1. Goal of the Lecture: Understand how to construct a cash flow statement, a cash budget, and pro-forma financial statements.

3. Financial Analysis and Planning I.Analyze Financial Health of Companies a. Ratio Analysis b. Common Size Statements c. Dupont System II.Cash Flow Analysis – Cash Flow Statement III.Financial Planning a. Cash Budgeting b. Pro Forma Financial Statements

4. a. Liquidity Ratios 1. Current Ratio = Current Assets/Current Liabilities 2. Quick Ratio = (Current Assets -Inventory) Current Liabilities b. Asset Management 1. Total Asset Turnover = Sales/Total Assets 2. Fixed Asset Turnover = Sales/Fixed Assets 3. Inventory Turnover = COGS/Inventory 4. Average Collection Period= Accounts Receivable (Sales/365) c. Debt Management 1. Total Debt to Total Assets = Total Debt Total Assets 2. Times Interest Earned = EBIT/Interest Expense 3. Fixed Charges Coverage = (EBIT + Lease Expense) (Interest + Lease Expense) I.Ratio Analysis - Five Types

5. d. Profitability 1. Return on Equity = Net Income Stockholders Equity 2. Operating Margin = Operating income(EBIT) Sales 3. Basic Earning Power = EBIT/Total Assets 3. Return on Total Assets = Net Income Total Assets 4. Net Profit Margin = Net Income/Sales e. Market 1. Price/Earnings Ratio = Market Price per Share Earnings Per Share 2. Dividend Yield = Dividends Per Share Share Price 3. Dividend Payout = Dividend Per Share Earnings Per Share

6. Ratios General MillsKellogg Current.85.89 Total Asset TO.81 1.1 Debt to Equity 117 259 EBITD Margin 21.2 18.5 ROA 8.810.1 ROE 28 50.3 Kellogg is slightly more liquid. Kellogg has the best asset management. Kellogg has the most leverage (financial risk). Kellogg seems most profitable. For liquidity, asset management and leverage, one ratio can often be used to make comparisons. But for profitability, looking at more than one ratio is often helpful. In this case, the large write-offs and high leverage makes Kellogg seem profitable but this could be misleading. Why? Hint: Compare betas. Example:Ratio Analysis

7. a. Uses Historical Information Distorted by Inflation b. Need to Look Beyond the Numbers c. Accounting Numbers can be Manipulated d. Ratio Complexity Related to International and Multi-diversified Firms e. Difficult to Determine a Comparison Industry for some Firms For Examples: See reuters.com II. Criticisms of Ratio Analysis

8. a. Components of ROE (Return on Equity) ROE = Net Income/Equity = (Net Income/Pre-tax Income) x (Pre-tax Income/EBIT) x (EBIT/Sales) x (Sales/Total Assets) x (Total Assets/Equity) = (Tax Burden) x (Interest Burden) x (Return on Sales) (Total Asset Turnover) x (Financial Leverage) b. To show the relationship between ROE and ROA ROE= (1-Tax Rate)[ROA + (ROA-Interest Rate)Debt/Equity] Note: The leverage effect can be positive or negative. III.Dupont System

9. A. Importance of Cash Flow 1. Cash Budgeting - need cash to pay bills 2. Used in Evaluating Investments – NPV 3. Avoid Accounting Ambiguity - unique cash amount 4. Cash Flow Statement IV.Financial (Cash Flow) Planning

10. 1. Three Parts a. Operating Activities b. Investment Activities c. Financing Activities 2.Cash Flow Statement - Advantages a.Breakdown by activities b. Removes accrual effects and restates on a cash basis c. Breaks out gross figures instead of net figures on debt and other transactions. V. Cash Flow Statement Analysis

11. 3.Cash Flow Statement - Disadvantages a. Confusion with the Indirect Approach (Starts with Net Income) b. Does Not Reconcile Taxes Reported on Income Statement and Actual Taxes Paid c. Does Not Require Separate Disclosure of Cash Flows Associated with Discontinuing Operations and Extraordinary Items d. Non-Cash Investing and Financing Reported in the Notes e. Interest is an Operating Expense, But Dividends are Reported as Financing Expense (Misleading)

12. Cash Flow Statement - Inflows and Outflows “Accounting statement that reports the flow of cash into and out of the firm in terms of operating, investing, and financing activities.” I. Cash Flow Statement Illustration of Inflows and Outflows II.InflowsOutflowsOperations Cash SalesPayment for Materials Collection of A/RWages, Rent, Tax, etc.Investments Sell SecuritiesWorking Capital From SubsidiariesCapital Investments Sell AssetsFinancing Issue SecuritiesPay Interest & Dividends Obtain LoanRepay Loans and Bonds Retire Equity For Examples: reuters.com, 10kwizard.com

13. 1. A Detailed Statement of Cash Inflows and Outflows (Short-Term Financing) a. Predict Economy and Business Future b. Estimate Sales - historical, industry trend, sales force c. Determine Cash Inflows From Operations – seasonals d. Determine Cash Outflows From Operations - cash cost e. Determine Other Extra Cash Inflows/Outflows - dividends, asset sales, capital investments, loans f. Subtract Total Outflows From Total Inflows g. Determine Financing Needed -> > Maximum Outflow Examples: See handout. VI. Cash Budget

14. XII. Pro Forma Financial Statements a. Long-Term b. Two Approaches 1. Take Cash Budget Numbers and Adjust for GAAP 2. Percentage of Sales Method - More Common - Project sales - Project costs, assets and liabilities as fixed percentages of projected sales - Some accounts will not vary with sales - leave fixed, - debt, dividends, common For Examples: See handout XIII. External Financing 1. Calculate pro forma retained earnings from income statement and pro forma change in assets and liabilities from the balance sheet. External Financing =  Assets -  Liabilities +  Refinancing -  Retained Earnings + Replacement Investment Pro Forma Financial Statements “Projection of Expected Future Financial Statements and Longer-Term Financing Needs”