Finance 101

Interactive Presentation, please ask questions
at any time
 Discuss
types of Financial Statements
Types of Financial Statements
A business’ financial performance is measured
using three related financial statements:
• Balance Sheet
• Income Statement
• Statement of Cash Flow
We will discuss all three!
Balance Sheet
Balance Sheet

The balance sheet (also called the Statement of Financial
Position) reports the assets, liabilities, and equity of a business
at a given point in time.
• Assets = The things of value that a company owns.
• Liabilities (Creditors) + Stockholders’ Equity (Owners/Shareholders) =
Claims against an entity’s assets.
Assets = Liabilities + Stockholders’ Equity
Balance Sheet Format

Assets
Current assets
Cash
Marketable securities
Accounts and notes receivable
Inventories
Prepaid expenses
Assets
Property, plant & equipment
Less: accumulated depreciation
Other assets
Total assets

Liabilities
Current liabilities
Accounts payable
Short term borrowing
Income taxes payable
Other accrued current liabilities
Liabilities
Long term borrowing
Deferred taxes
Other liabilities
Total liabilities

Stockholders’ equity
Preferred stock
Common stock
Additional paid in capital
Retained earnings
Total stockholders’ equity
Stockholders’
Equity
Balance Sheet - Definitions
Assets
- Resources owned or controlled by the company.
They include
monetary assets (cash, marketable securities and receivables) and
non-monetary assets (inventories, prepaid expenses and equipment).
Current Assets - Cash plus those assets which are expected to be
converted to cash or consumed during the coming year.
Liabilities - Outsider claims against company resources.
Examples include accounts payable and bank loans.
Current liabilities - Liabilities that mature within the coming fiscal year.
Net Working capital - current assets less current liabilities.
Stockholders’ equity - The contributed capital plus any other
increments in capital from profitable operations.
Retained earnings - Net earnings that remain in the business (as part
of stockholders’ equity) after the payment of dividends
Working Capital Example
WORKING CAPITAL = ACCOUNTS RECEIVABLE + INVENTORIES ACCOUNTS PAYABLE
2009
2010
Delta
Accounts Receivable
$200,000
$150,000 -$50,000
Positive
Inventories
$100,000
$80,000
-$20,000
Positive
Accounts Payable
$100,000
$80,000
-$20,000
Negative
Working Capital
$200,000
$150,000 -$50,000
Positive
Operating Performance Ratios
Performance ratios help put our financial data into perspective
Use performance ratios to:
• review for trends
• compare to competitors, industry benchmarks and business unit objectives
Assets
Liabilities

Days payable outstanding (DPO)
 Inventory Days Supply (IDS)

Liquidity ratios
 Working Capital Turnover

Debt ratio

Days Sales Outstanding (DSO)
 Permanent Investment Turnover
 Return on Net Assets
Equity

Return on Equity
Balance Sheet Strength
What does this mean?

Means a company generates enough cash to service its
debt, fund operations, pay a dividend to shareholders and
invest for the future.

Gives a company staying power to weather difficult
economic cycles.
Income Statement
Income Statement
Revenues (Sales and other income) - The amounts invoiced
to outside customers for the sale of products or services less
returns, allowances and discounts; and non-sales income such as
royalties, gain/loss on asset sales, interest income
Expenses - An outflow or other using up of assets -- or incurring
of liabilities -- from the rendering of goods or services
Variable Costs - A cost which is constant per unit, but which varies in total
directly and proportionately with production or sales volume.
Fixed Costs - A cost which does not vary significantly with changes in volume
within a relevant time period (one year) and range of activity.
Accrual Accounting
Revenues and expenses are recorded in the period in which they are
earned and incurred, whether or not such transactions have been finally
settled by the receipt or payment of cash or its equivalent .
Two Ways to Account For It:
What is Revenue?
What is Expense?
(1) Cash System
Checks Received
Checks Written
(2) Accrual System
Revenue is recorded
when it is earned
Cost of raw materials is expensed
when product is sold, not when
materials are purchased
Cost of buildings and equipment is
expensed over time as facilities are
utilized (depreciated), not when
initially paid for
Other expenses recorded when the
liability is incurred
Financial Metrics
Sales Growth Rate
Variable Contribution Margin = (Sales revenue less variable
costs) / Sales Revenue
• Must be sufficient to cover fixed costs plus provide a profit
ATOI Margin Percent = ATOI / Sales
Cash Flow
Why Cash Flow?
 Cash
is a strategic resource used to pay company
obligations and a return to shareholders:
• Purchases
• Salaries
• Taxes
• Dividends
 Earnings
is one element of cash flow, but it
includes depreciation which is a non-cash charge
 Cash
may come in or go out for reasons not
reflected on the income statement
Cash Flow– Our “Bank Account”

We begin with earnings

We “add-back” the non-cash cost of depreciation

We account for changes in working capital - we can either
use cash to increase working capital or recover cash by
decreasing working capital. Therefore it is the working
capital changes that impact cash flow

We account for cash spent on new permanent investment:
capital expenditures

We account for cash required for financing costs: corporate
dividends and interest
What Cash Flow Tells Us
 Cash
flow could be either positive or negative,
depending on the mission of the business.
 Cash
flow information tells us how much financing
is required to ensure operations can continue.
 Positive
cash flow indicates that funds may be
available for future investment.
Cash Flow And The Product Life Cycle
 Growth
businesses
• Negative cash flow due to high capital expenditures
 Mature
• Positive cash flow – earnings plus depreciation exceed
capital expenditures
 Declining
• Positive to negative cash flow – earnings are not growing
and capital expenditures are small - is it sustainable?
Sample Cash Flow Statement
ATOI
Depreciation & Amortization
Working Capital (Increase) Decrease
CASH FLOW FROM OPERATIONS
Capital Expenditures
FREE CASH FLOW
Investment Analysis Concepts
Investment Analysis Terms
Net Present Value (NPV) - The difference between the present value of
cash inflows and the present value of cash outflows. NPV is used to
analyze the profitability of an investment or project.
Discounted cash flow (DCF) analysis – Used to evaluate investment
opportunities by projecting free cash flow and then discounting (using
cost of capital) to arrive at a present value.
Terminal Value (TV) - used to determine the value of a project for all the
years beyond the reliable discount cash flow projections..
IRR (Internal Rate of Return) - The discount rate used in evaluating
investment opportunities which makes the net present value of all
cash flows from a particular project equal to zero.
CAGR – Compounded Annual Growth Rate
Cost of Capital (COC)
•
Weighted average cost of financing from all sources debt (outside borrowing) and equity (shareholders)
•
Example
Equity 13.5% x 85% =
Debt
4.5% x 15% =
COC (Wt. Avg.) =
•
11.475%
.675%
12.150%
Discounting at the COC allows us to compare the
value of future cash flows
Decision Making Metrics
Net Present Value - the difference between
discounted cash inflows & outflows
 Highlights
-
• Considers time value
• Analyzes investment’s entire life
• Reflects shareholder value added
• Impacted by size of investment
Decision Making Metrics
Discounted Payback Period - time it takes to recoup an
investment’s cost - using discounted cash flow
Highlights Easy to compute - discounted flows
Understandable
Measure of time funds are at risk
Does not consider benefits past the payback period
Decision Making Metrics
Internal Rate of Return - The “true” return of an investment the DR where NPV = Zero

Represents the percentage yield of an investment

The discount rate which equates the present value of cash inflows
with the present value of outflows ~ NPV = zero

The after-tax interest rate an investor could pay for funds and
breakeven

Allows comparison without bias of size

Does not account for risk

Biased towards investment with quick payback

Doesn’t account for $$ size
Decision Making Metrics
Profitability Index (PI) - a ratio of discounted cash inflows
and outflows.
PI = DCI/DCO
where: DCI = the sum of the disc. cash inflows
DCO = the sum of the disc. cash outflows
Values of PI are positive!
PI > 1, then investment’s return > COC
PI < 1, then investment’s return < COC
PI = 1, then investment’s return = COC
• Productivity measure
• More reliable than IRR
• Good tool for ranking projects
Determining Cash Flows for NPV
Inflows
Outflows

Sales revenue

COGP

Decrease in working
capital

Marketing and
distribution expense

…

R&D expense

General admin expense

Capital

Increase in working
capital

…
FINANCIAL VALUATION
Marketing Project
(000's)
2009
NPV
855
T.V. % of NPV 51.3%
2010
2011
2012
2013
2014
2015
2016
2017
2018
-
100
105
110
116
139
167
200
240
288
Selling Prices ($/kg)
Sales Revenue
$ -
$4.00
400
$4.00
420
$4.00
441
$4.20
486
$4.20
583
$4.20
700
$4.20
840
$4.20
1,008
$4.20
1,210
COGS
COGP($/kg)
COGP
COGS
$ -
$2.00
200
200
$2.00
210
210
$2.00
221
221
$2.18
253
253
$2.18
303
303
$2.18
364
364
$2.18
437
437
$2.18
524
524
$2.18
629
629
Sales
Volume (MT)
Gross Profit
% of Sales
200
50%
210
50%
350
200
100
PTOI
Income Taxes
ATOI
% of Sales
(350)
(133)
(217)
-
Cash Inflow
(217)
SG&A
-
0%
110
42
68
16%
221
50%
50
233
48%
50
280
48%
50
336
48%
50
403
48%
50
484
48%
50
Term. Value
581
48%
50
171
65
106
24%
183
70
114
23%
230
87
143
24%
286
109
177
25%
353
134
219
26%
434
165
269
27%
531
202
329
27%
1,371
-
68
106
114
143
177
219
269
329
1,371
72
4
4
9
18
21
26
31
37
72
4
4
9
18
21
26
31
37
153
125
79
4
156
89
92
194
98
190
238
108
298
292
118
416
1,218
439
855
Cash Outflow
Change in Working Capital
Cash Outflow
Net Cash Flow
DCF
Cumulative DCF
(217)
(217)
(217)
(72)
(72)
(289)
65
58
(232)
102
81
(150)
105
75
(76)
FINANCIAL VALUATION
Capital Project
(000's)
Revenue
NPV
T.V. % of NPV
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
Terminal
Year 1
Year 2
Year 3
Year 4
Year 5
Year 6
Year 7
Year 8
Year 9
Year 10
Value
100.0
Growth Rate
COGP
80.0
Depreciation
Gross Profit
119
83%
150.0
200.0
220.0
300.0
350.0
350.0
50.0%
33.3%
10.0%
36.4%
16.7%
105.0
140.0
158.4
216.0
252.0
252.0
288.0
306.0
306.0
10.0
10.0
10.0
10.0
14.0
14.0
16.0
17.0
17.0
0.0%
400.0
14.3%
425.0
6.3%
425.0
0.0%
20.0
35.0
50.0
51.6
74.0
84.0
84.0
96.0
102.0
102.0
20.0%
23.3%
25.0%
23.5%
24.7%
24.0%
24.0%
24.0%
24.0%
24.0%
SG&A
10.0
10.0
10.0
10.0
10.0
10.0
10.0
10.0
10.0
10.0
EBIT
10.0
25.0
40.0
41.6
64.0
74.0
74.0
86.0
92.0
92.0
Gross Margin %
ATOI (After-Tax Earnings)
6.2
15.5
24.8
25.8
39.7
45.9
45.9
53.3
57.0
57.0
6.2%
10.3%
12.4%
11.7%
13.2%
13.1%
13.1%
13.3%
13.4%
13.4%
Depreciation
-
10.0
10.0
10.0
10.0
14.0
14.0
16.0
17.0
17.0
Cash Inflow
6.2
25.5
34.8
35.8
49.7
59.9
59.9
69.3
74.0
74.0
-
-
-
-
-
-
-
-
-
-
7.5
8.1
3.5
13.0
8.1
-
8.1
4.1
-
Cash Outflow
200.0
7.5
8.1
3.5
13.0
8.1
-
8.1
4.1
-
Net Cash Flow
(193.8)
18.0
26.7
32.3
36.7
51.7
59.9
61.2
70.0
74.0
DCF
(193.8)
16.0
21.3
23.0
23.3
29.4
27.1
24.7
25.2
23.8
99.3
Cumulative DCF
(193.8)
(177.8)
(156.5)
(133.5)
(110.2)
(80.8)
(53.7)
(29.0)
(3.8)
20.1
119.4
% of Sales
Capital Expenditures
Change in Working Capital
200.0
308.5
What Applications Can You See for
These Discounted Metrics?
 Construction/equipment
projects
 Acquisitions (max purchase price)
 Divestitures (min selling price)
 Business strategy analysis
•
•
•
•
•
Advertising spending
Prioritizing R&D projects
New markets
Developing sales contracts
Lease vs buy
Project Sensitivity Analysis
Value
0
100
200
300
400
500
Base % Swing
Value Explained
Price annual growth rate
0.01
Capital Sensitivities - Project
Year 1 Market Size - Sensitivity
COGP - Project
COGS annual growth rate
Market Growth Rates - Sensitivity
0.04
–0.3
0
11.0
–0.25
0.25
0
10.8
1.089
1.21
7.5
0.02
0.03
5.5
0
4.6
4.7
4.0
0.05
0.07
1.6
0.02
0.03
0.8
0.02
0.03
0.6
4.7
3.76
0.2
0.5
0.1
1.452
0.04
–0.5
0.2
4.5
Selling Expense
0.1
5
Capital Maintenance, Parts and Upgrades
0.04
R&D Expense
0.05
Competitive Effect - Growth Rate Reduction
53.4
0.3
MLA Price/kg
Price/kg
0.03
3.525
0.8 0.3
Base Value: 293MM
• Shows that >75% of the variability is associated with the top three sensitivities
• Shows targets for further analysis
Determining Cash Flows for NPV
A Project example using a discounted cash flow analysis and specific assumptions
(e.g. 12% cost of capital)
Revenue ($ in 000)
Gross Profit ($ in 000)
Gross Profit as % of Revenue
Operating Profit ($ in 000)
Operating Profit as % of Revenue
Operating Cash Flow ($ in 000)
Net Cash Flow ($ in 000)
NPV
NPV with Terminal
IRR
Discounted Payback
Profitability Index
R&D Spend ($ in 000)
Capital Spend ($ in 000)
Pre-Launch
Year
1
$ 189,945 $
$
$
$
$
$ 125,431
$ 192,873
127.9%
4.00
3.18
$
1,700 $
$ 16,929 $
Pre-Launch
Year
2
$
7,035
$
0.0%
$
0.0%
0.0%
(320) $
(326)
(3,706) $
(3,712)
500.0
3,385.8
$
$
500.0
3,385.8
Launch
Year
3
$
12,060
$
39,828
66.0%
$
37,028
61.4%
$
23,352
$
7,316
$
500.0
$ 10,157.4
Post-Launch
Year
4
$
18,090
$
60,276
66.6%
$
58,464
64.6%
$
37,870
$
29,076
$
$
Post-Launch
Year
5
$
18,090
$
60,276
66.6%
$
58,464
64.6%
$
37,870
$
29,076
-
Based on a ten year time horizon post launch
$
$
-