1. Financial Analysis and Planning
Chapter 3
Financial Analysis and Planning

2. Overview of Lecture The Annual Report Ratio Analysis
The Du Pont Identity
Using Financial Statement Information
Financial Planning Models
External Financing and Growth

3. Corporate Finance in the News
Insert a current news story here to frame the material you will cover in the lecture.

4. Statement of Financial Position
The Annual Report
Statement of Financial Position
The Income Statement
Statement of Cash Flows

5. The Statement of Financial Position
Also known as The Balance Sheet
Assets  Liabilities + Shareholders’ equity
Assets represent investments made by company
Liabilities and Equity represent how investments are financed

6. Figure 3.1 The Statement of Financial Position

7. The Balance Sheet Equation
Liabilities
Equity
Assets

8. Example 3.1 Building the Statement of Financial Position
From British Airways’ 2009 annual report, it had current assets of £2.346 billion, non-current assets of £8.142 billion, current liabilities of £4.142 billion, and non-current liabilities of £4.5 billion. What does British Airways’ statement of financial position or balance sheet look like? What is shareholders’ equity? What is net working capital?

9. Example 3.1 Building the Statement of Financial Position
Net working capital is the difference between current assets and current liabilities, or £ £4.142 = -£1.796.

10. Net Working Capital
Net Working Capital = Current Assets minus Current Liabilities
It is important to ensure that net working capital is positive
Positive net working capital means that enough cash will be available to pay off liabilities arising

11. Accounting Figures drawn from Accounting Standards Market Value
Market vs Book Value
Book Value
Accounting Figures drawn from Accounting Standards
Market Value
Value based on prices or market valuations

12. Example 3.2 Market Value versus Book Value
Siouxsie plc has non-current assets with a book value of £700 and an appraised market value of about £1,000. Net working capital is £400 on the books, but approximately £600 would be realized if all the current accounts were liquidated. Siouxsie has £500 in long-term debt, both book value and market value. What is the book value of the equity? What is the market value?

13. Example 3.2 Market Value versus Book Value

14. Measures performance over a specific period
The Income Statement
Measures performance over a specific period

15. The Income Statement
Revenues
Expenses
Income

16. Three Important Considerations
The Income Statement
Three Important Considerations
Non-Cash Items
Time
Costs

17. Average Tax Rates Marginal Tax Rate
Taxes
Average Tax Rates
This is the percentage of income that is paid in taxes
Average Tax Rate is the tax bill divided by your taxable income
Marginal Tax Rate
The tax you would pay if you earn one more unit of currency

18. Which Tax Rate Should You Use in Financial Decisions?
Use the Marginal Tax Rate since that is the rate that you would be taxed on any additional income earned

19. Cash Flow The most important item to take from financial statements
Cash Flow is NOT the same as Net Working Capital
Cash Flows from Assets = Cash Flows to Creditors and Equity Investors
Total Cash Flow comes from operating activities, investing activities, and financing activities

20. Work the Web
Now is a good time to download a set of company accounts and look through them in detail.

21. Financial Statement Analysis
It is important to be able to analyse a firm’s financial statements and compare them to other firms

22. Financial Leverage Ratios
Ratio Analysis
Liquidity Ratios
Financial Leverage Ratios
Turnover Ratios
Profitability Ratios
Market Value Ratios

23. Liquidity or Short-Term Solvency Ratios
Current Ratio
Quick or Acid Test Ratio
Cash Ratio

24. Short-Term Solvency Ratios

25. Financial Leverage or Long-Term Solvency Ratios
Total Debt Ratio
Debt to Equity Ratio
Equity Multiplier
Times Interest Earned
Cash Coverage

26. Long-Term Solvency Ratios

27. Asset Management or Turnover Ratios
Inventory Turnover
Days’ Sales in Inventory
Receivables Turnover
Days’ Sales in Receivables
Total Asset Turnover

28. Asset Management Ratios

29. Profitability Ratios
Profit Margin
Return on Assets
Return on Equity

30. Profitability Ratios

31. Earnings per Share Price Earnings Ratio Market to Book Ratio
Market Value Ratios
Earnings per Share
Price Earnings Ratio
Market to Book Ratio

32. Market Value Ratios

33. ROE is Affected By Operating Efficiency Asset Use Efficiency
The Du Pont Identity
ROE is Affected By
Operating Efficiency
Asset Use Efficiency
Financial Leverage

34. The Du Pont Identity: Proof

35. Using Financial Statement Information: Choose a Benchmark
Look at the same ratio over a number of years
Time Trend Analysis
Compare ratio with similar firms
Companies in same industry (Check SIC Code)
Peer Group Analysis

36. Financial Statement Analysis: Some Issues
Some companies operate in several industries
Different Accounting Standards
Inappropriate Peers
You may want to compare your firm with the best in the industry
Choose similar firms at the top of the industry
Aspirant Analysis
Financial Websites: Yahoo! Finance, Reuters, FT.Com, ADVFN.com, Motley Fool
Company Accounts: Download from website
Sources of Information

37. Financial Statements can be used to plan over the long term
Financial Planning
Financial Statements can be used to plan over the long term
The Percentage of Sales approach to Financial Planning
External Financing Needed (EFN)

38. Example: Chute SA Income Statement Sales €1,000 Assets €500 Debt €250
Statement of Financial Position
Sales
€1,000
Assets
€500
Debt
€250
Costs
800
Equity
250
Net income
€ 200
Total
Assume that all variables are a constant percentage of sales
What happens if sales grow by 20 percent?

39. Statement of Financial Position
Example: Chute SA
Income Statement
Sales
€1,200
Costs
960
Net income
€ 240
Statement of Financial Position
Assets
€600 (+100)
Debt
€300
(+50)
Equity
300
Total
€600
(+100)
How can net income be €240 but equity only increases by €50?

40. The Percentage of Sales Approach
Assume only some variables are tied to sales growth

41. Bogle plc Income Statement
Example: Bogle plc
Bogle plc Income Statement
Sales
£1,000
Costs
800
Taxable income
£ 200
Taxes(28%) 56
Net income
£ 144
Dividends
£48
Addition to retained earnings 96
Costs are a constant percentage of sales (i.e. Constant profit margin)
Dividend payout ratio is constant
What happens with a 25 percent increase in sales?

42. Example: Bogle plc (25% increase in Sales)
Bogle plc Pro Forma Income Statement
Sales (projected)
£1,250
Costs (80% of sales)
1,000
Taxable income
£ 250
Taxes (28%) 70
Net income
£ 180
Dividend payout ratio = Cash dividends / Net income
= £48/£144 = 1/3
Projected dividends paid to shareholders = £180  1/3 = £ 60
Projected addition to retained earnings = €180  2/3 =
£180

43. Example: Bogle plc Statement of Financial Position

44. Example: Bogle plc New Statement of Financial Position

45. External Financing Needed
For Bogle plc:

46. Bogle plc Possible Scenario

47. External Financing and Growth: Hoffman AG
Income Statement
Sales
€500
Costs
400
Taxable income
€100
Taxes (34%) 34
Net income
€66
Dividends
€22
Addition to retained earnings 44

48. External Financing and Growth: Hoffman AG

49. Financing and Growth: Hoffman AG
You forecast sales of €600 next year. What will be the new debt-equity ratio?
Sales (projected)
€600.0
Costs (80% of sales)
480.0
Taxable income
€120.0
Taxes (34%)
40.8
Net income
€ 79.2
Dividends
€26.4
Addition to retained earnings
52.8

50. Financing and Growth: Hoffman AG
Assume Hoffman borrows €47.2, New DE Ratio is £297.2/£302.8 = .98

51. Growth and Projected EFN for Hoffman AG

52. Growth and Financing Requirements for Hoffman AG

53. Financial Policy and Growth
The Internal Growth Rate
The Sustainable Growth Rate
Determinants of Growth

54. The Internal Growth Rate
For Paradise plc:

55. The Sustainable Growth Rate
For Paradise plc:

56. Determinants of Growth
Remember Du Pont!
Profit Margin
Total Asset Turnover
Financial Policy
Dividend Policy

57. Financial Policy and Growth
If a firm does not wish to sell new equity and its profit margin, dividend policy, financial policy, and total asset turnover (or capital intensity) are all fixed, then there is only one possible growth rate.

58. Financial Planning Models: Some Caveats
Financial Planning Models ignore cash flow, risk, and timing
Financial Planning should not be a mechanical process
Financial Planning Should be an Iterative Process

59. Overview of Lecture The Annual Report Ratio Analysis
The Du Pont Identity
Using Financial Statement Information
Financial Planning Models
External Financing and Growth

60. Activities for this Lecture
Reading
Insert here
Assignment

61. Thank You