SESSION OBJECTIVES
At the end of this session participants should be able to:
Understand the FIO model
Understand the process of value creation
Identify the drivers of value
Identify links between financial statements
The Process of Value Creation
Selecting and
sourcing prudent
funding options
Selecting and making
sound resource
commitments
Creating economic value
for the owners
Operating resources
in a competitive,
cost-effective manner
The Three Basic Business Decisions
Financing
Decisions
Investment
Decisions
The three basic decisions
made by management
Operating
Decisions
INCOME STATEMENT
ANALYSIS
THE INCOME STATEMENT
• IT IS OF PRIME IMPORTANCE TO CEO
• IT IS A PERIOD STATEMENT
• IT IS BASED ON THE ‘MATCHING’
PRINCIPLE
• STATEMENT OF VALUE CREATION
REVENUE - EXPENSES = INCOME
INCOME STATEMENT
CLASSIFICATIONS
SALES
REVENUE
PRICE
X
VOLUME
-
EXPENSES
=
INCOME
PRODUCT VS.
PERIOD COST
DIRECT VS.
INDIRECT COST
VARIABLE VS
FIXED COST
DIVIDENDS + RETAINED EARNINGS
INCOME STATEMENT
ITEMS
REVENUE
Price X Volume
- COST OF GOODS SOLD
Product Cost
Direct Expense
Fixed and Variable Expense
- SELLING,GENERAL, AND ADMINISTRATIVE
Period Cost, Indirect Expense, Fixed and Variable Cost
- INTEREST
Financing Cost
- TAXES
= NET INCOME
COMMON SIZED ANALYSIS
COMMON SIZE ANALYSIS CONVERTS EACH
ITEM ON THE INCOME STATEMENT INTO A
PERCENTAGE IN ORDER FOR ANALYSIS TO BE
PERFORMED ON A COMMON BASIS. EACH
ITEM IS EXPRESSED AS A PER CENT OF
REVENUES.
• PERCENT OF TOTAL
• APPLES AND APPLES
• IDENTIFY TRENDS
COMMON SIZED ANALYSIS
THE INCOME STATEMENT
REVENUES
FACSIMILIE CO.
For the Period Ending 12/31/XX
$ 7523
100%
- COST OF GOODS SOLD
4849
65
= GROSS MARGIN
2674
35
- S.G.& A.
1524
20
= OPERATING INCOME
1150
15
- INTEREST EXPENSE
160
2
= NET INCOME BEFORE TAX
990
13
- TAXES ON INCOME
336
5
= NET INCOME
594
8
PERCENT ANALYSIS
ALLOWS ONE TO TRACK CHANGES IN FINANCIAL
STATEMENTS FROM ONE REPORTING PERIOD TO THE NEXT
CALCULATE THE CHANGE IN AN ITEM, THEN,
DIVIDE THAT BY PREVIOUS YEARS TOTAL
EXAMPLE: PERCENT CHANGE = (THIS YEAR LAST YEAR) DIVIDED BY LAST YEAR
PERCENT CHANGE FOR COST OF GOODS:
(5625 - 4849) / 4849 = 16.0%
INCOME STATEMENT
RATIOS
RETURN ON SALES
Net Income / Total Sales
GROSS MARGIN
Gross Margin / Total Sales
S. G. & A. RATIO
S.G.&A. Expenses / Total Sales
INTEREST COVERAGE
Operating Income / Interest Expense
OPERATING MARGIN
Operating Income / Sales
NET MARGIN
Net Income / Sales
INCOME STATEMENTLINKS TO BALANCE SHEET
BALANCE SHEET
INCOME STATEMENT
ACCOUNTS RECEIVABLE
REVENUES
INVENTORY
- COST OF GOODS
- OTHER EXPENSES
RETAINED EARNINGS
=NET INCOME
LIMITATIONS OF INCOME
STATEMENT
• EXPENSES ARE NOT DETAILED
• DEPRECIATION AND COST OF GOODS ARE
UNDERSTATED IN INFLATIONARY PERIODS
• CAPITALIZATION VS. EXPENSING
• IGNORES THE COST OF EQUITY FINANCING
SUMMARY
• INCOME STATEMENT PROVIDES INFORMATION
 REVENUES
 EXPENSES
 NET INCOME
• YOU HAVE LEARNED HOW TO CALCULATE AND
ANALYZE THE INCOME STATEMENT USING:
 COMMON SIZE ANALYSIS
 PERCENT CHANGE ANALYSIS
• ANALYSIS DOES NOT SHOW UNDERLYING CAUSES
BALANCE SHEET
ANALYSIS
THE BALANCE SHEET
• IT IS A SNAP SHOT SHOWING WHAT THE
COMPANY OWNS AND OWES AT A POINT IN TIME
• HOW MUCH DID WE INVEST?
• HOW IS THE INVESTMENT FINANCED?
• WHAT ASSETS DO WE OWN?
 TANGIBLE/ INTANGIBLE
 SHORT TERM/ LONG TERM
• ASSETS = LIABILITIES + OWNERS’ EQUITY
• IT IS OF PRIME IMPORTANCE TO CFO
THE BALANCE SHEET
CASH
CURRENT
ASSETS
A/R
INVENTORY
OTHER
FIXED
ASSETS
CURRENT
LIABILITIES
NET P.&E.
OTHER
=
ACCTS.
PAYABLE
WAGES
PAYABLE
LONG TERM
LIABILITIES
OWNER’S
EQUITY
ACCRUALS
LONG TERM
DEBT
RETAINED
EARNINGS
INVESTMENT IN FIXED
ASSETS
 DEPRECIATION EXPENSE
 ACCUMULATED DEPRECIATION
 DEPRECIATION METHODS
 STRAIGHT LINE
 ACCELERATED
 BOOK VALUE
 ECONOMIC VALUE
INVESTMENT IN WORKING
CAPITAL
• WORKING CAPITAL = CURRENT ASSETS CURRENT LIABILITIES
• MEASURES THE NET INVESTMENT IN
OPERATING CASH CYCLE
• WORKING CAPITAL NECESSARY TO:
 PRODUCE PRODUCT
 MAINTAIN DAY-TO-DAY OPERATIONS
 MAKE SALES
CAPITAL
• DEBT + OWNER’S EQUITY = INVESTED CAPITAL
• ANY INVESTMENT EARNING RETURNS IS CAPITAL

DEBT: INTEREST

EQUITY: DIVIDENDS & STOCK PRICE
• BALANCE SHOWS HOW ASSETS WERE FINANCED
• LEVERAGE: PROPORTION OF CAPITAL FROM DEBT
INVESTMENT
CAPITAL FROM
INVESTMENT
SHORT TERM LOANS
LONG TERM DEBT
OWNER’S EQUITY
WORKING CAPITAL
=
+
FIXED ASSETS
THE RETURN TO THE PROVIDERS OF CAPITAL COMES
FROM THE EARNINGS FROM INVESTMENTS
THE BALANCE SHEET AND
MANAGEMENT ACTION
WORKING CAPITAL
LONG TERM LIABILITIES
CREDIT POLICY
DEBT POLICIES
PRODUCTION SCHEDULES
PENSIONS
PAYMENT POLICY
TAX DEFERMENT
FIXED ASSETS
OWNER’S EQUITY
EQUIPMENT PURCHASES
STOCK ISSUANCE
ACQUISITIONS
REPURCHASE
LONG TERM INVESTMENTS
DIVIDEND POLICY
BALANCE SHEET RATIOS
QUICK RATIO
Current Assets - Inventories
Current Liabilities
DEBT AS A PERCENT
OF CAPITALIZATION
DEBT TO EQUITY
FINANCIAL LEVERAGE
DAY’S SALES O/S
INVENTORY TURNOVER
Total Debt
Debt + Equity
Total Debt
Equity
Assets
Equity
Accounts Receivable
Average Daily Credit Sales
Cost of Goods Sold
Average Inventory
BALANCE SHEET- LINKS TO
THE INCOME STATEMENT
BALANCE SHEET
INCOME STATEMENT
ACCOUNTS RECEIVABLE
REVENUES
INVENTORY
- COST GOODS
- OTHER EXPENSES
RETAINED EARNINGS
= NET INCOME
LIMITATIONS OF THE
BALANCE SHEET
• HISTORICAL COST RESULTS IN UNDERVALUED
ASSETS SUCH AS REAL ESTATE
• SOME LIABILITIES NOT RECORDED (OFF BALANCE
SHEET FINANCING)
• INTANGIBLE ASSETS MIS-PRICED
• BALANCE SHEET LOOKS BACKWARD
SUMMARY
BALANCE SHEET PROVIDES KEY INFORMATION
•
SIZE OF ACCOUNT BALANCES
•
NEW INVESTMENTS
•
FINANCING OF NEW INVESTMENTS
FINANCIAL TOOLS AVAILABLE TO ANALYZE
BALANCE SHEET
•
PERCENT CHANGE
•
COMMON SIZE
•
RATIO ANALYSIS
CASH FLOW STATEMENT
WHY EXAMINE CASH FLOW?
A COMPANY IS A COLLECTION OF PROJECTS EACH
GENERATING CASH. CASH FLOW STATEMENTS
TOTAL THE SOURCES AND USES OF CASH FOR ALL
PROJECTS.
CASH FLOW STATEMENT ANALYSIS ALLOWS US TO
DETERMINE:
•
NEED FOR EXTERNAL FUNDING
•
ABILITY TO PAY CASH RETURN TO INVESTORS
•
RELATIONSHIP BETWEEN INVESTMENT AND
GENERATION OF CASH
•
IT IS OF PRIME IMPORTANCE TO COO
THE CASH FLOW CYCLE
FOUR STAGES
•
FINANCING
•
INVESTING
•
OPERATING
•
RETURNING
THE CASH CYCLEFINANCING
(OWNER’S )
(LENDERS)
EQUITY
LIABILITIES
CASH
THE CASH CYCLEINVESTING
CASH
FIXED ASSETS
LABOR, MATERIALS,
OVERHEAD,ETC.
INVENTORY
THE CASH CYCLEOPERATING
CASH
I.O.U.
ACCOUNTS
RECEIVABLE
SG&A
INVENTORY
REVENUE
THE CASH CYCLERETURNING
OWNERS
EQUITY
TAXES
CASH
LENDERS
LIABILITIES
THE CASH CYCLE
EQUITY
LIABILITIES
TAXES
ACCOUNTS
RECEIVABLE
CASH
FIXED
ASSETS
LAB, MTLS, ETC
INVENTORY
SG&A
REVENUE
THE CASH FLOW STATEMENT
RECONCILES THE
BEGINNING AND ENDING
CASH BALANCES
CATEGORIZES CASH FLOW
BY ACTIVITY
•
OPERATING
•
INVESTING
•
FINANCING
CASH FLOWS FROM
OPERATIONS
+
CASH FLOWS FROM
INVESTING
+
CASH FLOWS FROM
FINANCING
=
NET CHANGE IN
CASH