Financial Analysis - Rationale

■ Who needs it?

– Investors, Suppliers, Customers, Others
■ Basis for Analysis
– Financial statements
– External information
■ Industry
■ Economy
■ Market
Financial Statements
■ The Four Financial Statements
■ Statement of Earnings (Income)
– Profit and Loss
■ Balance Sheet
– What is Owned & What is owed
– Assets - Liabilities - Preferred = Equity
■ Statement of Changes in Equity
■ Statement of Cash Flows
Statement of Cash Flows
■ Three Parts
– Operating/ Investing /Financing Activities
■ CFOA = Net Income + Adjustments +
Changes in NWC
■ What is a good cash flow number?
– CFOA
– CFIA
– CFFA
Analysis of Financial Statements
■ Ratios
– Liquidity
– Profitability
– Efficiency (Asset Utilization)
– Leverage
– Market Value
■ Common Size Statements
■ Growth Rates
Some Terms and Ratios
■ Net Operating profit
– EBIT(1-T)
■ EBIT adjusted for cash charges and taxes
■ Operating Income Return on Investment (OIROI)
– EBIT/Total Assets
■ EBITDA/SALES
■ Free Cash flow
– Net cash flow available to investors = EBIT(1-T) - Net
investment in Operating capital
■ Sustainable Growth Rate
– ROE (1-Payout)
MVA and EVA
■ Market Value Added
– MVA = Market value of equity - capital
supplied
■ EVA
– Cost of capital included
– EVA = (r – k) C
■r = OIROI
■ k = Total cost of capital
■ C = Invested capital
Comparative Analysis & Some
Issues
■ HistoricalComparison
■ Industry Benchmark
■ Peer Company Comparison
■ Quality of Earnings and Balance Sheet
■ FASB, SEC, Other standards
– REG FD
 Financial Planning
■ Financial Planning
– Ensure funds when needed
– Manage Sources of funds
– Part of overall planning process
– Analysis and feedback
■ Long-term, Short-term & medium-
term
Short-Term Forecasting and
Planning
■ PlanningRequires Forecasts
■ Main Forecasting/Planning Tools
– Cash Budget
■ Short-term

– Projected Financial Statements

■ Medium-term
 Cash Budget
■ Short-term forecast
– Forecasting, planning and management
of cash balances
– No business can do without it!
■ Forecast of cash flows, not earnings
– Receipts and Disbursements
Cash Budget - (Contd.)
■ Key Steps
– Forecasting Period
■ daily, weekly, monthly
– Forecasting Horizon
■1 year, 18 months
– Key Forecasting assumptions
■ Sales, Collections, Costs, Major outflows
 Cash Budget Format
■ Collection and Payments Worksheet
■ Receipts
■ Disbursements
■ Surplus/Deficit for the Period
■ Cash Balances
– Beginning, Ending, Target
■ Loan/Investment
Projected Financial statements
■ Direct Projections
■ Forecasts from Cash Budget
■ Key assumptions
– Sales, Costs, Key Ratios
– Variability of sales, ratios
■ Discretionary Funds Needed (DFN)
– Sources of financing
– Analysis and Feedback
DFN: Formula Approach
■ DFN = (A*/S0)∆S - (L*/S0)∆S - MS1(1 - d)
– A* = Assets increasing in proportion to sales
– L* = Liabilities increasing in proportion to
sales
– M = Net profit margin
– S0,S1 = Sales for last year, forecast year
– ∆S = (S1/S0) - 1
– d = Payout ratio
 Managing Growth
■ Sustainable growth rate
– g = ROE (1-d)/(1 - ROE (1-d))
■ Financial implications
■ Special case projections
■ Computerized planning models
Forecasting Financial Statements
- Check and Evaluation
■ HistoricComparisons
■ Key assumptions
– Sensitivity Analysis
– Scenarios: Good, Bad, and Indifferent
■ Other Factors
– Currency effect