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1 Structured Problem Solving using the 7 step methodology Conducting Analysis Agenda for today‟s session

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Page 1: Problem Solving

1

• Structured Problem Solving – using the 7 step methodology

• Conducting Analysis

Agenda for today‟s session

Page 2: Problem Solving

•Understanding and articulating the client problem that the project will solve.

•Thinking creatively about innovative, value-adding way to solve the client problem

•Decomposing the problem into key issues to analyze and hypotheses to test

Taking complex problems, analysing them and communicating findings so that clients want to take action

Essence of a good consultant How????

Problem solving is the essence of consulting……

Page 3: Problem Solving

3

The 7-step problem solving methodology is a structured approach

to problem solving and makes use of logical tools at each step….

1

Define problem

2

Structure

problem

3

Prioritize

issues 4

Plan

analyses

and

work

5

Conduct

Analyses

and work

6

Synthesise

findings

7

Develop

recomm

endations

Clientproblem

xxxx

xxxxxx

xxxxxx

xxxxxx

xxxxxx

xxxxxx

xxxxxx

xxxxxx

xxxxxxxx

xxxxxxxx

Think impact: what

do I need to know

and how do I frame

the problem?

Think disaggregation and

early hypothesis: what

could be the key elements

of the problem and do

they create early insight

into the answer?

Think IMPACT and

EFFICIENCY: which

parts of the tree are

most important for

me to focus on?

Think effectiveness:

How can the

resources be utilized

optimally?

Think answers not

analysis: what is the

simplest fact-based

approach that will prove/

disprove each issue?

Think “So what”: how do

I use the findings to tell a

compelling story?

Think buy-in and

actionable solution

: Is it clear what the

client needs to do

and how to do it?

Think next iteration:

what are user/team‟s

next priorities?

Communication

Page 4: Problem Solving

4

Step 1: Problem Definition

SOURCE: McKinsey

2

structure

problem

3

Prioritize

issues 4

Plan

analyses

and

work

5

Conduct

analyses

6

Synthesis findings

7

Develop

recomme-

ndations

Clientproblem

1

Define problem

Think impact: what

do I need to know?

Page 5: Problem Solving

5

Problem definition worksheet is a tool that consultants use

during the problem definition stage

Basic question to be resolved

Perspective and context Stakeholders

Criteria for success Scope of solution space

Defines success for the project. Must be

shared by client and the engagement

team. Should include relevant

quantitative and qualitative measures

e.g. visible improvements, effect on staff

mindset, market share growth, etc

Identifies primary decision makers (e.g.,

CEO, Division Manager) as well as internal

and external parties can support( or derail)

the project (e.g., shareholders, regulatory

authorities, SBU managers).

Indicates what will and will not covered

by the engagement team. Including

accuracy and quality expectation.

Defines what must be resolved to deliver impact for the client. The question should

be SMART. The more specific the statement the better, provided it is not so narrow

that the “wrong” problem is addressed

Spells out the situation and complication

facing the client e.g., trends in the

industry, relative position in the industry

etc

Think

SMART

Defines the limits of the set of solutions

that can be considered – e.g. team can

only consider organic growth and not

inorganic

Constraints within solution space Key sources of insight

Research on where expertise,

knowledge, engagement methodology

exist both internally (within the firm) and

externally (client, specialist firms etc)

e.g. Practice databases,

Page 6: Problem Solving

6

• Specific

• Measurable

• Action-oriented

• Relevant (to the key problem)

• Time-bound

“SMART” stands for…..

Page 7: Problem Solving

PROBLEM STATEMENT WORKSHEET – EXAMPLE

Perspective/context Decision makers/stakeholders1 3

Criteria for success Scope of solution space 2 4

5Constraints within solution space

Basic question to be resolved

How can ABC Bank close the N1 billion profitability gap in 2 years and create a sustainable economic platform for the future?

• Consolidation• Deregulation leading to many new non-traditional

players e.g. microfinance banks• Banking crisis • Emergence of internet and electronic-banking

• CEO of ABC Bank

• ABC Board of Directors

• Shareholders

• CBN

Close the N1billion gap within 2 years • Focus on retail banking only

• Focus on Nigeria only

Keep operating the bank as an independent

company

Key sources of insights

Pass studies on banking, CBN website, Financial

and banking databases and journals etc

6

Page 8: Problem Solving

8

1

Define problem

2

Structure

problem

3

Prioritize

issues 4

Plan

analyses

and

work

5

Conduct

Analyses

and work

6

Synthesise

findings

7

Develop

recomm

endations

Clientproblem

Think disaggregation and

early hypothesis: what

could be the key elements

of the problem and do

they create early insight

into the answer?

Communication

Step 2: Problem Structuring

Page 9: Problem Solving

Key advantages

• Facilitates problem-solving

– Parts of problem easier to

handle

– Ensures completeness

– Focus topics more easily

recognisable

• Facilitates planning

– Working in parallel possible

– Difficulties easier to detect

– Scheduling more transparent

– Goal-oriented approach

• Facilitates communication

– Concentration on key topics

– Context clearer

Principle of structured problem solving

SOURCE: McKinsey

Page 10: Problem Solving

Logic trees are tools that help to systematically structure a problem

Mutually

Exclusive

Collectively

Exhaustive

First line of support

Second line of support

ProblemStatementWorksheet

Basic question to be resolved

Relevant

Consis

tent

Consis

tent

Page 11: Problem Solving

Logic trees are the link between the problem statement worksheet

and a list of manageable questions

Sub-issue

Sub-issue

Sub-issue

Sub-issue

Sub-issue

Sub-issue

Issue/

hypothesis 1

Issue/

hypothesis 2

Issue/

hypothesis 3

Problem

statement

Why use logic trees?

1.

2.

3.

4.

To break a problem into component parts so that• Problem-solving work can be

divided into intellectually manageable pieces

• Priorities can be allocated to individuals

To maintain the integrity of the problem-solving approach• Solving the parts will really solve

the problem• The parts are mutually exclusive

and collectively exhaustive (i.e., no overlaps, no gaps)

To build a common understanding within the team of the problem-solving framework

To help focus the use of organizing frameworks and theories

Page 12: Problem Solving

Problem/Issue

Problem/Issue

Hypothesis-Driven – How?

Starts with a potential solution and develop a rationale to validate or disprove it

Data-Driven – “Why?”

Starts with the problem and decompose it to arrive at a solution.

Difference between issue tree and hypothesis tree

Page 13: Problem Solving

M

E

C

E

utually

xclusive

ollectively

xhaustive

Mutually exclusive:

Statements do not overlap

in content

Collectively exhaustive:

Statements jointly fully describe the

problem and/or the statement at the

next highest level

“MECE” means – a problem that has no overlaps and presented

in its entirety

SOURCE: McKinsey

Page 14: Problem Solving

FRAMING THE PROBLEM – ISSUE TREE EXAMPLE

How can

Acme

increase

profits from

existing

business

lines?

From

Widgets

From

Thrum-mats

From

Grommets

Increase

Revenues

Decrease

Expenses

Decrease

raw

material

costs

Decrease

labor

costs

Decrease

overhead

costs

Negotiate wage concessions

Implement a labor-saving

production process

Which Product Lines?

How? How? How?

Negotiate higher productivity

quotas

Page 15: Problem Solving

15

Why has the

machine stopped?

• The overload

fuse has blown

Why did the over-

load fuse blow?Why wasn‟t there

enough oil?

• The oil pump

doesn‟t pump

enough oil• Because the oil

strainer is

blocked with

metal swarf

Why has the shaft

worn?

• Because the

shaft has worn

Why doesn‟t the

oil pump work

properly?

Ask „Why?‟ until

you get to the bottom

of the problem

1

2

3

4

5

Most times, we need to deep dive to get to the root cases of problem.

5-why‟s is a useful tool that underpins the issue tree framework in the

investigation of root causes….

ILLUSTRATIVE

• There was not

enough oil on

the shaft

Page 16: Problem Solving

16

1

Define problem

2

Structure

problem

3

Prioritize

issues 4

Plan

analyses

and

work

5

Conduct

Analyses

and work

6

Synthesise

findings

7

Develop

recomm

endations

Clientproblem

Think IMPACT and

EFFICIENCY: which

parts of the tree are

most important for

me to focus on?

Communication

Step 3: Prioritisation of issues

Page 17: Problem Solving

• First step in constant, iterative

refinement process

– Porpoise between

hypotheses/theories and data

– Use 80/20 thinking

• „High grades‟ your effort on what is

most important

• Always ask „so what‟ … but also

ask what you‟ve forgotten

• Eliminating nonessential issues is

the key to having a reasonable

lifestyle on a difficult study

Eliminate nonessential issues

Problem

statement

Issue 1

Issue 2

Issue 3

Eliminated issues

Page 18: Problem Solving

18

Use judgement/intuition

Do back-of-the-

envelope calculations

Involve the team

Take risks

Focusing on

impact

Polishing

Be practical!

Use the 80/20 philosophy

20

80

80

20

Time and

effort

Benefit for

problem

solving

Page 19: Problem Solving

Efforts to structure the

problem

Requirements for analysing problems

• Focus on the main starting points of

the problem

• No gaps, no overlaps (MECE)

• Logical hierarchy of levels

• Logical elements are consistent on

individual levels

Time and effort invested

in analysing the problem

Benefits for

problem-solving

20% 100%

No cost

efficienc

y

80%

100%

Attempt to

be MECE

Attempt to be perfect

Benefits of the 80/20 rule for problem solving

Page 20: Problem Solving

20

Low High

Impact

Lo

wH

igh

Ea

se

of

imp

lem

en

tati

on

Developed solutions can be prioritised along 2 dimensions through

the prioritisation matrix

Page 21: Problem Solving

21

1

Define problem

2

Structure

problem

3

Prioritize

issues 4

Plan

analyses

and

work

5

Conduct

Analyses

and work

6

Synthesise

findings

7

Develop

recomm

endations

Clientproblem

xxxx

xxxxxx

xxxxxx

xxxxxx

xxxxxx

xxxxxx

xxxxxx

xxxxxx

xxxxxxxx

xxxxxxxx

Think effectiveness:

How can the

resources be utilized

optimally?

Communication

Step 4: Plan analyses and work

Page 22: Problem Solving

Early Do not wait for data, critical mass, or anything else

Often Revise, update, and improve as you porpoise

through the data

Specific Be very specific on analysis and source

Syndicated Test with team members, try alternative hypotheses

Realistic Make it manageable and realistic otherwise it will not

be used

Best practice work planning

Page 23: Problem Solving

Issue End product

Description

Should ABC

Bank invest

N200 M in

acquiring

Virgin

Bank?

• An issue is typically

an important

unresolved question,

phrased so that it

can be answered

“yes” or “no”

• The end

products is a

statement of

the output from

the analysis

• Yes, Virgin Bank is

the best option for

ABC Bank to

establish skills and

assets quickly

compared with both

organic growth and

other acquisition

options.

Hypothesis

• The hypothesis is a

statement of the

likely resolution of

the issue; it

includes the reason

for answering yes

or no

Analysis

• The analysis defines

the work necessary

and sufficient to

prove or disprove the

hypothesis or resolve

the issue

• Assessment of

organic options for

growth – time, risk

etc

• Comparison of other

local banks in the

market as well as

acquisition options

• Cash flow, NPV

• April 3, Tunde

Responsibility/

timing

• Financial

forecast and

value of

investment

• Responsibility

identifies the

person who will

obtain the data

and undertake

the analysis.

Also the

completion due

date

Source

• The source

identifies the

likely location or

means of

obtaining data to

undertake

analysis

• Analyst reports

on Nigerian

banking industry

• In-house

financial and

banking

specialists

• M&A valuation

methodology

Yes or no? How or why?

Developing the analysis sheet

Page 24: Problem Solving

DESIGNING THE ANALYSIS – WORKPLAN EXAMPLE

Issue/Hypothesis

Can we implement

the new production

process? Yes

Does the process

require new

facilities? No

If it does require

new facilities, can

we acquire them

economically?

Yes

Analyses

Technical

specifications

List of facilities that

meet new criteria

Map of “facilities

gap”

Sources of required

facilities/equipment

Cost to fill gaps

Effect on project

rate of return

Data Sources

Articles, interviews

Facilities management,

interviews

Facilities management,

thrum-mat line

supervisors, interviews

Operations, trade

publications

Operations, contractors,

interviews

Finance department,

prior analysis

End Product

Chart

List

Chart

List

Table

Spreadsheet

Responsibility

Tom

Tom

Belinda

Belinda

Belinda

Terry

Due dates

3-Jun

5-Jun

7-Jun

7-Jun

10-Jun

12-Jun

Page 25: Problem Solving

The final

workplan should

correspond to

the project

timing and

scope agreed to

Analysis (main study steps)

1. Complete overview of the

market and industry

• Gather market and industry

data

• Conduct trade interviews

• Analyse data and formulate

initial view of industry

Assessment of

attractiveness of the

foreign market and

industry

2. Carry out an assessment of

ABG‟s competitive position

• Complete analysis of trends

in market share, pricing and

distribution

• Complete comparative cost

analysis

• Interview sample of buyers

• Interview McKinsey contacts

in the retail industry

Critical review of ABG‟s

strengths

and weaknesses

compared to

competitors

3. Estimate potential for ABG‟s

future performance

• Define alternative scenarios

• Establish most likely case

scenario

• Conduct sensitivity analysis

• Assess maximum

improvement potential

Financial evaluation

of ABG‟s milling and

baking interests

Progress reviews with XYZ management

Key end products 1 2 3 4 5 6 7 8 9 10 11 12

Timetable (weeks)

4 – Workplan

Page 26: Problem Solving

26

1

Define problem

2

Structure

problem

3

Prioritize

issues 4

Plan

analyses

and

work

5

Conduct

Analyses

and work

6

Synthesise

findings

7

Develop

recomm

endations

Clientproblem

Think answers not

analysis: what is the

simplest fact-based

approach that will prove/

disprove each issue?

Communication

Step 5: Conduct analysis

Details on analyses will be

discussed later

Page 27: Problem Solving

27

1

Define problem

2

Structure

problem

3

Prioritize

issues 4

Plan

analyses

and

work

5

Conduct

Analyses

and work

6

Synthesise

findings

7

Develop

recomm

endations

Clientproblem

Think “So what”: do the

findings tell a compelling

story?

Communication

Step 6: Synthesis findings

Page 28: Problem Solving

Use situation, complication,

resolution

State the conditions

at point of problem

Flesh out difficulties

in making situation

better

Lay out possible

solution path

6 – Synthesise findings and build argument……

Situation

Complication

Resolution

and/o

rPyramid structure

Main assertion

Sub-assertion Sub-assertion

Supporting

data

Supporting

data

Supporting

data

Supporting

data

Page 29: Problem Solving

29

….. Using the Pyramids Principle – built from the bottom,

communicated from the top

Coherence1

Chapters

Subchapters

Bullet points

Decisivequestions:"What?""Why?" "How?"

Governingthought

Decisivequestion:

"So what?"

Particular insights, reasons, steps, benefits, etc.

Analysis results

Facts, assump-tions, etc.

1 Same level of abstraction at each level

Page 30: Problem Solving

30

SAMPLE: Synthesis (Note difference between summary and synthesis)

It has many places

to go in the evening

It has many places

to go during the day

?Decisive question:

„So what?‟Synthesis

of the facts

Lagos is a great

place to have fun

+

▪ There are many

restaurants

▪ There are many

theatres

▪ There are many

clubs

▪ There are many

shops

▪ There is a National

museum

▪ There are many

beauty spots

Summaryof the facts

Facts about Lagos

Page 31: Problem Solving

31

Please sort these statements and create a

logical pyramid with 3 levels. Formulate suitable overarching conclusions („so what's‟) that

synthesise the details, and come up with a governing thought that

synthesises all your conclusions

He is results-oriented

Able to work well in a team

Sufficient knowledge of subject area

His leadership skills are excellent

Conflict management

Familiarity with the organisation

He has the ability to delegate

Understanding of market requirements

Good time management

Can handle disagreements

Coaching

1

2

3

4

5

6

7

9

10

8

Synthesis exercise – what are the characteristics of a great

project manager?

11

Page 32: Problem Solving

32

Solution to synthesis exercise

Good project

managers possess

management,

professional and

interpersonal

capabilities

One governing thought at the top

(key message)

Overall conclusions in complete

sentence

They possess a set

of broad

management skills

Results-

oriented

1

Leader-

ship

skills

4

Ability to

delegate

7

Good

time

manage-

ment

9

Their professional

qualifications are

outstanding

(specialised

expertise)

Suffi-

cient

know-

ledge of

subject

area

3

Famili-

arity with

the

organi-

sation

6

Under-

standing

of market

require-

ments

8

They have polished

interpersonal skills

Able to

work well

in a team

2

Conflict

manage-

ment

5

Coach-

ing

11

Page 33: Problem Solving

33

1

Define problem

2

Structure

problem

3

Prioritize

issues 4

Plan

analyses

and

work

5

Conduct

Analyses

and work

6

Synthesise

findings

7

Develop

recomm

endations

Clientproblem

Think buy-in and

actionable solution

: Is it clear what the

client needs to do

and how to do it?

Communication

Step 7: Develop recommendations

High impact communication which

is designed to take care of

“Developing Recommendations” will

be handled as a separate module

Page 34: Problem Solving

34

• Conducting Analyses (Internal and external)

• Power of Excel

• Market analysis

• Financial Analysis and Accounting

Page 35: Problem Solving

Excel is a powerful tool for conducting analyses…….

Knowing what you want

to doFinding out how to do it

Implement what you

want to do

• What do I want to

accomplish with my

analysis?

• What type of calculations

do I need to include in my

analysis?

• How do I need to modify

the data so that I can use

it?

• Excel probably has some

functionality that helps you

do what you need to

• Use formulas and

functions that you are

familiar with

• Seek information on how

to do things:

– Use Excel‟s formula

builder

– Use Excel‟s help

function (F1 key)

– Use the internet to

search for help

– Ask a friend for tips

• Allow yourself to try and

fail! It does not have to be

right the first time

• If you are having trouble,

seek help

• Make sure analysis is

done correctly

Page 36: Problem Solving

Pivot tables are one of Excel‟s most useful features

A PivotTable is an important feature of MS Excel. It is an interactive table that quickly

summarizes large amounts of data, based on multiple conditions that have intersecting

points

You can use PivotTables to:

• Calculate different summaries (e.g. list the total number of customers per division)

• Analyze related totals (e.g., calculate the total spent per account)

• Sum a long list of figures and compare details (e.g., number of suppliers with sales

largers larger than NGN 1 million)

Creating pivot tables

• To create a pivot table, highlight the data you want to include, and click on the pivot table

icon on the Insert menu

Pivot tables can also be created

with the following keybaoard

shortcuts

• Alt + D + P

• Alt + N + V + T

• Try it, it WILL make you faster!

Page 37: Problem Solving

….. Also the use of basic formulas

Basic formulas in Excel have these two main syntax forms:

A1 + B2= SUM ( A1 : B2 )=

Equal sign Cell

references

Operator Equal sign Formula

name

Parenthesis Cell

references or

range

Examples of basic formlulas include:

• AVERAGE – returns the average of a cell range

• SUM – returns the sum of a range of cells

• MEDIAN – returns the median number in a cell range

• MAX – returns the highest number in a cell range

• MIN – returns the lowest number in a cell range

• And many more – use Excel‟s help function to learn more about them

Page 38: Problem Solving

More advanced formulas often have more elements

IF ( A1 > 1 ; “Yes” ; B2 )=

Equal sign Formula

name

Parenthesis Formula

input

(for IF:

logical test)

Formula

input

(for IF:

value if true)

Formula

input

(for IF:

value if false)

Separator for

formula

arguments (, in

some Excel

versions)

Excel 2007 helps you understand the syntax of your formulas as you

write them!

Page 39: Problem Solving

Other examples of advanced formulas

Function/

FunctionalityWhat does it do? How do we use it? Additional Comments

COUNTIFCounts the number of cells

within a range that meet the

given criteria

COUNTIF(cell range you are looking in,criteria -

value; cell reference - you are looking for)

To count entries using mathematical

operators, use "<32" in the <criteria>

parameter field, to count the number of

values in the range <32

Wildcard Usage: COUNTIF(C2:C40,"*te")

will tell you how many words end with "te"

SUMIFAdds the cells within a range

specified by a given criteria

SUMIF(cell range you are looking in,criteria -

value; cell reference - you are looking

for,Sum_range; the actual cells to add if their

corresponding cells in range match criteria)

To sum entries using mathematical

operators, criteria can be expressed as 32,

"32", ">32", or "apples"

VLOOKUP

Searches for a value in the first

column of a table array and

returns a value in the same

row from another column in the

table array

VLOOKUP(cell reference of the value to be

looked up,table array range where the first

column contains the value being looked

up,position of the column data needs to be

retrieved from,type of match)

Type of Match:

0, False : Gives an exact match

1, True : Gives an approximate or exact

match (be sure to sort your data in

ascenfding order before trying this)

HLOOKUP

Searches for a value in the first

row of a table array and returns

a value in the same column

from another row in the table

array

VLOOKUP(cell reference of the value to be

looked up,table array range where the first row

contains the value being looked up,position of

the row data needs to be retrieved from,type of

match)

Type of Match:

0, False : Gives an exact match

1, True : Gives an approximate or exact

match (be sure to sort your data in

ascenfding order before trying this)

Page 40: Problem Solving

Market analysis: Helps you understand how a market works, which

impacts the behavior and performance of market participants

S C P

Structure Conduct Performance

The structure of the

market . . .

. . . drives the way

companies behave and

compete with each other in

response to events

Their strategy determines

their economic

performance

Feedback

By understanding the structure of the

market, we can understand why companies

behave the way they do and why some firms

are successful, while others fail

Page 41: Problem Solving

Porter‟s Five Forces model provides a simple framework through

which we can understand the structure and interaction in the market

Barriers to entry

Can new companies easily

enter the market and

increase competition?

Substitute products

Can consumers push down

prices by buying other

products to do the same job?

Bargaining power of input

suppliers

Can those who supply raw

materials force producers to

pay more?

Bargaining power of

consumers

Can consumers exert power

to force lower prices?

Competition between

producers

Economics of

demand

Economics of

supply

Page 42: Problem Solving

Finance and Accounting: The basic principle of finance is called

the time value of money

Fundamental valuation is about applying the concept of time

value of money to expected cash flows in the future

“Money you have today is worth

more than money tomorrow”Time value of

money

Why is this the case?

Page 43: Problem Solving

Information about a company‟s financial position is found in the

financial statements – the balance sheet, income and cashflow

statements

• Shows whether the company‟s operation has resulted in a

profit or loss as of a defined time period

• Can be thought of like a motion picture since it reports how

a company has performed during the period(s) presented

• Portrays the financial position of the company by showing

what the company owns and what it owes at a reporting date

• Can be thought of as a snapshot since it reports the

company‟s financial position at a specific point in time.

▪ Reports on company‟s cash generation during the period(s)

separating it by operating, investing and financing activities

Balance sheet

Income statement

Cash Flow Statement

Page 44: Problem Solving

Balance sheet

Page 45: Problem Solving

Balance sheet item definitions

Accounts

receivable

Money owned from

customers

Notes receivable Money owned from loans

made (financial)

Inventory Assets that are held for sale

(or in the process of being

produced for sale)

Prepaid

expenses

Expenses that are paid in

advance (e.g., rent)

Property, plant

and equipment

Land, building, and

equipment owned by the

company; shown before and

after depreciation

Deferred

charges

Asset used to reduce future

income (usually tax)

Goodwill Intangible asset created upon

an acquisition

Assets

Accounts payable Money owed to vendors for

products purchased

Accrued liabilities Expenses incurred but not

yet paid (e.g. salaries)

Capital lease

obligations

Payments on a lease

treated as a loan

Deferred credits Income received but not yet

reported as income

Reserves for

employee benefits

plans

Money owed to employees

(usually pensions and

health benefits)

Minority interested Third party ownership in

company subsidiary

Stockholders‟

equity

Interest in assets after all

liabilities are paid

Liabilities and shareholders’ equity

NOT EXHAUSTIVE

Page 46: Problem Solving

Income statement

Page 47: Problem Solving

Income statement item definitionsNOT EXHAUSTIVE

Sales and other

operating

revenues

Money received for goods and

services provided

Income from

equity affiliates

Share of earnings in affiliated

companies

Operating

expenses

All operating costs (e.g. costs

required for lifting oil and gas

to the surface)

Selling, general

and

administrative

expenses

Selling cost and non-

production overhead costs

such as sales and marketing,

and R&D

Exploration

expenses

Costs incurred in the

exploration for oil and gas

Depreciation,

depletion and

amortization

Non-cash charge for the use of

a fixed asset (depreciation),

mineral resource (depletion) or

intangible (amortization)

Operating items

Other income May include operating and

non-operating income (best to

check financials)

Taxes Taxes paid or provisions made

for taxes to be paid

Interest and debt

expense

Interest paid on debt

Minority interest Portion of earnings of

subsidiary allocated to minority

investor

Non-operating items

Page 48: Problem Solving

Statement of cash flows

Operating

cash flow

• Cash flow originating from the firm’s operating activities;

sales of goods and services, purchase of supplies, SG&A,

taxes

Investing cash

flow

• Cash flow originating from the firm’s investing activities;

sale of fixed assets, sale of long-term financial assets,

collection of interest acquisitions, long-term financial

investments

Financing

cash flow

• Cash flow originating from the firm’s financing activities;

insurance of stocks and bonds, long-term borrowings, short-

term borrowings, repurchase of stocks and bonds,

repayment of long-term debt, repurchase of short-term debt,

interest payment, dividend payment

Page 49: Problem Solving

Statement of cash flows

Page 50: Problem Solving

50

The financial statements are linked NOT EXHAUSTIVE

Cash from operations

Cash from investing

Cash from financing

Net change in cash

Cash flow statement

Investment and divestment by

owners

Net income and other

earnings

Net change in owner equity

Statement of

shareholder’s equity

Revenue

Expenses

Net income

Income statement

Cash

+ Other assets

Total assets

- Liabilities

Shareholder’s equity

Ending balance

sheet

Cash

+ Other assets

Total assets

- Liabilities

Shareholder’s equity

Beginning

balance sheet

Page 51: Problem Solving

Basic accounting equation…..

Assets Liabilities Equity= +

•This equality must always be true

•For example, any increase in an asset must be

offset by a decrease in an asset or an increase

in a liability or equity

What a company

/ business owns

What a company

/ business owes= +What’s leftover

for the owners of

the business

Page 52: Problem Solving

52

The financial statements can be used to calculate margins that

measure cost efficiency of business activities

(1) Costs that can be directly attributed to the goods & services produced (i.e., cost of goods sold)(2) Earnings before interest and taxes

Metric

Gross MarginAbility of a company to control

“direct”(1) costs

Gross Profit

Sales

Formulae Measures

EBIT(2) MarginOverall operating efficiency;

accounts for all operating expenses

EBIT

Sales

Net Profit MarginProportion of sales available for

distribution to shareholders

Net Profit

Sales

Page 53: Problem Solving

The fundamental value of your company is set by growth, ROIC, and

cost of capital

Growth

Value The money I make

The money I invested to make money

How much additional capital I am able

to invest

Cost of

CapitalHow much my capital costs me

Return on

Invested

Capital

Page 54: Problem Solving

Return on invested capital is the fundamental driver of a company‟s

value; to have value ROIC must be higher than your cost of capital

The money I make

The money I invested to make moneyROIC =

After tax earnings from operations*

The amount of operating capital

invested in the company (I.C.)

ROIC =

*Often called “Noplat” or “Nopat” (Net Operating Profit Less Adjusted Taxes)

The opportunity cost of employing

capital to your business (for

example interest cost)

Cost of capital =

Page 55: Problem Solving

Understanding what impacts the ROIC

Return on

invested

capital

SG&A / Revenues

Cost of Goods Sold

/ Revenues

Depreciation /

Revenues

Property, plant and

equipment /

Revenues

Operating working

capital / Revenues

Other operating

assets, net /

Revenues

Pre-tax return

on invested

capital

Cash tax rate

Capital Turnover =

Revenues /

Invested Capital

Times1/

Operating margin =

EBITA/revenues

OR EBITA

1–

1–

X

X

+

+

+

+

Page 56: Problem Solving

56

How to create value

Economic

Profit

Invested

Capital

ROIC

WACCx

GrowthSales

margin

Capital

turnover

xValue

Reduce

WACC via capital

structure

Improve return

on capital

• Increase margin

• Increase capital

turnover

Invest in

businesses with

returns above cost

of capital

Increase

growth if returns are

higher than cost

of capital