Financial Analysis Fundamentals - Corporate Finance Club .
Financial Analysis Fundamentalscorporatefinanceinstitute.com
CFI InstructorsMeet the global team of CFI instructorsTim VipondJustin SandersScott PowellCEO & InstructorVancouverInstructorLondonDirector & sa DorianRyan SpendelowDirector & InstructorNew YorkInstructorHong Kong
Vertical and Horizontal Income Statement Analysiscorporatefinanceinstitute.com
Session objectivesLearn the keycomponents of theincome statementBenchmark against othercompanies in the industrycorporatefinanceinstitute.comPerform vertical andhorizontal analysis
Financial analysisThere are many important steps, such as trend and ratio analysis, in preparing a financial analysis.The starting point is the financial e.comBalanceSheetStatement ofCash Flows
Financial analysisThere are many important steps, such as trend and ratio analysis, in preparing a financial analysis.The starting point is the financial statements:Financial analysisInterpret financialresultsPyramid ratioanalysiscorporatefinanceinstitute.comTrend and ratioanalysisBasic ratio analysisFinancial statementsUsing ratio analysis
Components of ratio analysisRatio analysis covers two basic groups.When analysing the income statement, we use performance ratios – specifically those related toprofitability.Ratio analysisPerformance ratiosProfitability ratioscorporatefinanceinstitute.comFinancial leverageratiosEfficiency ratios
A breakdown of the income statementTenselIncome statement millionsYear 1Year 2Year 3Year 4Sales revenues81,42284,69888,23690,637Sales rect costsGross profit43,30146,94251,90947,699Gross profitResearch anddevelopment(5,884)(6,421)(7,893)(6,812)Research General al &administrationEBIT (operating profit)9,1869,2188,9925,368Income from opsInterest(1,073)(1,102)(1,147)(1,182)Interest inc/expTaxes(2,761)(2,429)(2,193)(1,764)TaxesNet income5,3525,6875,6522,422Net incomecorporatefinanceinstitute.comSales revenues are the most important components of theincome statement and are used in several of the ratios seenthroughout the module.Cost of good sold relates to direct labor and raw materialsneeded to create the product or service that is being sold, aswell as depreciation on manufacturing equipment used inproduction.Gross profit tells us what the gross margin is before we takeinto account any other costs needed to keep the companyrunning.Indirect expenses are those required to keep the companygoing. The most common are: research & development,marketing, sales, and general & administration.Operating income is used to pay the government, creditors,and ultimately the shareholders.Net income is the final part of the income statement andrepresents what is remaining to be paid to the shareholders.
Vertical analysisNet ting costsSalesGross stsSalesMaterialcostsSalesWorkoverheadSales
Gross profit marginThere are three key profitability ratios:Gross profitSalescorporatefinanceinstitute.com Grossprofitmargin
Operating profit marginEBITSalescorporatefinanceinstitute.com Operatingprofitmargin
Net profit marginNet incomeSalescorporatefinanceinstitute.com Netprofitmargin
Efficiency ratioThe tax ratio is the efficiency ratio that demonstrates how well managing tax.Tax expensePre-tax incomecorporatefinanceinstitute.com Taxratio
Solvency ratioThe interest coverage ratio tells us whether the company will be able to coverwhat it owes in interest to its creditors.EBIT(DA)Interest expensescorporatefinanceinstitute.com Interestcoverageratio
Horizontal analysisTenselIncome statementCAD millionsYear 1Year 2Year 3Year4Year 5Sales revenues81,42284,69888,23690,637Sales rect costsGross profit43,30146,94251,90947,699Gross profitResearch and development(5,884)(6,421)(7,893)(6,812)Research & neral and administration(2,960)(2,803)(2,762)(2,947)General & administrationEBIT (operating profit)9,1869,2188,9925,368Income from opsInterest(1,073)(1,102)(1,147)(1,182)Interest inc/expTaxes(2,761)(2,429)(2,193)(1,764)TaxesNet income5,3525,6875,6522,422Net incomeUse calculations from the past five years to perform trend analysisand predict future performancecorporatefinanceinstitute.com
Horizontal analysiscorporatefinanceinstitute.com
Benefits of horizontal analysisAre margins rising or failing?Is performance improving or declining?What is causing margins to fall?Are margins impacted by indirect costs?corporatefinanceinstitute.com
BenchmarkingThere are different ways to benchmark: Compare your company to two or more competing companies Compare your company’s ratios to the industry averageYour competitor/Industry averagecorporatefinanceinstitute.comYour company
Sources of benchmarking informationWhere can you find a competitor’s statements? Three key online sites including EDGAR, SEDAR and RNS Competitors’ investor relations websitesHistorical ratios for companies can be found on MSNMoney and Google Finance, but allow very little control overthe information and provide little insights on the calculationof ratios.Professional sources such as Bloomberg, Capital IQ, andequity research reports provide detailed information butare more costly.corporatefinanceinstitute.com
Conclusioncorporatefinanceinstitute.comUnderstand pastperformance, to predictfuture successIncome statement analysis isjust the first step to the overallanalysisUse vertical and horizontalanalysis, as well asbenchmarking, tomaximize your company’sperformanceMake better investmentand credit decisions fromoutside the company
Balance Sheet and Leverage Ratioscorporatefinanceinstitute.com
Session objectivesDetermine the financialstrength of a companyby analyzing thebalance sheetcorporatefinanceinstitute.comUse the balance sheet todetermine how efficiently acompany is being run
Financial analysisThere are many important steps, such as trend and ratio analysis, in preparing a financial analysis.The starting point is the financial e.comBalanceSheetStatement ofCash Flows
Financial analysisThere are many important steps, such as trend and ratio analysis, in preparing a financial analysis.The starting point is the financial statements:Financial analysisInterpret financialresultsPyramid ratioanalysiscorporatefinanceinstitute.comTrend and ratioanalysisBasic ratio analysisFinancial statementsUsing ratio analysis
Financial analysisSalesTotal AssetsSalesCapital AssetsSalesOther FASalesLand & buildingscorporatefinanceinstitute.comSalesWorking AssetsSalesInventorySalesPlant &machinerySalesReceivablesSalesPayablesSalesCash
Components of ratio analysisRatio analysis covers two basic groups:Ratio analysisProfitability ratioscorporatefinanceinstitute.comPerformance ratiosFinancial leverageratiosEfficiency ratiosLiquidity ratioSolvency ratio
Short term liquidity ckratio
Current ratioAccounts � �� c rule of thumb is 2:1corporatefinanceinstitute.comPrepaid expenses
Quick ratio or acid test ratio𝑪𝒖𝒓𝒓𝒆𝒏𝒕 𝒂𝒔𝒔𝒆𝒕𝒔 ��𝒆𝒏𝒕 c rule of thumb is 1:1corporatefinanceinstitute.com
Asset turnover ratio𝑺𝒂𝒍𝒆𝒔 𝑹𝒆𝒗𝒆𝒏𝒖𝒆𝑻𝒐𝒕𝒂𝒍 𝒐𝒓 𝒏𝒆𝒕 𝑨𝒔𝒔𝒆𝒕𝒔Tells us:How efficient is the company in using assets to generate revenue?For every 1 dollar of assets, how many dollars of revenue the company generates?corporatefinanceinstitute.com
ConclusionAlways use trend analysis to determine: What are the ratios doing? Are they improving or deteriorating?Short term liquidity ratios are an early warning signal tocash flow issues.corporatefinanceinstitute.com
Working capital overviewWorking capitalCurrent Asset – Current Liabilitiescorporatefinanceinstitute.com
Working capital overviewWorking capitalInventoryReceivablesOperating activitiescorporatefinanceinstitute.comPayables
Working capital overviewWorking capitalAccountsreceivable Inventory-Operating able
Working capital funding gapCompany buysinventoryCompany paysFor inventoryPayablesCompany sellsgoodsCustomer paysfor goodsReceivableInventoryWorking Capital Funding GapCash outcorporatefinanceinstitute.comCash in
Working capital funding gapWhat would happen to the workingCompany buysCompany paysCompany sellsCustomer payscapitalfundinggoodsgap?inventoryFor inventoryfor rking capital funding gapCash outcorporatefinanceinstitute.comCash in
Working capital funding gapCompany buysinventoryCompany paysFor inventoryCompany sellsgoodsPayablesCustomer paysfor goodsReceivableFaster customerPaymentsInventoryWorking capital funding gapCash outcorporatefinanceinstitute.comDelay companyPaymentsCash in”Just-in-time”
The working capital efficiency ratios2Ratios for eachInventory, Accountsreceivable, Accounts payablecorporatefinanceinstitute.com Working capitalefficiency ratio
InventoryInventory efficiency � 𝑜𝑓 ��𝑦𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝑋 365𝐶𝑜𝑠𝑡 𝑜𝑓 𝑠𝑎𝑙𝑒𝑠Inventoryturnover ratioInventorydays ratio
Accounts receivableAccounts receivable efficiency �𝒔𝑨𝒄𝒄𝒐𝒖𝒏𝒕𝒔 𝒓𝒆𝒄.𝑨𝒄𝒄𝒐𝒖𝒏𝒕𝒔 𝒓𝒆𝒄. 𝑿 𝟑𝟔𝟓𝑺𝒂𝒍𝒆𝒔Receivableturnover ratioReceivabledays ratio
Accounts payableAccounts payable efficiency � 𝒐𝒇 �� 𝒑𝒂𝒚.𝑨𝒄𝒄𝒐𝒖𝒏𝒕𝒔 𝒑𝒂𝒚. 𝑿 𝟑𝟔𝟓𝑪𝒐𝒔𝒕 𝒔𝒂𝒍𝒆𝒔Payableturnover ratioPayabledays ratio
The funding gapInventory days plus accounts receivable days minus accounts payable days will leave you withthe working capital funding gap expressed as days. 60Company buysinventory-30Company paysFor inventoryPayables 30Company sellsgoodsCustomer paysfor goodsReceivableInventoryWorking capital funding gapCash outcorporatefinanceinstitute.comCash in 60
PP&E efficiency ratioProperty, plant and equipment ratioSalesPP&E PP&EturnoverratioIf the ratio is comparatively low, it means either sales are low or you haveinvested too much in PP&E.corporatefinanceinstitute.com
Conclusioncorporatefinanceinstitute.comFinancial analysis isimportant in understandinga company’s financialcondition and performanceUse in conjunction withinformation from the incomestatement to gain valuablecompany insightsWith ratio and trendanalysis you can buildexpectations of futureperformancePerformance can beimproved to increaseoperational efficiencies
Cash Flow Statement and Ratioscorporatefinanceinstitute.com
Session objectivesUnderstand the inflowsand outflows of cashthroughout the yearExamine funding optionsfor an organization lookingto growcorporatefinanceinstitute.comCalculate solvency andleverage ratios
Financial analysisThere are many important steps, such as trend and ratio analysis, in preparing a financial analysis.The starting point is the financial e.comBalanceSheetStatement ofCash Flows
Analyzing cash flow groupsCash flowAssetmanagementEach category of the statement of cashflows enables you to analyze themovement of funds in the companyOperationalmanagementFinancing strategyAsset management relates specifically tothe management of investment in thecompany and is where commitment togrowth can be seen.Operational management refersto the operational strategyfollowed by an organization.Financing strategy reflects decisions madeby management in relation to the”leverage” of the company. Working capital Absorbing Releasing Margin management Debt / Equity Volume management Long-term / Short-term Operating profit Other instruments Capital expenditure amortization amortization Acquisitionscorporatefinanceinstitute.com Interest / Dividends
Understanding debtThere are many options available when looking for debt financing:DebtOperating line ofcreditOverdraftWorking capitalfunding gapcorporatefinanceinstitute.comTerm loansPurchase assets
Debt financing Bonds are a common form of debt financing The normal contract with rate of interest is called the ”coupon” Issuing bonds is a common method of raising funds Most useful in funding long-term investments““A bond is a debt instrument requiring the issuer (also called the debtor orborrower) to repay to the lender/investor the amount borrowed plus interest oversome specified period of timecorporatefinanceinstitute.comSource: Frank Fabozzi BondMarket analysis & strategies
Types of bondsFixed rateFloating rateZero couponcorporatefinanceinstitute.com Have coupons that remainconstant throughout the life ofthe bond Have coupons linked to aninterest rate benchmark Coupon reset periodically (e.g.every 3 months) Pay no interest Trade at a discount from theirvalue at maturityInflationlinked Principal amount indexed toinflation Interest rate is fixed, but principaland interest payments growCallable The issuer has the right to repaythe bond before the maturitydateConvertible Can be converted into shares ofstock in the issuing company
Warrants and convertibles comparedBonds with warrants Tend to be more common inprivate placements The warrant can be detached Warrants are exercised for cashcorporatefinanceinstitute.comConvertible bonds Convertible bonds are issuedpublicly The bond and the option arebundled together Bonds are exchanged forcommon stock
Types of syndicated loansSyndicated lending is where two or more banks provide credit to one borrower in one agreement.Term poratefinanceinstitute.comA loan with a fixed maturity and normally featuring the amortization ofprincipalOffering the borrower the right, but not the obligation to draw a loanLines only expected to be used in extraordinary circumstances (e.g.commercial paper backup)
Leasing as an optionWhen an asset is leased, it remains the property of the lessor. Different accounting standards treat leasesdifferently depending on how the lease is structured.Capital (finance) leaseOperating leaseUsually longer term; most of therisks and rewards of ownershiptransfer to lesseeUsually shorter term; risks andrewards do not transfer to thelesseeRecorded on balance sheetRecorded in income statementcorporatefinanceinstitute.com
Leasing as an optionA capital of finance lease is a way to borrow funds forassets directly through the assets’ ownerCapital (finance) leasecorporatefinanceinstitute.com
Leasing as an optionAn operating lease is a way to obtain use of an asset untilit is no longer required or usefulOperating leasecorporatefinanceinstitute.com
Who can tap into the debt marketsTo raise debt financing Show a history of profitability Have assets that can be pledged as securityIf a company is not yet profitable Raise equity financing Dilute the existing shareholder to raise capitalcorporatefinanceinstitute.com
Equity types – common sharesEquity consist largely of common shares. Ownership of common shares normally entitles the holder to:Voting rightsOwnershipResidual claimcorporatefinanceinstitute.comA right to vote on appointments to the board of directorsAn equal share in earning after obligations to debt holders and preferredstockholders are metA residual claim on the business and therefore have the ultimate control of thecompany’s affairs
Equity types – preferred share varietiesCumulative Entitle holder to fixed rate ofdividend and if unpaid arrearscumulateParticipating Have extra rights. In addition toreceiving fixed dividend alsoparticipate in company’ssurplus profitRedeemable Will be redeemed at a specifiedfuture date at the option ofeither the company of ible Right to convert the preferredstock into common stock at aspecified future date at aspecified rate of conversionRetractable Right to “retract” the share andpay the owner in cash at aspecified price at maturity
Retained earningsShare atefinanceinstitute.com
Managing the financing of business - leverageLeverage expresses the relationship between funding provided by lenders and fundingprovided by shareholders.High leverageLow leverage20Equity8080Long and shortterm debtLong and shortterm debt20Capital employed (100)corporatefinanceinstitute.comEquityCapital employed (100)
Growing the business using debtInvestment inassetsInvest in PP&EIncrease cash working om
Growing the business using debtThis is how you increase the leverage of the company by increasing debt rather than equity.Investment inassetsIncrease debtBorrow from the bankDebtAssetsEquitycorporatefinanceinstitute.com
The benefits of leverageLeverage is effective for a number of reasons:Reason 1It is often very quickand inexpensive toobtain a loan ofextension of a line ofcredit from the bankcorporatefinanceinstitute.comReason 2Reason 3Reason 4A short term line of creditmay be ideal forincreasing inventory for aseasonal business, and along term fixed paymentloan for a significantinvestment in equipmentto be used to increaseproduction over a longertime periodIncreasing debt thecurrent shareholders canincrease the value of thecompany without havingto reduce their share ofthe companyIf a company requires alarge amount of fundsintended for long termuse and investment inthe company, a shareoffering may be the bestoption
An effective capital structureCost %Debt is expensiveDebtFirm valueCost offundsEquity40 %corporatefinanceinstitute.com60 % Leverage %
An effective capital structureCost %Pay out more dividendsBuy back sharesFirm valueCost offundsDebtEquity40 %corporatefinanceinstitute.com60 % Leverage %
An effective capital structureCost %Debt is expensiveFirm valueCost offundsDebtEquity40 %corporatefinanceinstitute.com60 % Leverage %
An effective capital structureCost %“Sweet spot”Firm valueCost offundsDebtEquity40 %corporatefinanceinstitute.com60 % Leverage %
Leverage ratiosThere are several different ratios to use in order to assess the leveraging of a company:Debt toequity (or debtto capital) 𝑰𝒏𝒕𝒆𝒓𝒆𝒔𝒕 𝒃𝒆𝒂𝒓𝒏𝒊𝒏𝒈 ��𝒕𝒂𝒍 𝒔𝒉𝒂𝒓𝒆𝒉𝒐𝒍𝒅𝒆𝒓′ 𝒔 𝒆𝒒𝒖𝒊𝒕𝒚If the ratio is greater than 100%, more of an organization’sfunding comes in the form of debt rather than equityDebt toTNW* 𝑰𝒏𝒕𝒆𝒓𝒆𝒔𝒕 𝒃𝒆𝒂𝒓𝒏𝒊𝒏𝒈 ��𝒖𝒊𝒕𝒚 𝑰𝒏𝒕𝒂𝒏𝒈𝒊𝒃𝒍𝒆 𝒂𝒔𝒔𝒆𝒕𝒔A ratio of 1 would be reasonable, but if it’s greater than 1,then attention should be paid to how a company is managingits financing activitiesTotal liabilitiesto equity 𝑻𝒐𝒕𝒂𝒍 ��𝒖𝒊𝒕𝒚Total assetsto equity 𝑻𝒐𝒕𝒂𝒍 𝒂𝒔𝒔𝒆𝒕𝒔𝑬𝒒𝒖𝒊𝒕𝒚If the ratio is low, the company may be underleveraged. If thecompany number is high, then the organization, while takingadvantage of debt, may be over-leveredDebt to EBITDA 𝑰𝒏𝒕𝒆𝒓𝒆𝒔𝒕 𝒃𝒆𝒂𝒓𝒏𝒊𝒏𝒈 ��𝑰𝑻𝑫𝑨This ratio is used to assess the amount of leverage relative toEBITDA, this ratio is commonly used by lenders. Can range byindustry from 1 – 5 timescorporatefinanceinstitute.comThe ratio would be used with conjunction with the debt toequity ratio to determine the impact that operationalliabilities has on the funding of the business
Conclusioncorporatefinanceinstitute.comAnalyze how management israising and using funds byreviewing cash flow of thebusinessDescribe all the benefits andpossible pitfalls of leverageUnderstand how leveragecan be altered using avariety of debt and equityoptionsThe cash flow analysis is oneside
Money and Google Finance, but allow very little control over the information and provide little insights on the calculation of ratios. Professional sources such as Bloomberg, Capital IQ, and equity research reports provide detailed information but are more costly.
Finance Volume 1 Ross et al. Fundamentals of Corporate Finance, Sixth Edition, Alternate Edition Front Matter 1 Preface 1 I. Overview of Corporate Finance 33 1. Introduction to Corporate Finance 33 2. Financial Statements, Taxes, and Cash Flow 55 II.
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