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1 (of 22) FIN 468: Intermediate Corporate Finance Topic 2–Financial Statements Larry Schrenk, Instructor.

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Presentation on theme: "1 (of 22) FIN 468: Intermediate Corporate Finance Topic 2–Financial Statements Larry Schrenk, Instructor."— Presentation transcript:

1 1 (of 22) FIN 468: Intermediate Corporate Finance Topic 2–Financial Statements Larry Schrenk, Instructor

2 2 (of 22) Topics The Statements Ratio Analysis and Types of Ratios DuPont Equation Forecasting Pro Forma Statements

3 The Statements 3 (of 22)

4 Stock versus Flow 1. Income StatementFlow 2. Balance SheetStock 3. Statement of Cash Flows Flow 4 (of 22)

5 Assets (LHS) Firm Value Organized by ‘Receivable’ Liquidity Allocation of Firm’s Investable Funds Assets Portfolio Liabilities (RHS) Claims on Firm Value Organized by ‘Payable’ Liquidity Allocation of Return and Risk to Investors Claims Portfolio Balance Sheet Organization

6 Sales – Variable Costs Gross Costs – Fixed Costs EBIT – Interest EBT – Taxes Net Income – Dividends Additions to Retained Earnings Earnings…▪ From Unit Production From Total Production After Financing Included After Taxes Included Retained by the Firm ▪ Income Statement Organization

7 Ratio Analysis and Types of Ratios 7 (of 22)

8 1. Consider the Perspective 2. Toolbox Approach 3. Check Annualization 4. Beware of Anomalies 5. Ratios as Red Flags 6. Use Customized Ratios 7. No Official Rules Principles

9 1. Short-Term Solvency (Liquidity) 2. Long-Term Solvency (Leverage) 3. Efficiency 4. Profitability 5. Market Value Classification

10 Comparisons  Time-Trend Analysis Firm’s Performance over Time  Peer Group Analysis Similar Companies or Industry Analysis Use

11 Form Purpose  Short-Term Liquidity  Can the Firm Meet Current Obligations? Examples  Cash Ratio, Current Ratio, Quick Ratio Short-Term Solvency

12 Form Purpose  Long-Term Liquidity  Can the Firm Remain Solvent? Examples  Total Debt Ratio, Debt/Equity Ratio Long-Term Solvency: Degree of Leverage Analysis

13 Form Purpose  Firm Service its Long-Term Obligations?  Is Bankruptcy a Concern? Examples  Times Interest Earned (TIE), Cash Coverage Long-Term Solvency: Coverage Analysis

14 Form Purpose  How Efficiently does the Firm Use the Value Invested in each Asset? Balance Sheet Assets as Portfolio Liquidity-Return Trade-Off Examples  Turnover Analysis Efficiency: Analysis

15 Form Purpose  Is the Firm Generating Reasonable Earnings Relative to Total Assets or Equity  NOTE: Accounting Measures Examples  Return on Assets (ROA), Return on Equity (ROE) Profitability: Analysis

16 No Common Form or Purpose Use of Market Data Examples  PE Ratio, Market-to-Book Ratio Market Value: Analysis

17 No Underlying Theory Diversified Firms Globalization Varying Accounting Procedures Different Fiscal Years Some Cautions

18 DuPont Equation 18 (of 22)

19 Decomposition Analysis, Not Calculation DuPont Equations: Analysis

20 The DuPont Equation

21 Extending the DuPont Equation

22 Forecasting Pro Forma Statements 22 (of 22)

23 Percent of Sales Approach Some items vary directly (at least approximately) with sales. ‘Driver’

24 Percent of Sales Approach Some items may not vary with sales  Items whose value cannot be easily changed  Items whose value is determined by other variables, and  Items under the policy control of the firm: Financing policy: long-term debt and equity Payout policy: dividends

25 Income Statement Costs may vary directly with sales. Why? Depreciation and interest expense may not vary directly with sales. Why? Dividends generally do not vary directly with sales. Why?

26 Balance Sheet–Assets Generally current assets vary directly with sales. Why? Generally long-term assets do not vary directly with sales. Why?

27 Balance Sheet–Liabilities Many current liabilities vary directly with sales. Why? But notes payable do not vary with sales. Why? Long term debt does not vary with sales. Why?

28 Balance Sheet–Equity How does retained earnings change? Changes on equity (and all the various sub-groups)do not vary with sales. Why?

29 External Financing Needed (EFN) After applying the percentage of sales method, the balance sheet will most likely not balance. External Financing/Funds Needed (EFN)  difference between forecasted increase in assets and the forecasted increase in liabilities and equity.

30 External Financing Needed (EFN) EFN is the new capital that must be raised.  This is often called the ‘plug’  EFN can be negative. Financing policy determines the type of instruments to be used, i.e., whether new funds are raised through debt, equity or some combination of the two.

31 Pro Forma Example Exogenous Parameters  Annual Sales Increase: 10%  Firm Policies: Payout ratio: 75% Financing: EFN will be raised through equity.

32 Pro Forma Example Color Codes  Red Numbers are those which change with sales, e.g., accounts receivable.  Blue numbers are those that do not change with sales, e.g., fixed assets.  Purple numbers are those whose value is determined by firm policies, e.g., dividends.  Black numbers are values which are entirely a function of other variables, e.g. retained earnings.

33 Income Statement 2006pro forma Sales$2,311 COGS$1,644 Depreciation $276 EBIT $391 Interest Paid $141 EBT $250 Taxes $85 Net Income $165 Dividends $121 Addition to Ret. Earn.$44 Pro Forma Income Statement

34 Income Statement 2006pro forma Sales$2,311 COGS$1,644 Depreciation $276 EBIT $391 Interest Paid $141 EBT $250 Taxes $85 Net Income $165 Dividends $121 Addition to Ret. Earn.$44 Pro Forma Income Statement Changes with Sales No Change Pre-Determined Follows Policy

35 Income Statement 2006pro forma Sales$2,311$2,542 Increases by 10% COGS$1,644 Depreciation $276 EBIT $391 Interest Paid $141 EBT $250 Taxes $85 Net Income $165 Dividends $121 Addition to Ret. Earn.$44 Pro Forma Income Statement

36 Income Statement 2006pro forma Sales$2,311$2,542 COGS$1,644$1,808 Increases with Sales Depreciation $276 EBIT $391 Interest Paid $141 EBT $250 Taxes $85 Net Income $165 Dividends $121 Addition to Ret. Earn.$44 Pro Forma Income Statement

37 Income Statement 2006pro forma Sales$2,311$2,542 COGS$1,644$1,808 Depreciation $276 $276 No Change: No Capital Invest. EBIT $391 Interest Paid $141 EBT $250 Taxes $85 Net Income $165 Dividends $121 Addition to Ret. Earn.$44 Pro Forma Income Statement

38 Income Statement 2006pro forma Sales$2,311$2,542 COGS$1,644$1,808 Depreciation $276 $276 EBIT $391 $458 Interest Paid $141 $141 No Change (Debt Not Changed) EBT $250 Taxes $85 Net Income $165 Dividends $121 Addition to Ret. Earn.$44 Pro Forma Income Statement

39 Income Statement 2006pro forma Sales$2,311$2,542 COGS$1,644$1,808 Depreciation $276 $276 EBIT $391 $458 Interest Paid $141 $141 EBT $250 $317 Taxes $85 $108 Tax Rate is 34% Net Income $165 Dividends $121 Addition to Ret. Earn.$44 Pro Forma Income Statement

40 Income Statement 2006pro forma Sales$2,311$2,542 COGS$1,644$1,808 Depreciation $276 $276 EBIT $391 $458 Interest Paid $141 $141 EBT $250 $317 Taxes $85 $108 Net Income $165 $209 Dividends $121$157 Dividends are 75% of Net Income Addition to Ret. Earn.$44 Pro Forma Income Statement

41 Income Statement 2006pro forma Sales$2,311$2,542 COGS$1,644$1,808 Depreciation $276 $276 EBIT $391 $458 Interest Paid $141 $141 EBT $250 $317 Taxes $85 $108 Net Income $165 $209 Dividends $121$157 Addition to Ret. Earn.$44$52 Add to Retained Earning Pro Forma Income Statement

42 Pro Forma Balance Sheet Balance Sheet 2006pro forma Assets Current Assets Cash $298 Accounts Receivable $688 Inventory $922 Total $1,908 Fixed Assets Net Plant & Equip. $1,080 Goodwill $600 Total Fixed Asst $1,680 Total Assets $3, pro forma Liabilities and Owner's Equity Current Liabilities Accounts Payable $344 Notes Payable $196 Total $540 Long-Term Debt $457 Owner's Equity CS and Surplus $550 Retained Earnings$2,041 Total $2,591 Total Liabilities/Equity$3,588

43 Pro Forma Balance Sheet Balance Sheet 2006pro forma Assets Current Assets Cash $298 $328 Accounts Receivable $688 Inventory $922 Total $1,908 Fixed Assets Net Plant & Equip. $1,080 Goodwill $600 Total Fixed Asst $1,680 Total Assets $3, pro forma Liabilities and Owner's Equity Current Liabilities Accounts Payable $344 Notes Payable $196 Total $540 Long-Term Debt $457 Owner's Equity CS and Surplus $550 Retained Earnings$2,041 Total $2,591 Total Liabilities/Equity$3,588 Increases with Sales

44 Pro Forma Balance Sheet Balance Sheet 2006pro forma Assets Current Assets Cash $298 $328 Accounts Receivable $688 $757 Inventory $922 Total $1,908 Fixed Assets Net Plant & Equip. $1,080 Goodwill $600 Total Fixed Asst $1,680 Total Assets $3, pro forma Liabilities and Owner's Equity Current Liabilities Accounts Payable $344 Notes Payable $196 Total $540 Long-Term Debt $457 Owner's Equity CS and Surplus $550 Retained Earnings$2,041 Total $2,591 Total Liabilities/Equity$3,588 Increases with Sales

45 Pro Forma Balance Sheet Balance Sheet 2006pro forma Assets Current Assets Cash $298 $328 Accounts Receivable $688 $757 Inventory $922$1,014 Total $1,908 Fixed Assets Net Plant & Equip. $1,080 Goodwill $600 Total Fixed Asst $1,680 Total Assets $3, pro forma Liabilities and Owner's Equity Current Liabilities Accounts Payable $344 Notes Payable $196 Total $540 Long-Term Debt $457 Owner's Equity CS and Surplus $550 Retained Earnings$2,041 Total $2,591 Total Liabilities/Equity$3,588 Increases with Sales

46 Pro Forma Balance Sheet Balance Sheet 2006pro forma Assets Current Assets Cash $298 $328 Accounts Receivable $688 $757 Inventory $922$1,014 Total $1,908$2,099 Fixed Assets Net Plant & Equip. $1,080$1,080 Goodwill $600 Total Fixed Asst $1,680 Total Assets $3, pro forma Liabilities and Owner's Equity Current Liabilities Accounts Payable $344 Notes Payable $196 Total $540 Long-Term Debt $457 Owner's Equity CS and Surplus $550 Retained Earnings$2,041 Total $2,591 Total Liabilities/Equity$3,588 No Change (Fixed Assets)

47 Pro Forma Balance Sheet Balance Sheet 2006pro forma Assets Current Assets Cash $298 $328 Accounts Receivable $688 $757 Inventory $922$1,014 Total $1,908$2,099 Fixed Assets Net Plant & Equip. $1,080$1,080 Goodwill $600 $600 Total Fixed Asst $1,680 Total Assets $3, pro forma Liabilities and Owner's Equity Current Liabilities Accounts Payable $344 Notes Payable $196 Total $540 Long-Term Debt $457 Owner's Equity CS and Surplus $550 Retained Earnings$2,041 Total $2,591 Total Liabilities/Equity$3,588 No Change (Fixed Assets)

48 Pro Forma Balance Sheet Balance Sheet 2006pro forma Assets Current Assets Cash $298 $328 Accounts Receivable $688 $757 Inventory $922$1,014 Total $1,908$2,099 Fixed Assets Net Plant & Equip. $1,080$1,080 Goodwill $600 $600 Total Fixed Asst $1,680$1,680 Total Assets $3,588$3, pro forma Liabilities and Owner's Equity Current Liabilities Accounts Payable $344 Notes Payable $196 Total $540 Long-Term Debt $457 Owner's Equity CS and Surplus $550 Retained Earnings$2,041 Total $2,591 Total Liabilities/Equity$3,588 New Total Assets

49 Pro Forma Balance Sheet Balance Sheet 2006pro forma Assets Current Assets Cash $298 $328 Accounts Receivable $688 $757 Inventory $922$1,014 Total $1,908$2,099 Fixed Assets Net Plant & Equip. $1,080$1,080 Goodwill $600 $600 Total Fixed Asst $1,680$1,680 Total Assets $3,588$3, pro forma Liabilities and Owner's Equity Current Liabilities Accounts Payable $344 $378 Notes Payable $196 Total $540 Long-Term Debt $457 Owner's Equity CS and Surplus $550 Retained Earnings$2,041 Total $2,591 Total Liabilities/Equity$3,588 Increase with Sales

50 Pro Forma Balance Sheet Balance Sheet 2006pro forma Assets Current Assets Cash $298 $328 Accounts Receivable $688 $757 Inventory $922$1,014 Total $1,908$2,099 Fixed Assets Net Plant & Equip. $1,080$1,080 Goodwill $600 $600 Total Fixed Asst $1,680$1,680 Total Assets $3,588$3, pro forma Liabilities and Owner's Equity Current Liabilities Accounts Payable $344 $378 Notes Payable $196 $196 Total $540 Long-Term Debt $457 Owner's Equity CS and Surplus $550 Retained Earnings$2,041 Total $2,591 Total Liabilities/Equity$3,588 No Change (Financing Policy)

51 Pro Forma Balance Sheet Balance Sheet 2006pro forma Assets Current Assets Cash $298 $328 Accounts Receivable $688 $757 Inventory $922$1,014 Total $1,908$2,099 Fixed Assets Net Plant & Equip. $1,080$1,080 Goodwill $600 $600 Total Fixed Asst $1,680$1,680 Total Assets $3,588$3, pro forma Liabilities and Owner's Equity Current Liabilities Accounts Payable $344 $378 Notes Payable $196 $196 Total $540 $574 Long-Term Debt $457 $457 Owner's Equity CS and Surplus $550 Retained Earnings$2,041 Total $2,591 Total Liabilities/Equity$3,588 No Change (Financing Policy)

52 Pro Forma Balance Sheet Balance Sheet 2006pro forma Assets Current Assets Cash $298 $328 Accounts Receivable $688 $757 Inventory $922$1,014 Total $1,908$2,099 Fixed Assets Net Plant & Equip. $1,080$1,080 Goodwill $600 $600 Total Fixed Asst $1,680$1,680 Total Assets $3,588$3, pro forma Liabilities and Owner's Equity Current Liabilities Accounts Payable $344 $378 Notes Payable $196 $196 Total $540 $574 Long-Term Debt $457 $457 Owner's Equity CS and Surplus $550 $550 Retained Earnings$2,041 Total $2,591 Total Liabilities/Equity$3,588 This is will increased once we have determined EFN.

53 Pro Forma Balance Sheet Balance Sheet 2006pro forma Assets Current Assets Cash $298 $328 Accounts Receivable $688 $757 Inventory $922$1,014 Total $1,908$2,099 Fixed Assets Net Plant & Equip. $1,080$1,080 Goodwill $600 $600 Total Fixed Asst $1,680$1,680 Total Assets $3,588$3, pro forma Liabilities and Owner's Equity Current Liabilities Accounts Payable $344 $378 Notes Payable $196 $196 Total $540 $574 Long-Term Debt $457 $457 Owner's Equity CS and Surplus $550 $550 Retained Earnings$2,041$2,093 Total $2,591 Total Liabilities/Equity$3,588 Retained Earnings = 2, (from the Income Statement) = 2,093

54 Pro Forma Balance Sheet Balance Sheet 2006pro forma Assets Current Assets Cash $298 $328 Accounts Receivable $688 $757 Inventory $922$1,014 Total $1,908$2,099 Fixed Assets Net Plant & Equip. $1,080$1,080 Goodwill $600 $600 Total Fixed Asst $1,680$1,680 Total Assets $3,588$3, pro forma Liabilities and Owner's Equity Current Liabilities Accounts Payable $344 $378 Notes Payable $196 $196 Total $540 $574 Long-Term Debt $457 $457 Owner's Equity CS and Surplus $550 $550 Retained Earnings$2,041$2,093 Total $2,591$2,643 Total Liabilities/Equity$3,588$3,675 EFN = Total Assets – Total Liabilities = 3,588 – 3,675 = 104

55 Pro Forma Balance Sheet Balance Sheet 2006pro forma Assets Current Assets Cash $298 $328 Accounts Receivable $688 $757 Inventory $922$1,014 Total $1,908$2,099 Fixed Assets Net Plant & Equip. $1,080$1,080 Goodwill $600 $600 Total Fixed Asst $1,680$1,680 Total Assets $3,588$3, pro forma Liabilities and Owner's Equity Current Liabilities Accounts Payable $344 $378 Notes Payable $196 $196 Total $540 $574 Long-Term Debt $457 $457 Owner's Equity CS and Surplus $550 $654 Retained Earnings$2,041$2,093 Total $2,591$2,747 Total Liabilities/Equity$3,588$3,779 Increase Stock by EFN = = 654

56 Pro Forma Balance Sheet Balance Sheet 2006pro forma Assets Current Assets Cash $298 $328 Accounts Receivable $688 $757 Inventory $922$1,014 Total $1,908$2,099 Fixed Assets Net Plant & Equip. $1,080$1,080 Goodwill $600 $600 Total Fixed Asst $1,680$1,680 Total Assets $3,588$3, pro forma Liabilities and Owner's Equity Current Liabilities Accounts Payable $344 $378 Notes Payable $196 $196 Total $540 $574 Long-Term Debt $457 $457 Owner's Equity CS and Surplus $550 $654 Retained Earnings$2,041$2,093 Total $2,591$2,747 Total Liabilities/Equity$3,588$3,779 Balanced!

57 Pro Forma Ratios RatioCurrentPro formaChange ROE6.37%7.61%19.47% Times Interest Earned2.77 times3.25 times17.06% Total Asset Turnover0.64 times0.67 times4.45% Current Ratio3.53 times3.65 times3.41%

58 Other Firm Policies Dividend Policy Financing Policy  Fund EFN through long-term debt. Using the Excel Goal Seek function  Fund EFN while maintaining the same debt to equity ratio. Using the Excel Solver function


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