firm’s assets excluding potential influence from interest
payments or leverage effects.
Return on common equity 

Net income
118

 12.5%
Common equity 940
Stockholders want to earn a return on their money invested. This ratio indicates the profitability of a
stockholders’ invested money from an accounting perspective
Source: Brigham, Houston (2012), 108ff.
Autumn Term 2013
Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch
44
Balance sheet and income statement
Balance Sheet
(chf m)
USD
m
Income Statement
2008
2011
2007
2010
Assets
Cash and cash equivalents
Accounts receivable
Inventories
Current assets
10
375
615
1'000
80
315
415
810
Net plant and equipment
Non-current assets
1'000
1'000
870
870
Total assets
2'000
1'680
Liabilities and Equity
Accounts payable
Notes payable
Accruals
Total current liabilities
Long-term bonds
Total debt
Common stock (50'000'000 shares)
Retained earnings
Total equity
Total liabilities and equity
60
110
140
310
30
60
130
220
750
1'060
580
800
130
810
940
130
750
880
2'000
1'680
(chf in
USD
m millions)
2008
2011
2007
2010
Net Sales
Operating Costs
3'000.0
(2'616.2)
2'850.0
(2'497.0)
383.8
(100.0)
353.0
(90.0)
EBIT
Interest
Taxes
283.8
(88.0)
(78.3)
263.0
(60.0)
(81.2)
Net Income
117.5
121.8
57.5
60.0
53.0
68.8
EBITDA
Amortization
Depreciation
Common dividends
Addition to retained earnings
Source: Brigham, Houston (2012), 67.
Source: Brigham, Houston (2012), 62.
Autumn Term 2013
Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch
45
Profitability ratios
Net income 118

 3.9%
Sales
3000
The profit margin on sales shows the profit per unit of sales
Profit margin 

Return on total assets 

Stockholders want to earn a return on their money invested. This ratio indicates the profitability of a
stockholders’ invested money from an accounting perspective
Basic earning power 

Net income
118

 5.9%
Total assets 2000
EBIT
284

 14.2%
Total assets 2000
This ratio shows the raw earning power of the firm’s assets excluding potential influence from interest
payments or leverage effects.
Return on common equity 

Net income
118

 12.5%
Common equity 940
Stockholders want to earn a return on their money invested. This ratio indicates the profitability of a
stockholders’ invested money from an accounting perspective
Source: Brigham, Houston (2012), 108ff.
Autumn Term 2013
Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch
46
Balance sheet and income statement
Balance Sheet
(chf m)
USD
m
Income Statement
2008
2011
2007
2010
Assets
Cash and cash equivalents
Accounts receivable
Inventories
Current assets
10
375
615
1'000
80
315
415
810
Net plant and equipment
Non-current assets
1'000
1'000
870
870
Total assets
2'000
1'680
Liabilities and Equity
Accounts payable
Notes payable
Accruals
Total current liabilities
Long-term bonds
Total debt
Common stock (50'000'000 shares)
Retained earnings
Total equity
Total liabilities and equity
60
110
140
310
30
60
130
220
750
1'060
580
800
130
810
940
130
750
880
2'000
1'680
(chf in
USD
m millions)
2008
2011
2007
2010
Net Sales
Operating Costs
3'000.0
(2'616.2)
2'850.0
(2'497.0)
383.8
(100.0)
353.0
(90.0)
EBIT
Interest
Taxes
283.8
(88.0)
(78.3)
263.0
(60.0)
(81.2)
Net Income
117.5
121.8
57.5
60.0
53.0
68.8
EBITDA
Amortization
Depreciation
Common dividends
Addition to retained earnings
Source: Brigham, Houston (2012), 67.
Source: Brigham, Houston (2012), 62.
Autumn Term 2013
Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch
47
Market value ratios
Numbers of shares:
50m
Price per share
23
Price/earnings ratio 

 9.8x
Share price: 23
Earnings per share 118
50

This ratio shows how much an investor is willing to pay per unit of reported earnings. Thus, the P/E
ratio indicates, by comparison with its peers, whether a company is regarded as being risky or
expected to have poor growth.
Price per share
23.00

 1.2x
Book value per share 940
50
The market to book ratio typically exceeds 1.0 as the balance sheet does not reflect inflation or
goodwill. In addition, this ratio provides an indication whether a company is able to earn high returns.
Market/boo k ratio 

Source: Brigham, Houston (2012), 111ff.
Autumn Term 2013
Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch
48
Balance sheet and income statement
Balance Sheet
(chf m)
USD
m
Income Statement
2008
2011
2007
2010
Assets
Cash and cash equivalents
Accounts receivable
Inventories
Current assets
10
375
615
1'000
80
315
415
810
Net plant and equipment
Non-current assets
1'000
1'000
870
870
Total assets
2'000
1'680
Liabilities and Equity
Accounts payable
Notes payable
Accruals
Total current liabilities
Long-term bonds
Total debt
Common stock (50'000'000 shares)
Retained earnings
Total equity
Total liabilities and equity
60
110
140
310
30
60
130
220
750
1'060
580
800
130
810
940
130
750
880
2'000
1'680
(chf in
USD
m millions)
2008
2011
2007
2010
Net Sales
Operating Costs
3'000.0
(2'616.2)
2'850.0
(2'497.0)
383.8
(100.0)
353.0
(90.0)
EBIT
Interest
Taxes
283.8
(88.0)
(78.3)
263.0
(60.0)
(81.2)
Net Income
117.5
121.8
57.5
60.0
53.0
68.8
EBITDA
Amortization
Depreciation
Common dividends
Addition to retained earnings
Source: Brigham, Houston (2012), 67.
Source: Brigham, Houston (2012), 62.
Autumn Term 2013
Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch
49
Market value ratios
Numbers of shares:
50m
Price per share
23
Price/earnings ratio 

 9.8x
Share price: 23
Earnings per share 118
50

This ratio shows how much an investor is willing to pay per unit of reported earnings. Thus, the P/E
ratio indicates, by comparison with its peers, whether a company is regarded as being risky or
expected to have poor growth.
Price per share
23.00

 1.2x
Book value per share 940
50
The market to book ratio typically exceeds 1.0 as the balance sheet does not reflect inflation or
goodwill. In addition, this ratio provides an indication whether a company is able to earn high returns.
Market/boo k ratio 

Source: Brigham, Houston (2012), 111ff.
Autumn Term 2013
Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch
50
Balance sheet and income statement
Balance Sheet
(chf m)
USD
m
Income Statement
2008
2011
2007
2010
Assets
Cash and cash equivalents
Accounts receivable
Inventories
Current assets
10
375
615
1'000
80
315
415
810
Net plant and equipment
Non-current assets
1'000
1'000
870
870
Total assets
2'000
1'680
Liabilities and Equity
Accounts payable
Notes payable
Accruals
Total current liabilities
Long-term bonds
Total debt
Common stock (50'000'000 shares)
Retained earnings
Total equity
Total liabilities and equity
60
110
140
310
30
60
130
220
750
1'060
580
800
130
810
940
130
750
880
2'000
1'680
(chf in
USD
m millions)
2008
2011
2007
2010
Net Sales
Operating Costs
3'000.0
(2'616.2)
2'850.0
(2'497.0)
383.8
(100.0)
353.0
(90.0)
EBIT
Interest
Taxes
283.8
(88.0)
(78.3)
263.0
(60.0)
(81.2)
Net Income
117.5
121.8
57.5
60.0
53.0
68.8
EBITDA
Amortization
Depreciation
Common dividends
Addition to retained earnings
Source: Brigham, Houston (2012), 67.
Source: Brigham, Houston (2012), 62.
Autumn Term 2013
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51
Agenda: Case study
Beans Incorporation vs. Garlic Incorporation
Autumn Term 2013
Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch
52
Case study: Interpretation of financial statements

Your client tells you he is interested in investing in a company from the food industry as he sees
great growth potential in this industry

He has already selected two potential targets and now wants your professional advice on which
company is more likely to report good results in the future

Please try to give your client your opinion based on what you have learned in this course

Read the financial statements and calculate the ratios based on 2008 figures

Compare these ratios with those of the other company and with those of the industry average
Beans Inc.
Autumn Term 2013
vs.
Garlic Inc.
Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch
53
Case study: Beans Incorporation I
Beans Inc.
Balance sheet
Income statement
(chf m)
2011
2008
2010
2007
(chf m)
Net sales
Operating sosts
EBITDA
Amortization
Depreciation
EBIT
Interest
EBT
Taxes
Net income
3780
2650
1130
0
75
1055
96
959
384
576
3500
2500
1000
0
90
910
81
829
332
497
Assets
Cash and cash equivalents
Accounts receivable
Inventories
Current assets
Net plant and equipment
Total assets
325
491
548
1'365
1'470
2'835
80
455
508
1'042
1'297
2'339
259
317
224
274
29.9%
27.9%
15.2%
11.51
28.6%
26.0%
14.2%
9.95
Liabilities and equity
Accounts payable
Notes payable
Accruals
Total current liabilities
Long-term bonds
Total debt
Common stock (50'000'000 shares)
Retained earnings
Total equity
Total liabilities and equity
302
227
75
604
590
1'194
250
1'391
1'641
2'835
263
193
70
525
490
1'015
250
1'074
1'324
2'339
Common dividends
Addition to retained earnings
EBITDA margin
EBIT margin
Net income margin
EPS
Share price
Book value per share
Numbers of shares (in m)
Autumn Term 2013
Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch
2011
2008
2010
2007
152
33
50
54
Case study: Beans Incorporation II
Beans Inc.
•
By analyzing its financial
statements, what are the
strengths and weaknesses of this
company?
•
Where do you see risks or
opportunities?
Statement of cash flow
(chf m)
Operating activities
Net income
Additions
Depreciation and Amortization
Increase in accounts payable
Increase in accruals
Substractions
Increase in accounts receivable
Increase in inventories
Net cash provided by operating activities
2011
2008
576
75
40
5
(36)
(41)
619
Long-term investing activities
Cash used to acquire fixed assets
(248)
Financing activities
Increase in notes payable
Increase in bonds
Payments of dividends
Net cash provided by financing activities
34
100
(259)
(125)
Net increase in cash and equivalents
Cash and equivalents at beginning of the year
Cash and equivalents at end of the year
Autumn Term 2013
245
80
325
Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch
55
Case study: Garlic Incorporation I
Garlic Inc.
Balance sheet
Income statement
(chf m)
2011
2008
2010
2007
(chf in millions)
Net sales
Operating costs
EBITDA
Amortization
Depreciation
EBIT
Interest
EBT
Taxes
Net income
3180
2703
477
0
150
327
123
204
82
123
3000
2550
450
0
120
330
91
239
96
143
Assets
Cash and cash equivalents
Accounts receivable
Inventories
Current assets
Net plant and equipment
Total assets
148
509
541
1'198
1'318
2'516
80
480
450
1'010
1'120
2'130
55
67
65
79
15.0%
10.3%
3.9%
2.45
15.0%
11.0%
4.8%
2.87
Liabilities and equity
Accounts payable
Notes payable
Accruals
Total current liabilities
Long-term bonds
Total debt
Common stock (50'000'000 shares)
Retained earnings
Total equity
Total liabilities and equity
159
127
130
416
812
1'228
250
1'037
1'287
2'516
180
150
90
420
490
910
250
970
1'220
2'130
Common dividends
Addition to retained earnings
EBITDA margin
EBIT margin
Net income margin
EPS
Share price
Book value per share
Numbers of shares (in m)
Autumn Term 2013
Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch
2011
2008
2010
2007
32
26
50
56
Case study: Garlic Incorporation II
Garlic Inc.
•
By analyzing its financial
statements, what are the
strengths and weaknesses of this
company?
•
Where do you see risks or
opportunities?
Statement of cash flow
(chf m)
Operating activities
Net income
Additions
Depreciation and amortization
Increase in accounts payable
Increase in accruals
Substractions
Increase in accounts receivable
Increase in inventories
Net cash provided by operating activities
Long-term investing activities
Cash used to acquire fixed assets
2011
2008
123
150
(21)
40
(29)
(91)
172
(348)
Financing activities
Increase in notes payable
Increase in bonds
Payments of dividends
Net cash provided by financing activities
(23)
322
(55)
244
Net increase in cash and equivalents
68
Cash and equivalents at beginning of the year
Cash and equivalents at end of the year
Autumn Term 2013
80
148
Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch
57
Case study: Solution guideline





Value Creation
Liquidity ratios
Asset management ratios
Debt ratios
Profitability ratios
Market value ratios
Profitability
Liquidity

Security/Risk
Try to assess whether the given company shows a healthy relation between profitability, liquidity and
risk

If a company shows high exposure to risky investments, one expects the profitability to be
accordingly

Try to come to a conclusion on which company is more likely to pursue an expansive strategy and
strengthen its position within the market

In terms of ability to generate cash flows, capital structure and working capital management
Autumn Term 2013
Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch
58
Case study: Solution guideline II


Try to compare the companies with each other and
put the results into perspective using the industry
average values on the right
Industry average figures can be seen as a guide


Ratios
Liquidity
Current ratio
4.2x
Quick ratio
2.2x
Asset Management
Why is the company less profitable than
Inventory turnover
average peer companies?
Days sales outstanding
Fixed assets turnover
Why does one company have such a high
Debt Management
P/E multiple and what does that mean for the
Total debt to total assets
Times interest earned
operating business?
Industry average
10.9x
36 days
2.8x
40.0%
6x
Profitability

Financial statements can never fully answer
Profit margin
5.0%
Return on total assets (ROA)
9.0%
Basic earning power
18.0%
such questions. However, they can raise the
Return on common equity (ROE)
15.0%
right questions
Market Value
Price / earnings (P/E)
Market / book (M/B)
11.3x
1.7x
Source: Brigham, Houston (2012), 118.
Autumn Term 2013
Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch
59
Contents





Learning targets
Pre-course reading
Lecture „Interpreting Financial Statements“
Pre-course reading case studies / questions
Solutions to case studies
Autumn Term 2013
Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch
60