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Financial Analysis & Forecasting

Fin 601

Corporate Financial Management

LeBow College of Business

US_Composite_Corp.xls

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Common Size Financial Statements

Standardized Financial Statements

Balance Sheet % of total assets

Income Statement

% of sales

Statement of Cash Flows?

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Ratio Analysis

Who performs ratio analysis?

Outsiders: creditors/investors Insiders: management

How do you use ratio analysis?

Cross sectional comparison

Time series analysis

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Group 1: Liquidity Ratios

Current Ratio

Quick Ratio

CLCACR

CL

INVCAQR

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Group 2: Leverage Ratios/

Debt Management Ratios

Debt Ratio

Debt/Equity Ratio

LTD/Equity Ratio

TA

TDDR

TE

TDED /

TE

LTDEdebttermLong /

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Group 2: Leverage Ratios/

Debt Management Ratios

Times Interest Earned Coverage Ratio

Interest

EBITTIE

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Group 3: Activity/Turnover Ratios

Receivables Turnover

Average Collection Period/Days Sales Outstanding

RA

SalesARTO

/

ARTODSO

365

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Group 3: Activity/Turnover Ratios

Inventory T-O

Days Sales in Inventory

INV

CGS

TOINV

TOINVDSI

365

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Group 3: Activity/Turnover Ratios

Total Asset Turnover

TA

SalesTATO

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Group 4: Profitability Ratios

Gross Profit Margin

Operating Profit Margin

Net Profit Margin

Sales

CGSSalesGPM

)(

Sales

EBITOPM

SalesEBITDA

Sales

NINPM

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Group 4: Profitability Ratios

Return on Assets

Return on Equity

TANIROA

TE

NIROE

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Group 5: Valuation Ratios

Price-Earnings

Market to Book

Enterprise Value to EBITDA

where EV = Market Cap of the stock + market value of interest bearing debt - cash

EPS

sharepericePE

Pr

sharepervalueBook

sharepervalueMarketBM /

EBITDA

EV

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Exercise

Excel Spreadsheet: US_Composite_Corp.xls

Compute ratios listed in ratio analysis tab

Additional data needed:

Current price = $90/share

# of shares outstanding = 29M

PAUSE NOW

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The ROE / ROA disparity?

The Dupont Identity

ROE= (profit margin) x TATO x Equity Multiplier

TE

TAx

TA

Salesx

Sales

NIROE

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DuPont Calculation

ROE PM TATO

Equity

Multiplier

USComposite

.11 .04 1.2 2.32

IndustryAverage

.15 .02 1.25 6

Note: Industry average DR = .833 so TE/TA = 1-.833=.167 and TA/TE = 1/.167= 6

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Return on Invested Capital

If a firm is an all equity firm, how will the ROICand ROE compare?

ROE = ROIC

TETDtEBITROIC

)1(

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Pro forma financial statements

pro forma

Historical relationships Sales forecast

Goal: estimate the amount of financingneeded for the upcoming period

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A simple start

Income Statement

Sales 2262Costs 2176

Net Income 86

Balance Sheet

Fixed Assets 1879 Long term debt 1074

Equity 805

Total 1879 1879

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Construct a pro-forma income statement and balance sheetassuming sales grow by 20% and all other accounts are a fixed

percentage of sales.

Income Statement

SalesCosts

Net Income

Balance Sheet

Fixed Assets Long term debt

Equity

Total

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Construct a pro-forma income statement and balance sheetassuming sales grow by 20% and all other accounts are a fixed

percentage of sales.

Income Statement

Sales 2714Costs

Net Income

Balance Sheet

Fixed Assets Long term debt

Equity

Total

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Construct a pro-forma income statement and balance sheetassuming sales grow by 20% and all other accounts are a fixed

percentage of sales.

Income Statement

Sales 2714Costs 2611

Net Income

Balance Sheet

Fixed Assets Long term debt

Equity

Total

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Construct a pro-forma income statement and balance sheetassuming sales grow by 20% and all other accounts are a fixed

percentage of sales.

Income Statement

Sales 2714Costs 2611

Net Income 103

Balance Sheet

Fixed Assets Long term debt

Equity

Total

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Construct a pro-forma income statement and balance sheetassuming sales grow by 20% and all other accounts are a fixed

percentage of sales.

Income Statement

Sales 2714Costs 2611

Net Income 103

Balance Sheet

Fixed Assets 2255 Long term debt

Equity

Total 2255

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Construct a pro-forma income statement and balance sheetassuming sales grow by 20% and all other accounts are a fixed

percentage of sales.

Income Statement

Sales 2714Costs 2611

Net Income 103

Balance Sheet

Fixed Assets 2255 Long term debt 1289

Equity

Total 2255

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Construct a pro-forma income statement and balance sheetassuming sales grow by 20% and all other accounts are a fixed

percentage of sales.

Income Statement

Sales 2714Costs 2611

Net Income 103

Balance Sheet

Fixed Assets 2255 Long term debt 1289

Equity 966

Total 2255

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Construct a pro-forma income statement and balance sheetassuming sales grow by 20% and all other accounts are a fixed

percentage of sales.

Income Statement

Sales 2714Costs 2611

Net Income 103

Balance Sheet

Fixed Assets 2255 Long term debt 1289

Equity 966

Total 2255 2255

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Whats the problem?

Think of the link between the IS and the BS!=> RE = NI - dividends

Balance Sheet

Fixed Assets 2255 Long term debt

Equity

Total 2255

PAUSE NOW

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Whats the problem?

Think of the link between the IS and the BS!=> RE = NI - dividends

Balance Sheet

Fixed Assets 2255 Long term debt

Equity

Total 2255 2255

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Whats the problem?

Think of the link between the IS and the BS!=> RE = NI - dividends

Balance Sheet

Fixed Assets 2255 Long term debt

Equity 908

Total 2255 2255

=805+103

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Whats the problem?

Think of the link between the IS and the BS!=> RE = NI - dividends

Balance Sheet

Fixed Assets 2255 Long term debt 1347

Equity 908

Total 2255 2255

=805+108

=2255 - 908

(PLUG)

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A more complex example

Refer to the Excel file:US_Composite_Corp.xls

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Excess Capacity

Suppose US Composite is operating at 70%capacity.

The need for additional Fixed Assets may bereduced or eliminated

How much can sales grow before additional

Fixed Assets are needed?30%/70% = 43%

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Feedback effects

Additional financing (debt or equity) results inincreased payments (interest or dividends)which effects the level of RE available forplowback into the firm, further increasing theneed for financing.

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Uses of pro forma statements

Sensitivity Analysis

Scenario Analysis

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How can we apply this to our own

work lives?

Understanding of financial statements andthe analysis process helps to gain anoverview look of the firm.

The ROIC Ratio