Corporate finance chapter 03 interpreting finacial statements

Financial Statements Review – Financial Statements Provide: • current and historical information to owners and creditors • a convenient way for owners and creditors to set performance

Financial Statements Review

– Financial Statements Provide:

• current and historical information to owners and creditors

• a convenient way for owners and creditors to set performance targets

• a convenient standard template for financial planning

• 3.9 Growth & the Need for External Financing

• 3.10 Working Capital Mgnt.

• 3.11 Liquidity & Cash Mgnt.

– Provide a convenient templates for financial planning

3.2 Review of Financial Statements

The Balance Sheet

• Summarizes a firms assets, liabilities, and owner’s equity at a moment in time

• Amounts measured at historical values and

historical exchange rates

• Prepared according to GAAP, Generally Accepted Accounting Principles

– GAAP modified occasionally by the Financial Accounting Standards Board

• Exchange-listed companies must comply with

Securities and Exchange Commission (SEC) rules

The Balance Sheet

• Major Divisions:

– Assets

• Current assets (less than a year)

• Long-term assets (longer than a year

– Depreciation

– Liabilities and Stockholder’s Equity

• Liabilities

– Current Liabilities – Long-term debt

• Equity

GPC Balance Sheet at Dec 31, 2xx1

2xx0 2xx1 Change Assets

Cash & mkt'ble secs 100.0 120.0 20.0

The Income Statement

• Summarizes the profitability of a

The Income Statement

• The shareholder’s equity may be much higher

or lower than the market value of the firm

– The value of the firm’s land may have halved or doubled, but this would not be reported in the

GPC Income Statement for Year Ending 2xx1

Sales revenues 200.0 Cost of goods sold (110.0)

The Cash-Flow Statement

• Show the cash that flowed into and from a firm in during a time period

– Focuses attention on a firm’s cash situation

• A firm may be profitable and short of cash – Unlike the balance sheet and income

statement, cash flow statements are

independent of accounting methods

• The IRS uses accounting income to compute tax, so accounting rules have a second order effect on cash flows through taxes

GPC Cash Flow Statement, for the Year ending Dec 31, 2xx0

Net income 23.4 + Depreciation 30.0

- Increase in acc rec (10.0)

- Increase in invent (30.0) + Increase in acc rec 12.0

*Total cash from operations 25.4

- Invest in new ppe (90.0)

*Cash flow invest' activities (90.0)

+ Inc short-term debt 94.6

*Cash flow from financing 84.6

**Chng cash & mkt securities 20.0

GPC Balance Sheet at Dec 31, 2xx1

2xx0 2xx1 Change Assets

Cash & mkt'ble secs 100.0 120.0 20.0

Sales revenues 200.0Cost of goods sold (110.0)

- Increase in acc rec (10.0)

- Increase in invent (30.0)+ Increase in acc pay 12.0

*Total cash from operations 25.4

- Invest in new ppe (90.0)

*Cash flow invest' activities (90.0)

-Div paid (10.0)

3.4 Returns to Shareholders

v Return on Equity

• Recall our definition in Chapter 2 of the holding period return, and compare this with the economic measure of income

4

1 200

$

8 2

come EconomicIn

StartPrice

nds CashDivide StartPrice

EndPrice turn

• This is the Total Shareholder Return

Returns to Shareholders v

Return on Equity (Continued)

• Traditionally, corporate performance has been measured by Return on Equity, ROE

% 8

7 300

$

4 23

rsEquity ShareHolde

NetIncome

rsEquity ShareHolde

Income Accounting

ROE

( 300 313 4 ) / 2 7 . 6 %

4 23

sEquity r'

StockHolde

NetIncome (RoE)

Equity

on

Return

% 1

9 2 / 720 600

60

alAssets AverageTot

EBIT (RoA)

60 Sales

EBIT (RoS)

Sales

on Return

= +

=

=

= +

Sales Turnover

Asset

Times 7

.

0 2 / 180 150

110

Inventory Average

Sold Goods

of Cost Turnover

Inventory

Times 6

.

3 2 / 60 50 200

s Receivable Average

Sales Turnover

s Receivable

= +

=

=

= +

=

=

= +

=

=

Financial Leverage

Times 9

.

2 21

60

Expense Interest

EBIT Earnt

Interest Times

%

57 720

6 406

Assets Total

Debt

Total Debt

Times 7

.

0 6

256 180

s Liabilitie Current

s Receivable

Cash Earnt

Interest Times

Times 4

.

1 6

256 360

s Liabilitie Current

Assets

Current Current

Market Value

6

0 4

313

20 187

Share per

Value Book

Share per

Price Book

Market to

0

8 4

23

2 187

Share per

Earnings

Share Per

Price Earnings

to Price

• Other companies ratios

• The firm’s historical ratios

• Data extracted from financial markets

• Sources

Relationships Amongst Ratios

• It is sometimes valuable to decompose

ratios into sums, differences, products

and quotients of other ratios Many such schemes start with:

Turnover Asset

* sales

on Return

EBIT Assets

EBIT RoA

• (Table 3.7 & 3.8 of textbook)

– Consider two firms that are identical except that Nodebt is financed using $1,000,000 of equity and Halfdebt is financed using

$500,000 of equity and $500,000 of debt

– further assume that the EBIT of both firms is

$120,000 and tax is 40%

Case: Borrow at 10%: Effect

of Business Cycle on ROE

Economic ROA ROE ROE

Conditions Nodebt Halfdebt

Bad Year 1% 0.6% -4.8%

Normal Year 12% 7.2% 8.4%

Good Year 30% 18.0% 30.0%

GPC Financial Statements, Years xxx1 - xxx3

(Nearest $ Million) (Percent of Year's Sales) Year xxx0 xxx1 xxx2 xxx3 xxx1 xxx2 xxx3

Income Statement

Sales 200 240 288 100.0% 100.0% 100.0% Cost of goods sold 110 132 158 55.0% 55.0% 55.0% Gross margin 90 108 130 45.0% 45.0% 45.0% Selling, general & admin expenses 30 36 43 15.0% 15.0% 15.0% EBIT 60 72 86 30.0% 30.0% 30.0% Interest expences 30 45 64 15.0% 18.8% 22.2%

Net income 18 16 13 9.0% 6.7% 4.7% Dividends 5 5 4 2.7% 2.0% 1.4%

Change in shareholder's equity 13 11 9 6.3% 4.7% 3.3%

Balance Sheet

Assets:

Cash & equivalents 10 12 14 17 6.0% 6.0% 6.0% Receivables 40 48 58 69 24.0% 24.0% 24.0% Inventories 50 60 72 86 30.0% 30.0% 30.0% Property, Plant & equipment 500 600 720 864 300.0% 300.0% 300.0%

Total Assets 600 720 864 1037 360.0% 360.0% 360.0%

Liabilities:

Payables 30 36 43 52 18.0% 18.0% 18.0% Short-term debt 120 221 347 502 110.7% 144.6% 174.2% Long-term debt 150 150 150 150 75.0% 62.5% 52.1%

Total Liabilities 300 407 540 704 203.7% 225.1% 244.3%

Shareholder's equity 300 313 324 333 156.3% 134.9% 115.7%

(Nearest $ Million) Year xxx0 xxx1 xxx2 xxx3

(Percent of Year's Sales)

Balance Sheet

Assets:

Cash & equivalents 6.0% 6.0% 6.0% Receivables 24.0% 24.0% 24.0% Inventories 30.0% 30.0% 30.0% Property, Plant & equipment 300.0% 300.0% 300.0%

Total Assets 360.0% 360.0% 360.0% Liabilities:

Payables 18.0% 18.0% 18.0% Short-term debt 110.7% 144.6% 174.2% Long-term debt 75.0% 62.5% 52.1%

Total Liabilities 203.7% 225.1% 244.3% Shareholder's equity 156.3% 134.9% 115.7%

GPC Financial Statements, Years xxx1 - xxx3

(Nearest $ Million) (Percent of Year's Sales)Year xxx0 xxx1 xxx2 xxx3 xxx1 xxx2 xxx3 F(sales)? xxx4

Income Statement

Cost of goods sold 110 132 158 55.0% 55.0% 55.0% Yes 190

Gross margin 90 108 130 45.0% 45.0% 45.0% N/A(Yes) 156Selling, general & admin expenses 30 36 43 15.0% 15.0% 15.0% Yes 52

Property, Plant & equipment 500 600 720 864 300.0% 300.0% 300.0% Yes 1037

Total Assets 600 720 864 1037 360.0% 360.0% 360.0% N/A(Yes) 1244

Liabilities:

Short-term debt 120 221 347 502 110.7% 144.6% 174.2% No

Long-term debt 150 150 150 150 75.0% 62.5% 52.1% No

Total Liabilities 300 407 540 704 203.7% 225.1% 244.3% N/A 904

Shareholder's equity 300 313 324 333 156.3% 134.9% 115.7% N/A 340

GPC Financial Statements, Years xxx1 - xxx3

(Nearest $ Million) Year xxx0 xxx1 xxx2 xxx3 xxx4

GPC Financial Statements, Years xxx1 - xxx3

(Nearest $ Million) Year xxx0 xxx1 xxx2 xxx3 xxx4

External Funds Needed

% 58 31

) 30 0 1 (

* ) 40 0 1 (

* 40 86 84

51 80

1036

) 30 0 1 (

* ) 40 0 1 (

* ) 26 87 40

86 ( 300

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(

Million 0956

190

$

) 30 0 1 (

* ) 40 0 1 (

* ) 26 87 2

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* 40 86 ((

2 0

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EBIT S

L S

A

d t

Int EBIT

EFA growth

d t

Int S

S EBIT S

S S

S L S

A EFN

External Funds Needed for Growth

– Sometimes the new assets required to

generate income are not a high as in this example, and the company may able to support a level of growth with no external funding (-0.00038 in our case)

) 1

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