How to Use the Financial Plan
• Make it simple

Regroup all the inputs
• Sensibilities Studies
• Set of different Cases



Base Case
Best and Worst Cases (external influence)
Strategic Decisions (internal)
• Synthesis and Graphic Presentation
Vietnam Master in Management – HCMC dec 2003
Profitability
Input Data Improvement
• It is useful to bring all
the input data together

Easier to make
sensibilities studies
BPcons.xls - SENSIB!A182
Vietnam Master in Management – HCMC dec 2003
Profitability
Sensibilities studies
• Goals


To cover a broad scope of possible futures
To identify the business drivers
• Most important factors to determine the future

To measure the risks
• Usually a few major scenarios



Base Case (or Management Case)
Best and Worst Case
Influence of major capex decisions
Vietnam Master in Management – HCMC dec 2003
Profitability
Saigon Hotel Sensibilities
Unit rate
Occupancy
Capex new
rooms
Base
Dip in 03-04 Dip in 03-06
(60-65 US$) (50%-65%)
Best
Lower dip
(65-70 US$)
Reduced dip
(70%-75%)
Worst
Longer dip
(till 2005)
Longer dip
(till 2006)
Extension
As in Base
As in Base
4 MioUS$
Slower recov (2003-04)
Chain
Better than
Base
Better than
Base
Vietnam Master in Management – HCMC dec 2003
Capex chain
license
1 MioUS$
(2003)
Profitability
How to analyze sensibilities
studies
• Analyze most important indicators

Profit and loss
• Revenues
• EBITDA
• EAT

Balance Sheet
• Equity
• Debt

Ratios
• ROCE
• ROE
• Debt/equity ratio
• Use graphs
Vietnam Master in Management – HCMC dec 2003
Profitability
Saigon Hotel Revenues
REVENUES
4.000
3.500
3.000
2.500
2.000
1.500
1.000
500
0
2002
base
2005
2004
2003
best
worst
Vietnam Master in Management – HCMC dec 2003
2006
extension
2007
chain
Profitability
Saigon Hotel EBITDA
2.500
2.000
1.500
1.000
500
0
2002
base
2005
2004
2003
best
worst
Vietnam Master in Management – HCMC dec 2003
2006
extension
2007
chain
Profitability
Saigon Hotel EAT
800
600
400
200
0
-2002002
2005
2004
2003
2006
2007
-400
-600
-800
-1.000
-1.200
-1.400
base
best
worst
Vietnam Master in Management – HCMC dec 2003
extension
chain
Profitability
Saigon Hotel Cash Flow
CASH FLOW FROM OPERATIONS
2.500
2.000
1.500
1.000
500
0
2002
base
2005
2004
2003
best
worst
Vietnam Master in Management – HCMC dec 2003
2006
extension
2007
chain
Profitability
Saigon Hotel Equity
EQUITY
7.000
6.000
5.000
4.000
3.000
2.000
1.000
0
2002
base
2005
2004
2003
best
worst
Vietnam Master in Management – HCMC dec 2003
2006
extension
2007
chain
Profitability
Saigon Hotel Financial Debt
FINANCIAL DEBT
9.000
8.000
7.000
6.000
5.000
4.000
3.000
2.000
1.000
0
2002
base
2005
2004
2003
best
worst
Vietnam Master in Management – HCMC dec 2003
2006
extension
2007
chain
Profitability
Saigon Hotel : ROCE
ROCE
15%
10%
5%
0%
2002
2005
2004
2003
2006
2007
-5%
-10%
base
best
worst
Vietnam Master in Management – HCMC dec 2003
extension
chain
Profitability
Saigon Hotel ROE
ROE
15%
10%
5%
0%
2002
-5%
2003
2004
2005
2006
2007
-10%
-15%
-20%
-25%
-30%
-35%
base
best
worst
Vietnam Master in Management – HCMC dec 2003
extension
chain
Profitability
Financial analysis and leverage
• Necessity to have a quick vision of the financial situation
of a company


common language
comparability
• Profitability ratios

to measure the efficiency and the profitability
• Leverage ratios

to measure the indebtness
Vietnam Master in Management – HCMC dec 2003
Profitability
Financial analysis and leverage
• Coverage ratios

how are the debt and the interests covered by the cash-flow ?
• Liquidity ratios

how liquid is the company ?
• Distribution ratio

what does the company distribute to the shareholders ?
Vietnam Master in Management – HCMC dec 2003
Profitability
Necessity of the Financial
Analysis
• Who needs the financial analysis ?

the banker
• to assess a new loan or to maintain a credit line

the supplier
• to be sure to be paid by his customers

the customer
• to be sure that his supplier will stay in the business

the market (stock exchange)
• to assess companies
• to valuate companies
Vietnam Master in Management – HCMC dec 2003
Profitability
What is important for the
analysis ?
• To be able to compare ...

different companies
• with the same activity (hotels, airlines, etc.)
• with different activities

one company across the time
• . . . everyone must use the same indicators

necessity of a common language
• no discussion on the facts
• but discussion on the interpretation of the facts
Vietnam Master in Management – HCMC dec 2003
Profitability
What is important for the
analysis ?
• Limits to the comparability

differences in accounting rules and practices
• in different countries (laws, fiscal regulations, accounting rules)
• inside the countries (internal practices of the companies)
• depreciation period
• research & development
• brands

leads to a growing standardization of the rules
• BUT … the practices remain different
Vietnam Master in Management – HCMC dec 2003
Profitability
What is important for the
analysis ?
• Trust in the figures


published by the companies themselves
the Board of Directors is responsible
• Risks


“window dressing”
“cover-up”
• Remedies




external auditors
market authorities
stock price
complains by shareholders
• the “Swissair Case : Accounts of 2000”
• the “Enron Case”
Vietnam Master in Management – HCMC dec 2003
Profitability
The Swissair Case
Accounts 2000
• Underestimation of the losses of subsidiaries

Sabena, AOM-Air Liberté
• Underestimation of committed reinvestments

Sabena, AOM-Air Liberté, LTU
• Hidden commitments

put options given to other shareholders in joint-ventures
Vietnam Master in Management – HCMC dec 2003
Profitability
The Enron Case
• Underestimation of “off-balance” items

Additional investments committed
• False profits on asset sales

Assets were sold by Enron to Enron funded companies
• Over-estimation of turn-over / activities

Enron controlled only fees on turn-over and NOT turn-over
• Finally … destruction of documents and files


by the company …
… and its external auditors
Vietnam Master in Management – HCMC dec 2003
Profitability
Profitability Ratios : the ROE
• The key concept : Return on equity

ROE  Rfin  EAT/EQ
• Key concept for the shareholder

profitability of their investment in shares of this company
compared to alternate financial assets
 other shares
 fixed rates bonds (of companies or government)
• How to measure the equity ?



book-value or...
...market price
the difference can be huge for listed companies
Vietnam Master in Management – HCMC dec 2003
Profitability
Drivers of the ROE
• What are the drivers of the ROE ?
• The profit margin on Sales
• The productvity of capital employed

all the assets used by the company
 fixed assets
 working capital
 cash
• The financial structure of the company

level of debt vs. equity
Vietnam Master in Management – HCMC dec 2003
Profitability
Profitability Ratios : ROCE
• The Return On Capital Employed (ROCE) measures what
the company earns (before interest and tax) per unit of
capital employed




ROA  ROCE  EBIT/Assets
ROCE = EBIT/(FIX+WC+CASH)
in the practice the total Assets of the Balance Sheet are often
used
this ratio is not influenced by the financial structure of the
company
• because we use the EBIT

is also called Return On Investment (ROI) or Return On Assets
(ROA)
Vietnam Master in Management – HCMC dec 2003
Profitability
ROCE after taxes
• It can be useful to calculate the ROCE after taxes


ROCE* = ROCE.(1-Tc)
where Tc is the average tax rate
Vietnam Master in Management – HCMC dec 2003
Profitability
Relation between ROE and ROA
• If the company has no financial debt



ROE = ROCE* = ROCE.(1-Tc)
for the demonstration please see in a finance reference book
this is logical because in this case the total of assets is equal to
the equity and no interest is paid
• The higher the ROCE the higher the ROE
• The lower the tax rate the higher the ROE
Vietnam Master in Management – HCMC dec 2003
Profitability
Relation between ROE and ROA
• If the company has financial debt



ROE = ROCE.(1-Tc) + (ROCE-id).(1-Tc).Dfin/EQ
where id is the average rate of interest on the debt
for the demonstration see in the book
• The ROCE should be higher than the interest rate



if ROCE > id then ROE > ROCE*
if the ROCE is higher than the interest rate on the debt then the
ROE is higher than the ROA after taxes
if ROCE < id then ROE < ROCE*
Vietnam Master in Management – HCMC dec 2003
Profitability
Leverage Effect
• This equation is very important in finance

ROE = ROCE.(1-Tc) + (ROCE-id).(1-Tc).Dfin/EQ
• The higher the ROCE the higher the ROE
• The lower the tax rate the higher the ROE
• The higher the debt (Dfin) vs. equity (EQ) the higher the
ROE

if the ROCE is higher than the interest rate
• This is called the Leverage Effect
Vietnam Master in Management – HCMC dec 2003
Profitability
Leverage Effect
• It means that the ROE can be improved by increasing
the debt level

if and only if the ROCE is higher than the interest rate
• How far can the Equity be reduced and the financial
debt increased ?


the company must find a bank to bring the debt
the bank will look at the risks not to be repaid
- higher risks will be compensated by higher interest rates
- higher interest rates will reduce the Leverage effect
Vietnam Master in Management – HCMC dec 2003
Profitability
Risks of the Leverage Effect
• The company can be in a bad situation


if the interest rate increases
if the future Free Cash flows are lower than expected
• less business
• additional unexpected investments to do
• change in economic conditions
– tax rate
– exchange rate


if the shareholders want more dividends
if the bankers become nervous
Vietnam Master in Management – HCMC dec 2003
Profitability
Leverage effect : example
No debt
50% debt
75% debt
Assets
EBIT
Taxation rate
Interest rate
100 $
20 $
50%
10%
100 $
20 $
50%
10%
100
20 $
50%
10%
Equity
debt
100 $
0$
50 $
50 $
25 $
75 $
RES
ROA
ROE
10 $
20%
10%
Vietnam Master in Management – HCMC dec 2003
Profitability
Saigon Hotel – Leverage Effect
• Case 1 : Extension with initial capital structure

4 Mio US$ capex and 4 Mio US$ debt
• Case 2 : Extension with more equity

2 Mio US$ equity and 2 Mio US$ debt
• Case 3 : As Case 1 but continued adverse circumstances

Unit rate and occupancy
• Case 4 : As Case 2 but continued adverse circumstances
Vietnam Master in Management – HCMC dec 2003
Profitability
Saigon Hotel leverage : ROCE
10%
8%
6%
4%
2%
0%
2002
-2%
2003
2004
2005
2006
2007
-4%
-6%
-8%
-10%
base
extension
equity
Vietnam Master in Management – HCMC dec 2003
worst
equity worst
Profitability
Reference levels for
ROCE and ROE
• What is a sound level for the ROCE ?



higher than the interest rate
in the range 10%-18% in western economies
the level is a reference for expected profitability of new capital
expenditures
• What is a sound level for the ROE ?


in the range 12%-25%
depends on the risk of the business
• activity related risks (high tech vs. low tech)
• maturity of the business (start up vs. mature)
• financial structure (highly leveraged vs. standard)
Vietnam Master in Management – HCMC dec 2003
Profitability
Saigon Hotel leverage : ROE
15%
10%
5%
0%
2002
-5%
2003
2005
2004
2007
2006
-10%
-15%
-20%
-25%
-30%
-35%
extension
worst
Vietnam Master in Management – HCMC dec 2003
equity worst
Profitability
Saigon Hotel leverage : D/E ratio
3,0
2,5
2,0
1,5
1,0
0,5
0,0
2002
2003
extension
2004
2005
worst
Vietnam Master in Management – HCMC dec 2003
2006
2007
equity worst
Profitability
Leverage ratios
• The indebtness of a company can be measured by the
debt-equity ratio ()


debt-equity ratio    Dfin/EQ
be sure the leases are included in the debt
• Alternate : the debt ratio

debt ratio  Dfin/(Dfin+EQ)
• Some authors use only the medium and long term
financial debt (DMLT)

we prefer all the financial debts (possibility of switch between
DMLT and DSTfin)
Vietnam Master in Management – HCMC dec 2003
Profitability
Reference level for
the debt-equity ratio
• It must be sustainable for the company


payment of interests
reimbursement of the debt
• Consequently it will be different from company to
company depending on :


the projected Cash flows and Free Cash flows
the sensibility to outside factors
- general economic situation
- influence of new competitors
- etc.
Vietnam Master in Management – HCMC dec 2003
Profitability
Liquidity ratios
• These ratios measure how liquid is the company
• Current ratio


current ratio  currents assets / current liabilities
current ratio  (S+R+CASH) / (Dop+Dfin,short term)
• Acid test (Quick test)


this ratio reflects the fact that some current assets are less
liquid (inventories)
acid test  (R+CASH) / (Dop+Dfin,short term)
Vietnam Master in Management – HCMC dec 2003
Profitability
Reference levels for liquidity
ratios
• All these ratios depend on the industry
• Current ratio

if possible, higher than 1
• Acid test

if possible, higher than 0.7 / 0.8
Vietnam Master in Management – HCMC dec 2003
Profitability
Distribution ratio
• The pay-out ratio measures the share of the net result
distributed to the shareholders

pay-out  DIV / EAT
• Reference level



depends on the financial needs of the company
for listed companies : expectations of the markets
standard for mature companies : 40% to 60%
Vietnam Master in Management – HCMC dec 2003
Profitability
General remark on the
calculations of ratios
• For the P&L no doubt : use the year figures
• For the Balance Sheet which figures ?



at the end of the year ?
at the end of last year ?
another figure ?
• Correct calculation : daily average
• Use the average (end of the year/end of last year)

best estimate of the reality
• Be always coherent
Vietnam Master in Management – HCMC dec 2003
Profitability
Conclusions of the lesson
• The Sensibilities studies are useful



To look at the different possible futures
To identify the business drivers
To identify the risks
• The financial ratios are quick tools to analyze the
financial situation of companies
• By using the financial ratios one can compare


different companies
across the time
• Limits of the financial ratios


can we trust the Balance Sheet & Profit &Loss ?
reference levels depend of the industry
Vietnam Master in Management – HCMC dec 2003
Profitability