Welcome to Class 16
Research: Financial Domain &
Case Studies – Part 1
Chapter 8
Financial Domain of Corporate Performance
Assessment of corporate financial performance requires:
1. The integration of BOTH accounting and finance knowledge.
2. The ability to interpret Annual Report data.
It involves an investigation of changes in a firm’s:
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Revenue
Profitability
Cash flow
Liquidity
Asset utilization
Financial leverage
Operating leverage
Return on stockholder investment
Stock value, and more
Natural Limitations of Performance Assessment
 Performance is a matter of opinion
 Terminology is often inconsistent
Variations of Opinion
Variation of Opinion
Mathematical achievements by a firm can be interpreted
from different perspectives.
Thus, a 5% increase in revenue may be considered “good”
performance by one analyst
BUT
Insufficient, disappointing, and “bad.” by another analyst.
Each analyst may be comparing the firm’s achievements to a
different set of performance benchmarks. Or, they may be
assigning different value to individual performance components.
In other words, precise performance is a matter of “OPINION.”
Variations in Terminology
Technicate
A “terminologist” is one who studies, uses, or assigns words or
phrases to "technicate" terms in order to convey a
particular thought or idea.
Every profession has multiple terminologists.
The result is "terminological incongruity" which has many
negative effects.
It increases the probability of miscommunications and it is a
nemesis to students and others trying to enter a new
profession.
“Technicate” is an original word created to demonstrate what
terminologists do in creating or redefining words to
describe thoughts or ideas.
Communication is enhanced
when terminology used –
is defined and clarified.
Thus, we define how the following term
will be used for analysis purposes:
“INVESTED CAPITAL”
Invested Capital
For clarification purposes, in the context of this analysis
environment, Invested Capital will represent the
total of all funds contributed by both the creditors
and the shareholders.
Invested Capital
Invested Capital = Creditor Capital + Equity Capital
[IC] = [CC] + [EC]
or
Creditor Capital + Equity Capital = Invested Capital
[CC] + [EC] = [IC]
Accounting Equation
Assets = Liabilities + Equity
[A] = [L] + [E]
or
Liabilities + Equity = Assets
[L] + [E] = [A]
Think about it…
Creditor
Capital
Equity
Capital
Liabilities
Invested
Capital
Invested
Capital
Equity
Assets
Assets
A closer look at
Assets, Liabilities, & Equity
Assets, Liabilities, & Equity
The broad categories of assets, liabilities, and equity are
divided into segments to enhance the understanding of crucial
balance sheet relationships.
For example:
Assets are divided into those that are "current" and “noncurrent."
Liabilities are separated in a similar fashion.
Equity is divided into "paid in" and "earned."
Invested capital, is divided into "borrowed" and "equity."
Businesses engaged in financial services or related activities as their
primary source of revenue generally do not divide their
assets and liabilities into current and noncurrent.
These organizations include S & Ls, banks, investment houses, etc.
Assets:
(1) Current Assets (assist with required payments)
(2) Noncurrent Assets (enable the firm to conduct its business)
[facilities, equipment, property, long-term investments, intangibles, etc.]
Liabilities (Borrowed Capital):
(1) Current Liabilities or near-term debt (due within 1 yr. or the operating cycle)
(2) Long-term debt (all the other debt)
Shareholder Equity (Equity Capital):
(1) Earned Capital (accumulated earnings that have been retained in the business)
(2) Paid-in Capital (money paid by stockholders to purchase stock)
Invested Capital:
(1) Borrowed Capital (credit extended by suppliers,
(2) Equity Capital (investments by stockholders)
banks, and note and bondholders, etc.)
Understanding the relationship between the
different classes of accounts is fundamentally
important to financial analyses.
These are highlighted in the Financial Position Model
Financial Position Model
Important relationship between CA & CL
Assets
Claims on Assets
Current Assets
Current Liabilities
Stockholder Equity
Help pay bills
Are Debts generally
due within the next year
(1) Paid-in
(2) Earnings
Noncurrent Assets
Long-term Debt
Items such as buildings & equipment
that support business operations
(Also, long-term investments, etc.)
Provides operating capital for the
purchase of Noncurrent Assets and
provides some assistance with current liquidity
Important relationship
A thorough understanding of the
Financial Position Model
is crucial to
Financial Decision-Making
The Financial decision-making domain
includes:
1. Internal Financing Decisions
2. Asset/Debt Decisions
3. Debt/Equity Decisions
Internal
Financing
Financing
Decisions
Debt/Equity
Asset/Debt
1. Internal Financing Decisions:
Tactical and Strategic
Internal financing decisions fall into two main categories:
(1) Short-term focus
Tactical financing decisions
(2) Long-term focus
Strategic financing decisions
Internal Financing Decisions: TACTICAL
(1) Tactical financing decisions center on maximizing internal
funding by suggesting operating changes.
For example, directing staff to consider
► SPEEDING the turnover of accounts receivable (ACP)
► Using JIT (just-in-time) inventory techniques
Objective: Improve performance by improving current system
Internal Financing Decisions: STRATEGIC
(2) Strategic financing decisions center on completely changing
the way of specific functions within the firm are conducted
for improved efficiency and enhanced cash flow
Significant changes in corporate operations, such as:
► OUTSOURCING customer service, or
► SUBCONTRACTING major manufacturing (e.g. NIKE)
Objective: Improve performance by completely changing system
2. Asset and Debt Management Decisions
Asset and Debt decisions include consideration of how to
maximize utilization of high-ticket assets such as
property, facilities, equipment, intangibles, etc.
These decisions are also directed at maintaining an optimum
balance between:
1. current assets and current liabilities
2. current and noncurrent debt
3. current and noncurrent assets
Capital budgeting: Decisions about whether to buy or sell
property, plant, & equipment are part of this domain
3. Debt/Equity Decisions
Debt and Equity decisions are primarily concerned with:
1. The use and extent of long-term financing
2. The optimum level and configuration of equity
3. The appropriate balance between total debt and
total equity.
Decision-making in this domain involves considering issues
such as:
1. How much money is needed to sustain growth
2. How should the company acquire those funds
(For example, should the corporation issue bonds, issue common
stock, issue preferred stock, or borrow from other sources?)
Important Financial questions:
 How much short-term cash is necessary and what is the best
strategy to ensure that cash is available when necessary?
 What is the best long-term strategy for investment in this
company?
 What is the optimum financial leverage?
 What are the most appropriate sources of cash in-flow?
 What is the optimum relationship between equity and debt
financing?
Special note on Proxy Statements….
THEY ARE VERY IMPORTANT!!!
They include:
1. Invitation to the annual meeting
2. Legal rights and administrative details available to the
shareholders
3. Biographies of all directors (most with pictures)
4. Board committees & board compensation
5. Executive compensation
6. Shareholder proposals
7. Information on salaries and bonuses
8. Information on stock options and other significant
declarations by the TMT
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End, Research: Financial Domain &
Case Studies – Part 1
Re-read Chapters 8