Financial analysis for non finance people

SMI Finance- Introduction to Financial Analysis

Gary Krall

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Outline

♦ Overview of Financial Analysis

♦ Accounting & Financial Statements

♦ Key Measures and Ratios

♦ Capital Investment Evaluation

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Primary Uses of Financial Analysis

♦ Provide Assessment of Business Performance

♦ Forecasting Tool for Future Financial Requirements

♦ Analysis of Capital Investment Decisions

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Accounting & Financial Statements

♦ Financial Statements are the “Scorecards”

♦ Accounting is the language of financial reporting

♦ Generally Accepted Accounting Principles (GAAP) are the

“rules” of Accounting

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Accounting

♦ Financial Accounting for External Reporting Purposes

♦ SEC Reporting Requirement for US based companies

♦ Prepared according to GAAP issued by FASB

♦ Managerial Accounting

♦ More Detailed Financial Information intended for internal use

♦ Sales Reports, Expense and Cost Statements, Business Segment

Financial Information, Capital spending tracking etc.

♦ Does not need to adhere to FASB standards

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Accounting Methods

♦ Accrual Accounting

• Based on “Matching” Principle

• Revenue is recognized when it has been “earned”- when the sale has taken place and goods/services are sold shipped and invoiced

• Concurrently, corresponding costs and expenses are matched against revenue to determine whether or not there is a profit or loss for the period

♦ Cash Basis of Accounting• Recognizes revenue and expense transactions when payments are made

or received

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Financial Statements

♦ Income Statement

♦ Balance Sheet

♦ Statement of Cash Flows

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Income Statement

♦Summary of Operating Results over a period of time-• Usually a month, quarter or year

♦Periodic “Report Card”

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Income StatementSales Revenue

Cost of Goods Sold

Production Margin

Operating Expenses

Operating Income

Income Taxes

Net Income

AKA – The “P &L”

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Income Statement

Sales Revenue

♦ Sales = Price * Quantity

♦ Less discounts & allowances

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Income Statement

Cost of Goods Sold

♦ Fixed Costs• Constant With Activity

♦ Variable Cost (Cash Costs)• Increases With Activity

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Income Statement

Production Margin

Revenue - Cost of Goods Sold

Contribution Margin ( Unit Basis )

(Revenue - Variable Cost) / Volume

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Income StatementSales Revenue

Cost of Goods Sold

Production Margin

Operating Expenses

Operating Income

Income Taxes

Net Income

AKA – The “P &L”

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Financial Operational Analysis

Consolidated Statement of IncomeMinerals Technologies Inc. and subsidiary companies

2005 2004 % GrowthNet Sales $995,838 $923,667 8%Operating costs and expenses: Cost of goods sold 784,807 709,032 11% Marketing, distribution, and admin expenses 100,139 96,562 4% Research and development expenses 29,062 28,996 0%

Income from operations 81,830 89,077 -8%

Non-operating income / deductions, net (3,545) (4,505) -21%

Income before provision for taxes on income 78,285 84,572 -7%Provision for taxes on income 23,289 24,299 -4%Minority interests 1,732 1,710 1%

Net Income $53,264 $58,563 -9%

Average Shares Outstanding For Period 20,345 20,530 -1%

Earnings per common share $2.62 $2.85 -8%

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Balance Sheet

♦ Snapshot of Financial Condition at a point in time

♦ What is Owned- Assets

♦ What is Owed-Liabilities

♦ Residual-Ownership Interest

♦ Accounts show historical values not market values

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Balance Sheet

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Balance Sheet

Assets- Economic resources expected to benefit future activities.

♦ Cash♦ Accounts Receivable♦ Inventory♦ Property, Plant, & Equipment♦ Intangible Assets

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Balance Sheet

Liabilities- The economic obligation of an entity to outsiders.

♦ Debt- Bank Loans, Bonds Payable♦ Accounts Payable♦ Income Taxes Payable♦ Other Required GAAP disclosures

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Balance Sheet

Stockholder’s (Owner’s) Equity-Residual

♦ Common & Preferred Stock

♦ Retained Earnings (post dividends)

♦ Paid in Capital

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Balance SheetConsolidated Balance Sheet

Minerals Technologies Inc. and subsidiary companies

Assets Dec 31, 2005 Dec 31, 2004 % Growth Current assets: Cash and cash equivalents 53,450$ 112,967$ -53% Accounts receivable (less doubtful accounts): 184,272 156,276 18% Inventories 118,895 106,125 12% Other current assets 20,583 20,303 1% Total current assets 377,200 395,671 -5%

Property, plant, and equipment, less accumulated depreciation and depletion 628,745 614,285 2%Other assets and deferred charges 150,358 144,946 4%

Total assets $1,156,303 $1,154,902 0%

Liabilities and Sharholders' Equity Current liabilities: Short-term debt 62,847$ 30,000$ 109% Current maturities of long-term debt 53,698 3,917 1271% Accounts payable 61,323 56,381 9% Income taxes payable 6,409 12,521 -49% Accrued compensation and related items 14,956 17,072 -12% Other current liabilities 32,019 32,962 -3%

Total current liabilities 231,252 152,853 51%

Long term debt 40,306 94,811 -57%Accrued postretirement benefits 23,214 21,426 8%Deferred taxes on income 49,374 45,238 9%Other noncurrent liabilities 40,995 41,261 -1%

Total liabilities 385,141 355,589 8%

Shareholders' equity: Preferred stock 0 0 n/a Common stock at par value; 100,000,000 shares authorized: 2,800 2,778 1% Additional paid-in capital 261,159 248,230 5% Retained earnings 828,591 779,397 6% Deferred Compensation (3,263) (2,088) 56% Accumulated comprehensive income (loss) (5,879) 35,624 n/a

1,083,408 1,063,941 2% Less common stock held in treaury, at cost 312,246 264,628 18%

Total shareholders' equity 771,162 799,313 -4%

Total liabilities and shareholders' equity 1,156,303$ 1,154,902$ 0%

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Statement of Cash Flows

♦ Shows the cash that flowed into and from the firm during a period of time. A firm may be profitable and yet short of cash.

♦ Total cash flow = cash from operating activities + cash from investing activities + cash from financing activities.

♦ Unlike the balance sheet and income statement, cash flow statements are largely independent of accounting methods

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Financial Performance Measures

♦ SMI Management• Operational Analysis

– Production Margin– Profit After Tax– Operating Expense Analysis– Contribution Analysis

• Resource Management– Asset Turnover– Working Capital Management

• Profitability– Return on Investment– Return on Net Assets

♦ Lenders/Creditors• Liquidity

– Current Ratio– Cash Flow

• Financial Leverage– Debt to Equity– Cash Flow

♦Owners of MTI• Profitability

– Return on Net Assets– Return on Equity– Earnings per Share

• Disposition of Earnings– Dividends per Share– Dividend Yield

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Management’s Point of View

♦ Operational Analysis

♦ Resource Management

♦ Profitability

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Income Statement

Consolidated Statement of IncomeMinerals Technologies Inc. and subsidiary companies

2005 2004 % Growth 2005 2004Net Sales $995,838 $923,667 8%Operating costs and expenses: Cost of goods sold 784,807 709,032 11% 78.8% 76.8% Marketing, Selling, and Admin expenses 100,139 96,562 4% 10.1% 10.5% Research and development expenses 29,062 28,996 0% 2.9% 3.1%

Income from operations 81,830 89,077 -8% 8.2% 9.6%

Non-operating income / deductions, net (3,545) (4,505) -21% -0.4% -0.5%

Income before provision for taxes on income 78,285 84,572 -7% 7.9% 9.2%Provision for taxes on income 23,289 24,299 -4% 2.3% 2.6%Minority interests 1,732 1,710 1% 0.2% 0.2%

Net Income $53,264 $58,563 -9% 5.3% 6.3%

Average Shares Outstanding For Period 20,345 20,530 -1%

Earnings per common share $2.62 $2.85 -8%

% Sales

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♦ Ratio Analysis

♦ Based on relationships between accounts on the income

statement and balance sheet.

♦ Categories of Financial Ratios

• Asset Management or Turnover Ratios• Profitability Ratios• Short-Term Solvency Ratios• Long-Term Solvency Ratios• Market Value Ratios

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♦ Asset Management or Turnover Ratios♦ Total Asset Turnover♦ Fixed Asset Turnover♦ Working Capital Management

♦ Accounts Receivable Collection♦ Inventory Turnover

♦ Profitability♦ Profit Margin = Net Income/Sales♦ Return on Net Assets: RONA= Net Income/Net Assets♦ RONA also = Net Income/Sales x Sales/Net Assets

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Leverage and RONA

Reduce Increase

Net Assets Net Income

by $4.0M by $4.0M

Net Income $3.6 $3.6 $7.6

Avg. Net Assets $67.2 $63.2 $67.2

Return on Net Assets 5.4% 5.7% 11.3%

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MTI RONA & ROE History

MTI RONA 2001-2005

2005 2004 2003 2002 2001Net Income $53,264 $58,563 $48,220 $53,752 $49,793

Net Assets $723,593 $751,336 $689,163 $640,774 $509,554RONA 7.4% 7.8% 7.0% 8.4% 9.8%

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Capital Investment

♦ Generally High Dollar, Long-Term, and Strategic Expenditures

♦ Capital Budgeting

♦ Risk/Reward Trade-Off

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Capital Investment Evaluation

♦ Return on Investment

♦ Payback Period

♦ Discounted Cash Flow Methods

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Capital Investment Evaluation-ROI

Return on Investment- ROI♦ ROI = Average Incremental Net Income

Average Incremental Investment♦ MTI’s Principal Focus is on the 5-Year Average ROI♦ ROI is simple to calculate and is directly comparable to returns on other familiar investments and to the company’s cost of capital.

♦ Ignores the time value of money

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Capital Investment Evaluation-Payback

♦ Payback period-length of time to recoup the original investment through the investment’s cash flows.

♦ Focuses on the timing of the cash inflows to measure project risk

♦ Assumes that the longer the payback period the larger the capital project’s risk

♦ Ignores the time value of money and cash flows beyond the payback period

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Capital Investment Evaluation-Discounted Cash Flow

♦ Based on the time value of money concept which assumes a dollar is worth more today than in the future.

♦ Focuses on the “Present Value” of future cash inflows at a specified discount rate-usually MTI’s cost of capital

♦ Cost of Capital• Hurdle Rate, discount rate, opportunity cost

♦ There are two principal methods of discounted cash flow analysis:1. Internal Rate of Return (IRR)2. Net Present Value

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♦ Internal Rate of Return (IRR)♦ IRR is the rate at which the present value of the future cash

inflows (Net Income) of a project are equal to the present value of the project’s cash outflows (capital investment).

♦ The Project’s IRR is compared to MTI’s required rate of return.1. If the project’s IRR is greater than MTI’s required rate of

return the project adds economic value and is accepted.2. If the project’s IRR is less than the required rate of return

the project is not accepted.

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Net Present Value – NPV

♦ Sum of the present value of all cash flows minus original

investment

♦ Discount cash flows at MTI’s cost of capital

♦ Accept projects with NPV > 0, reject those with NPV <0

♦ When NPV =0 the discount rate = IRR

Financial analysis for non finance people

Economy & Finance

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