Financial Analysis

• Finance defined

• Basic business forms

• Corporate governance

• Accounting representation

• Cash Flow

• Financial Analysis

• Growth

Finance• “The science of the motion of money”

– Finance and accounting– Finance and economics– Finance and management

• Body of knowledge• Basic areas in finance

– Investments and financial institutions– Corporate finance

• NWC• LT financing• Long term investment

Forms of organizations

• Sole proprietorship, partnership, corporation– Advantages– Disadvantages

• Focus of the course: CORPORATION• Snapshot of a corporation

– Right side– Left side

Corporate Governance• 4 actors:

– Shareholders– Creditors– Officers– Stakeholders

• 1 GOAL?• Agency problems = Cost

– Direct (compensations and perquisites)– Indirect (monitoring and non-optimal decision making)

Financial position

• Income Statement (over a period)NI=(Sales-COGS-Dpr-Int) X (1-T)

• Retained Earnings(over a period)

End RE=Beg. RE +NI - Div

• Balance Sheet (At one point in time)– Assets=Liabilities + Equity = Liability + Stocks + RE

•

Cash flow• Define sources and uses of cash• Another (smarter) way to look at cash flow:

– Cash flow from assets=CF to creditors +CF to owners

• Cash from asset =Operating cash flow = EBIT-T+Dpr

- Use of NWC = End NWC-Beg.NWC

- Long term asset spending = End NFA - Beg.NFA + Dpr

• Cash to creditor = Interest paid –net new borrowing• Cash to owners = dividends paid- net new equity raised• Calculate and interpret (from Hermetic Inc.)

Sources and Uses of Cash

Change Sources UsesCash 5AR 50INV 65GFA 145AP 50NP 65LTD 20Stock 0NI 126.55DPR 30DIV 26.55Total 291.55 291.55

Another way to look at Cash flows

Cash flow from ASSETS Cash flow to creditors & owners

EBIT 200TAXES -53.45 Interest expenses 20DPR 30 Change in LTD -20

Cash flow from operations 176.55 Cash flow to creditors 0

Change in CA 120 Dividends 26.55Change in CL -115 Change in stocks 0

NWC spending 5 Cash flow to owners 26.55

Change in NFA 115Depreciation 30

Capital spending 145

Total 26.55 26.55

Financial Statements Analysis

• ISREBSCF• Common size analysis• Ratio analysis

– Cross sectional analysis– Time serie analysis

• 5 families– ST Liquidity– LT Liquidity– Activity– Profitability– Market

Ratio analysis• ST Liquidity:

– Current ratio=CA/CL– Acid test=(CA-Inv.)/CL

• LT Liquidity: – Debt-to-equity ratio=D/E– Cash coverage ratio= (EBIT+Dpr)/Int

• Activity:– Short-term asset turnover– Asset turnover=Sales/Asset

• Profitability– Profit margin=NI/Sales– ROA=NI/Asset– ROE=NI/Equity

Dupont Equation

• ROE=NI/Sales x Sales/Assets x Assets/Equity• ROE=Profit x Asset x Equity

Margin Turnover Multiplier– Operating efficiency

– Asset use efficiency

– Financial leverage

• ROE=ROA x Equity multiplier• Differentiate ROE and ROA• Remedy to “paralysis by analysis”

Growth

• Internal growth: Debt is constant– g= ROA x b/(1-ROA x b)

• Sustainable growth: Debt to equity is constant– g=ROE x b/(1-ROE x b)

• Differentiate between internal and sustainable growth.

• What are the factors that affect growth? • Forecasting tool

Cases Study

Sunset Board

S&S Air