SESSION OBJECTIVES
At the end of this session participants should be able to:
Understand the FIO model
Understand the process of value creation
Identify the drivers of value
Identify links between financial statements
The Process of Value Creation
Creating economic value for the owners
Selecting and sourcing prudent funding options
Selecting and makingsound resource commitments
Operating resources in a competitive,
cost-effective manner
The three basic decisions made by management
Operating Decisions
Financing Decisions
Investment Decisions
The Three Basic Business Decisions
INCOME STATEMENT ANALYSIS
THE INCOME STATEMENT
• IT IS OF PRIME IMPORTANCE TO CEO
• IT IS A PERIOD STATEMENT
• IT IS BASED ON THE ‘MATCHING’ PRINCIPLE
• STATEMENT OF VALUE CREATION
REVENUE - EXPENSES = INCOME
INCOME STATEMENT CLASSIFICATIONS
SALES PRICE X VOLUMEREVENUE
EXPENSES PRODUCT VS. DIRECT VS. PERIOD COST INDIRECT COST
INCOME DIVIDENDS + RETAINED EARNINGS
-
= VARIABLE VS FIXED COST
INCOME STATEMENT ITEMS
REVENUE Price X Volume- COST OF GOODS SOLD Product Cost Direct Expense Fixed and Variable Expense- SELLING,GENERAL, AND ADMINISTRATIVE Period Cost, Indirect Expense, Fixed and Variable Cost - INTEREST Financing Cost- TAXES= NET INCOME
COMMON SIZED ANALYSIS
COMMON SIZE ANALYSIS CONVERTS EACH ITEM ON THE INCOME STATEMENT INTO A PERCENTAGE IN ORDER FOR ANALYSIS TO BE PERFORMED ON A COMMON BASIS. EACH ITEM IS EXPRESSED AS A PER CENT OF REVENUES.
• PERCENT OF TOTAL
• APPLES AND APPLES
• IDENTIFY TRENDS
COMMON SIZED ANALYSISTHE INCOME STATEMENT FACSIMILIE CO.
For the Period Ending 12/31/XXREVENUES $ 7523 100%
- COST OF GOODS SOLD 4849 65
= GROSS MARGIN 2674 35
- S.G.& A. 1524 20
= OPERATING INCOME 1150 15
- INTEREST EXPENSE 160 2
= NET INCOME BEFORE TAX 990 13
- TAXES ON INCOME 336 5
= NET INCOME 594 8
PERCENT ANALYSISALLOWS ONE TO TRACK CHANGES IN FINANCIAL STATEMENTS FROM ONE REPORTING PERIOD TO THE NEXT
CALCULATE THE CHANGE IN AN ITEM, THEN,
DIVIDE THAT BY PREVIOUS YEARS TOTAL
EXAMPLE: PERCENT CHANGE = (THIS YEAR - LAST YEAR) DIVIDED BY LAST YEAR
PERCENT CHANGE FOR COST OF GOODS:
(5625 - 4849) / 4849 = 16.0%
INCOME STATEMENT RATIOS
RETURN ON SALES Net Income / Total Sales
GROSS MARGIN Gross Margin / Total Sales
S. G. & A. RATIO S.G.&A. Expenses / Total Sales
INTEREST COVERAGE Operating Income / Interest Expense
OPERATING MARGIN Operating Income / Sales
NET MARGIN Net Income / Sales
INCOME STATEMENT- LINKS TO BALANCE SHEET
BALANCE SHEET INCOME STATEMENT
ACCOUNTS RECEIVABLE REVENUES
INVENTORY - COST OF GOODS
- OTHER EXPENSES
RETAINED EARNINGS =NET INCOME
LIMITATIONS OF INCOME STATEMENT
• EXPENSES ARE NOT DETAILED
• DEPRECIATION AND COST OF GOODS ARE UNDERSTATED IN INFLATIONARY PERIODS
• CAPITALIZATION VS. EXPENSING
• IGNORES THE COST OF EQUITY FINANCING
SUMMARY
• INCOME STATEMENT PROVIDES INFORMATION REVENUES
EXPENSES
NET INCOME
• YOU HAVE LEARNED HOW TO CALCULATE AND ANALYZE THE INCOME STATEMENT USING:
COMMON SIZE ANALYSIS
PERCENT CHANGE ANALYSIS
• ANALYSIS DOES NOT SHOW UNDERLYING CAUSES
BALANCE SHEET ANALYSIS
THE BALANCE SHEET• IT IS A SNAP SHOT SHOWING WHAT THE COMPANY OWNS AND OWES AT A POINT IN TIME
• HOW MUCH DID WE INVEST?
• HOW IS THE INVESTMENT FINANCED?
• WHAT ASSETS DO WE OWN?
TANGIBLE/ INTANGIBLE
SHORT TERM/ LONG TERM
• ASSETS = LIABILITIES + OWNERS’ EQUITY
• IT IS OF PRIME IMPORTANCE TO CFO
THE BALANCE SHEET
CURRENT ASSETS
FIXED ASSETS
CASH
A/R
INVEN-TORY
OTHER
NET P.&E.
OTHER
CURRENT LIABILITIES
LONG TERM LIABILITIES
OWNER’S EQUITY
=
ACCTS.PAYABLE
WAGES PAYABLE
ACCRUALS
LONG TERM DEBT
RETAINED EARNINGS
INVESTMENT IN FIXED ASSETS
DEPRECIATION EXPENSE
ACCUMULATED DEPRECIATION
DEPRECIATION METHODS STRAIGHT LINE
ACCELERATED
BOOK VALUE
ECONOMIC VALUE
INVESTMENT IN WORKING CAPITAL
• WORKING CAPITAL = CURRENT ASSETS - CURRENT LIABILITIES
• MEASURES THE NET INVESTMENT IN OPERATING CASH CYCLE
• WORKING CAPITAL NECESSARY TO:
PRODUCE PRODUCT
MAINTAIN DAY-TO-DAY OPERATIONS
MAKE SALES
CAPITAL
• DEBT + OWNER’S EQUITY = INVESTED CAPITAL
• ANY INVESTMENT EARNING RETURNS IS CAPITAL
DEBT: INTEREST
EQUITY: DIVIDENDS & STOCK PRICE
• BALANCE SHOWS HOW ASSETS WERE FINANCED
• LEVERAGE: PROPORTION OF CAPITAL FROM DEBT
INVESTMENT
CAPITAL FROM INVESTMENT
SHORT TERM LOANS WORKING CAPITAL
LONG TERM DEBT = +
OWNER’S EQUITY FIXED ASSETS
THE RETURN TO THE PROVIDERS OF CAPITAL COMES FROM THE EARNINGS FROM INVESTMENTS
THE BALANCE SHEET AND MANAGEMENT ACTION
WORKING CAPITAL LONG TERM LIABILITIES CREDIT POLICY DEBT POLICIES
PRODUCTION SCHEDULES PENSIONS
PAYMENT POLICY TAX DEFERMENT
FIXED ASSETS OWNER’S EQUITY
EQUIPMENT PURCHASES STOCK ISSUANCE
ACQUISITIONS REPURCHASE
LONG TERM INVESTMENTS DIVIDEND POLICY
BALANCE SHEET RATIOSQUICK RATIO
DEBT AS A PERCENT OF CAPITALIZATION
DEBT TO EQUITY
FINANCIAL LEVERAGE
DAY’S SALES O/S
INVENTORY TURNOVER
Current Assets - Inventories
Current Liabilities
Total DebtDebt + Equity
Total DebtEquity
AssetsEquity
Accounts Receivable
Average Daily Credit Sales
Cost of Goods SoldAverage Inventory
BALANCE SHEET- LINKS TO THE INCOME STATEMENT
BALANCE SHEET INCOME STATEMENT
ACCOUNTS RECEIVABLE REVENUES
INVENTORY - COST GOODS
- OTHER EXPENSES
RETAINED EARNINGS = NET INCOME
LIMITATIONS OF THE BALANCE SHEET
• HISTORICAL COST RESULTS IN UNDERVALUED ASSETS SUCH AS REAL ESTATE
• SOME LIABILITIES NOT RECORDED (OFF BALANCE SHEET FINANCING)
• INTANGIBLE ASSETS MIS-PRICED
• BALANCE SHEET LOOKS BACKWARD
SUMMARYBALANCE SHEET PROVIDES KEY INFORMATION
• SIZE OF ACCOUNT BALANCES
• NEW INVESTMENTS
• FINANCING OF NEW INVESTMENTS
FINANCIAL TOOLS AVAILABLE TO ANALYZE BALANCE SHEET
• PERCENT CHANGE
• COMMON SIZE
• RATIO ANALYSIS
CASH FLOW STATEMENT
WHY EXAMINE CASH FLOW?A COMPANY IS A COLLECTION OF PROJECTS EACH GENERATING CASH. CASH FLOW STATEMENTS TOTAL THE SOURCES AND USES OF CASH FOR ALL PROJECTS.
CASH FLOW STATEMENT ANALYSIS ALLOWS US TO DETERMINE:
• NEED FOR EXTERNAL FUNDING
• ABILITY TO PAY CASH RETURN TO INVESTORS
• RELATIONSHIP BETWEEN INVESTMENT AND GENERATION OF CASH
• IT IS OF PRIME IMPORTANCE TO COO
THE CASH FLOW CYCLE
FOUR STAGES
• FINANCING
• INVESTING
• OPERATING
• RETURNING
Financing Investing
OperatingReturn
ing
THE CASH CYCLE-FINANCING
(OWNER’S ) (LENDERS)
CASH
EQUITY LIABILITIES
THE CASH CYCLE-INVESTING
CASH
FIXED ASSETSLABOR, MATERIALS,
OVERHEAD,ETC.
INVENTORY
THE CASH CYCLE-OPERATING
INVENTORY
SALE
REVENUE
I.O.U.
ACCOUNTS RECEIVABLECASH
SG&A
THE CASH CYCLE- RETURNING
OWNERS LENDERS
EQUITY LIABILITIES
CASH
TAXES
THE CASH CYCLE
ACCOUNTS RECEIVABLECASH
TAXES
FIXED ASSETS
LAB, MTLS, ETC SG&A
INVENTORY REVENUE
EQUITY LIABILITIES
THE CASH FLOW STATEMENTRECONCILES THE BEGINNING AND ENDING CASH BALANCES
CATEGORIZES CASH FLOW BY ACTIVITY
• OPERATING
• INVESTING
• FINANCING
CASH FLOWS FROM OPERATIONS
CASH FLOWS FROM INVESTING
+
CASH FLOWS FROM FINANCING
+
NET CHANGE IN CASH
=