1. Sustainable Growth and Financial Statement Analysis

2. 2007 Pro Forma Balance Sheet
2007 Forecasts
2007 Pro Forma Income State.
Sales 150
Costs 135
Net Income 15
Dividends 6
Ret. Earnings 9
2007 Pro Forma Balance Sheet
Liabilities
Assets 300
Equity
whoops!
2006 Income Statement
Sales 100
Costs 90
Net Income 10
Dividends 4
Ret. Earnings 6
2006 Balance Sheet
Liabilities
Assets 200
Equity

3. External Funds Needed (EFN)
2007 Pro Forma Income State.
Sales 150
Costs 135
Net Income 15
Dividends 6
Ret. Earnings 9
2007 Pro Forma Balance Sheet
Liabilities
Assets 300
Equity
Total 300 Total
There is a funding shortfall of 41 (A = 300, L&NW = 259)
This must be made up by:
Issuing new equity
Allowing the ratio of liabilities/sales to rise
Some combination of (1) and (2)

4. EFN More Generally (Eq. 3.22, p. 70)
PM = Net Profit Margin
b = retention ratio (retained earnings/net income)

5. Sustainable Growth Rate
Growth rate in sales = g (i.e., S1 = (1+g)S0 and ΔS = S1 – S0 = gS0
At what rate can we grow without issuing new equity or allowing liabilities/sales to increase (e.g., EFN = 0)?

6. Dell’s Working Capital
How did Dell fund 52% growth in sales for 1996?
Use 1995 data to forecast 1996 balance sheet and compare with 1996 actual
Can Dell sustain another year of 50% sales growth without issuing new equity or increasing its debt ratio?
What role does Dell’s cash conversion cycle play in its funding needs?

7. How Can We Assess and Explain Financial Performance?

8. Financial Ratio Types Market Value Profitability Asset Management
Leverage
Liquidity

9. Market Value Ratios Examples: Market-to-Book; Price-Earnings
Questions: How do securities markets value the company’s assets? Earnings?

10. Profitability Ratios
Examples: Return on assets, equity, invested capital; gross, net profit margin
Questions: How profitable is the company per dollar invested in the business; per dollar of sales?

11. Asset Management Ratios
Examples: asset turnover, days’ sales in receivables, inventory turnover, days’ sales in payables
Questions: How efficiently does the company use its assets? How long does it take assets or liabilities to turn into cash?

12. Financial Leverage Ratios
Examples: Debt/assets; Debt/equity; Interest coverage
Questions: How much of a burden does debt pose relative to assets, equity or cash flow? How risky is the company?

13. Liquidity Ratios
Examples: Current ratio, quick ratio, interval measure
Questions: How easily can the company meet its immediate cash requirements? How risky is the company?

14. Financial Ratios Relative to What?
By themselves, financial ratios have no meaning. We need to compare to:
Past data for the same company
Data for similar companies (e.g., same industry)
Other ratios (i.e., DuPont ratios, Cash Conversion Cycle)

15. Does One Trend Coincide with Another?

16. DuPont Ratios Net Income x Sales x Assets = Net Income
Sales Assets Equity Equity
Net profit X Asset x Equity = ROE
margin turnover multiplier

17. Like-A-Weed mini-case
How is Like-A-Weed doing?
Why is the net profit margin declining?
Does the company have a financial or an operating problem?
What should Like-A-Weed do?