1. Steps in Financial Analysis
ACCY 291
Financial Statement Analysis
Steps in Financial Analysis

2. Steps in comprehensive financial analysis
1. BUSINESS STRATEGY Analysis
2. ACCOUNTING Analysis
3. FINANCIAL Analysis
4. PROSPECTIVE Analysis

3. Business Strategy
Industry analysis and
Competitive strategy analysis
Understand the business and the firm.
Accounting
Evaluate
accounting &
financial reporting quality.
Financial
Evaluate
past performance.
Prospective
Make forecasts and
Value business.

4. BUSINESS STRATEGY Analysis
An effort to learn about the company’s product, strategy, and operating environment.
A qualitative analysis of profit drivers, profit potentials, and the associated risk.
SWOT analysis can be useful
Know the Industry
Know the key players (leaders, followers, newcomers)
What is the source of competitive advantage/weakness?
What are Goals, Strategies, and Implementation history?
Where does the firm want to go?
Is the goal achievable?
Does the firm have a good track record?

5. FINANCIAL Analysis PROSPECTIVE Analysis
Quantitative evaluation of past performance,
Assessment of the status quo that is informative of the future.
PROSPECTIVE Analysis
Forecast of future financial statements.
Equity valuation.
What is involved is an empirical analysis where, we
Make informed guesses based on past data.
Simplify complex numbers into simpler key parameters.

6. ACCOUNTING Analysis Background
We use “Accrual Accounting” vs. ______ accounting.
What is an “accrual”?
Key features?
Outcome?
Accrual accounting system leads to…
Manager’s accounting and financial reporting discretion.
Manager’s financial reporting strategy.
Release of voluntary information
Timing of the release of information

7. ACCY 291
Financial Statement Analysis
Financial Analysis
Preliminaries

8. Overview of a Firm from Financial Analysis standpoint
i-freedebt
Assets
i-bearing debt OE
Investment
Financing
Payoffs to the “capital providers”
(Measure of “Profit” for the “enterprise”)
Managers’ task?
Investment
Operating
Financing
Accounting

9. Payoffs to the capital providers
i-free debt
Assets
i-bearing debt OE
Payoffs to the “capital providers”
Measured in accounting numbers is typically called
____________________
Measured in cash is typically called

10. NOPAT and Free Cash Flow
NOPAT (Net Operating Profit After Tax)
= Accounting profits for both debtholders and shareholders
= All sales, minus expenses payable to all parties except debtholders and shareholders.
Since debtholders and shareholders are combined into one class, this measure cannot be influenced by capital structure.
Free Cash Flow (FCF)
= Cash flows for both debtholders and shareholders
= All cash inflows, minus cash outflows to all parties except debtholders and shareholders.

11. Day-to-Day Performance Goals
i-free debt
Assets
i-bearing debt OE
Managers’ objective (in finance theory)?
Maximize ________________ The market value of the enterprise is considered to be ____________________.
Practical period-by-period Performance Goals (Typically relevant in conventional Ratio analysis) Maximize _____________ While Minimizing____________ “Other things equal”
Together, they imply Maximizing___________

12. A Thought
If the firm’s value is present value of future free cash flows, then why do we bother with NOPAT in measuring the firm’s performance in any period?

13. Properties of NOPAT (Net Operating Profit After Tax)
What is NOPAT?
How different from net income?

14. NOPAT
is after tax income that would have been obtained regardless of its capital structure
Revenue 1000
CGS (500)
other S&A expense (150)
depreciation (50)
Interest expense (100)
Pretax income 200
tax expense (40%) (80)
Net income 120
NOPAT can be computed either as
EBIT(1- )
net income + interest expense (1- )
NOPAT
if interest expense is 200, not 100?
if interest expense is 0, not 100?

15. Properties of NOPAT
Combined income payable to both the debt holders and the shareholders (the two are often called “capital providers”)
Cannot be affected by the amount of borrowing or borrowing rate.
Further caveats:
Definition of NOPAT can be different for different people.
NOPAT cannot be pulled out from income statement. It needs to be computed.
NI= (EBIT- Interest expense)*(1-t)
EBIT *(1- t) = Net Income + Interest expense*(1- t)

16. EBIT and NOPAT Definition for our discussions
Financial
assets
______ Income
i-free debt
?_____
i-bearing debt
Operating
assets OE
______ Income
Assets
Some authors define NOPAT as one excluding interest income.

17. Income statements of CVS & Walgreens
Fiscal Year Ending
Dec-07
Aug-07
Sales (Net)
76,329.5
53,762.0
Cost of Goods Sold
60,221.8
38,518.1
Gross Profit
16,107.7
15,243.9
Selling, General, & Admin Expenses
10,219.8
11,417.3
Operating Income Before Depreciation
5,887.9
3,826.6
Depreciation, Depletion, & Amortization
1,094.6
675.9
Operating Income After Depreciation
4,793.3
3,150.7
Interest Expense
468.3
0.0
Non-Operating Income/Expense
33.7
38.4
Special Items
Pretax Income
4,358.7
3,189.1
Income Taxes - Total
1,721.7
1,147.8
Minority Interest
Income Before Extraordinary Items & Discontinued Op.
2,637.0
2,041.3
Extraordinary Items
Discontinued Operations
Net Income (Loss)
NOPAT? ______________ using reported tax rate
NOPAT? ______________ using “normal” tax rate