Balance sheet and income statement - ETH

Corporate Finance Interpreting Financial Statements Dr. Markus R. Neuhaus Dr. Marc Schmidli, CFA

Autumn Term 2013

Markus Neuhaus I Corporate Finance I [email protected]

1

Corporate Finance: Course overview 2013 20.09. Fundamentals

M. Neuhaus & M. Schmidli

27.09. No lecture 04.10. Interpreting Financial Statements

M. Neuhaus & M. Schmidli

11.10.

Mergers & Acquisitions I & II (4 hours)

M. Neuhaus & S. Beer

18.10

Investment Management

M. Neuhaus & P. Schwendener

25.10

Business Valuation (4 hours)

M. Neuhaus & M. Bucher

01.11

Value Management

M. Neuhaus, R. Schmid & G. Baldinger

08.11

No lecture

15.11

Legal Aspects

Ines Pöschel

22.11

Turnaround Management

M. Neuhaus & R. Brunner

29.11

No lecture

06.12

Financial Reporting

M. Neuhaus & M. Jeger

13.12

Taxes (4 hours)

M. Neuhaus & M. Marbach

20.12

Summary Repetition

M. Neuhaus

Autumn Term 2013

Markus Neuhaus I Corporate Finance I [email protected]

2

Markus R. Neuhaus PricewaterhouseCoopers AG, Zürich

Phone: Email:

  

Grade Qualification Career Development



Subject-related Exp.



Lecturing



Published Literature



Other professional roles:

Autumn Term 2013

+41 58 792 40 00 [email protected]

Chairman Doctor of Law (University of Zurich), Certified Tax Expert Joined PwC in 1985, became Partner in 1992 and CEO from 2003 – 2012, became Chairman in 2012 Corporate Tax Mergers & Acquisitions SFIT: Executive in Residence, lecture: Corporate Finance Multiple speeches on leadership, business, governance, commercial and tax law Author of commentary on the Swiss accounting rules Publisher of book on transfer pricing Author of multiple articles on tax and commercial law, M&A, IPO, etc. Member of the board of économiesuisse, member of the board and chairman of the tax chapter of the Swiss Institute of Certified Accountants and Tax Consultants Markus Neuhaus I Corporate Finance I [email protected]

3

Marc Schmidli PricewaterhouseCoopers AG, Zürich

Phone: Email:

   

Grade Qualification Career Development Lecturing



Published Literature

+41 58 792 15 64 [email protected]

Partner Dr. oec. HSG, CFA charterholder Corporate Finance PricewaterhouseCoopers since July 2000 Euroforum – Valuation in M&A situations Guest speaker at ZfU Seminars, Uni Zurich, ETH, etc. Finanzielle Qualität in der schweizerischen Elektrizitätswirtschaft Various articles in „Treuhänder“, HZ, etc.

Autumn Term 2013

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Contents     

Learning targets Pre-course reading Lecture „Interpreting Financial Statements“ Pre-course reading case studies / questions Solutions to case studies

Autumn Term 2013

Markus Neuhaus I Corporate Finance I [email protected]

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Learning targets 

Framework for financial statement analysis  Understanding the need for financial statement analysis  Understanding the financial reporting system  Refreshing principal elements of financial statements (Balance sheet, income and cash flow statements)



Analysis of financial statements  Understand the purpose and use of ratio analysis  Being able to apply the various ratio analyses  Being able to evaluate corporate performance by the integrated analysis of ratios

Autumn Term 2013

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Contents     

Learning targets Pre-course reading Lecture „Interpreting Financial Statements“ Pre-course reading case studies / questions Solutions to case studies

Autumn Term 2013

Markus Neuhaus I Corporate Finance I [email protected]

7

Pre-course reading 

Books  Mandatory reading:  Brigham, Houston (2012): Chapter 4 (pp. 96-130)  White, Sondhi, Fried (2003): Chapter 3 (pp. 74-99)  Optional reading:  Brigham, Houston (2012): Chapter 3 (pp. 56-95)



Slides  Slides 1 to 11 – mandatory reading  Other Slides – optional reading, will be dealt within the lecture

Autumn Term 2013

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Contents     

Learning targets Pre-course reading Lecture „Interpreting Financial Statements“ Pre-course reading case studies / questions Solutions to case studies

Autumn Term 2013

Markus Neuhaus I Corporate Finance I [email protected]

9

Agenda I 1. Introduction 

Financial analysis



Classes of users



Need for financial statement analysis

2. Ratio analysis 

Significance of ratio analysis



Sources



Financial reporting systems and standards



Important groups of ratio analysis

Autumn Term 2013

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Agenda II 3. Case study Beans Incorporation vs. Garlic Incorporation

4. Q&A and discussion

Autumn Term 2013

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11

Agenda: Introduction 

Financial analysis



Classes of users



Need for financial statement analysis

Autumn Term 2013

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12

Financial analysis 

Evaluation of a firm‘s performance and development mainly by  identifying the key drivers of a firm‘s performance and financial position

 calculating and interpreting important ratios of the firm  Balanced Scorecard (soft – hard) 

A well rounded financial analysis takes into account not only the financials alone but also surrounding factors which can have significant influence on the firm’s development. Financial management does not operate in a vacuum. Environment

Macroeconomic situation, industry, market

Business

Management, products, margins, technology, knowledge base, competition

Financial Statements

Balance sheet, income statement, cash flow, stockholders’ equity, budget

Financial Analysis

Source: White, Sondhi, Fried (2003), 2ff.

Autumn Term 2013

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Classes of users 

Internal users (such as managers or board members)



External users of financial information encompass a wide range of interests but can be classified into three general groups:  Credit and equity investors  Government, regulatory bodies, tax authorities  General public and special interest groups, labor unions and consumer groups

Source: White, Sondhi, Fried (2003), 4.

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Need for financial statement analysis 



Internal:

External:

Financial statements provide the company with information on its performance and development over time and are a crucial basis for most financial decisions (i.e. investment, financing)

Financial statements facilitate the interaction between the company and its business environment by providing third parties with essential information on the company’s development



Costs



Creditors



Efficiency



Investors



Profitability



Shareholders



Investments



Government



Financing (needs) Financial analysis has great significance and impact on a company‘s development as it influences expectations on the capital markets

Autumn Term 2013

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Agenda: Ratio analysis 

Significance of ratio analysis



Sources



Financial reporting systems and standards



Important groups of ratio analysis

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Ratio analysis 

Financial statements help predict the future development of a company Firm A has total debt of $ 1’060m and $ 88m interest charges whereas firm B has total debt of $ 52m and $ 4m interest charges. Which firm is stronger, better financed? Or which firm is more liquid or more likely to generate higher cash flows?  Figures standing alone, such as total debt or interest charges, are not really helpful  By putting debt into perspective with other appropriate figures, we are able to predict which firm is more likely to succeed  such comparisons are ratio analysis

The debt burden can be evaluated (a) by comparing each firm‘s debt with its assets and (b) by comparing the interest the company has to pay with the income it has available Source: Brigham, Houston (2012), 98f.

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Significance of ratio analysis 

„help predict the future development of a company”

As a company’s value is determined by its ability to generate cash today and in the future, ratio analysis has great importance 

Share price development



Credit rating



However, there is no generally used list of ratios that could be applied to any company



Groups of ratios1):  Liquidity ratios  Asset management ratios  Debt or financing ratios  Profitability ratios  Market value ratios

1)

Details later: see page 25ff.

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Principal elements of financial statements as primary source for financial analysis    

Balance sheet Income statement Statement of cash flows Statement of stockholders‘ equity



Further sources: Broker/analyst reports, Bloomberg, Reuters, Factset etc.

Collectively, these interrelated financial statements provide relevant and timely information about the past and are essential for making crucial business decisions about investment or financing activities today and in the future. Financial statements are a key component to build trust in the financial community. Source: White, Sondhi, Fried (2003), 5. Autumn Term 2013

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Financial reporting systems and standards 

Reporting systems and standards compel the company to meet a great number of requirements in order to ensure that the financial statements are, above all, transparent and comparable



The two most commonly used standards are: 

IFRS (International Financial Reporting Standards)



US GAAP (United States Generally Accepted Accounting Principles)



Differences are found mainly in the classification of certain events (e.g. whether an interest payment is reported under operating costs or financing costs etc.) or with regard to financial instruments. Both aim to provide a “true and fair view”of the company’s performance.



In addition, there are local GAAPs (Generally Accepted Accounting Principles). In Switzerland we have rules in the Code of Obligation which permit hidden reserves and the FER (Fachempfehlung für Rechnungslegung) which is a light form of IFRS.

Source: White, Sondhi, Fried (2003), 5ff. Autumn Term 2013

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Balance sheet 



Snapshot of the company‘s assets and liabilities at a certain reporting date Assets = Liabilities + Equity

Balance Sheet (chf m) USD m

2008 2011

2007 2010

Assets Cash and cash equivalents Accounts receivable Inventories Current assets

10 375 615 1'000

80 315 415 810

Net plant and equipment Non-current assets

1'000 1'000

870 870

Total assets

2'000

1'680

60 110 140 310

30 60 130 220

750 1'060

580 800

130 810 940

130 750 880

2'000

1'680

Liabilities and Equity Accounts payable Notes payable Accruals Total current liabilities Long-term bonds Total debt Common stock (50'000'000 shares) Retained earnings Total equity Total liabilities and equity

Source: Brigham, Houston (2012), 62. Autumn Term 2013

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Income statement  

Reports on the performance of a firm, the results of its operating activities Matching principle = revenues and related costs must be accounted for during the same period of time. This requires the recognition of expenses incurred to generate revenues in the same period as the related revenues (revenue recognition, accrual method). Income Statement (chf in USD m millions)

2011 2008

2010 2007

Net Sales Operating Costs

3'000.0 (2'616.2)

2'850.0 (2'497.0)

383.8 (100.0)

353.0 (90.0)

EBIT Interest Taxes

283.8 (88.0) (78.3)

263.0 (60.0) (81.2)

Net Income

117.5

121.8

57.5 60.0

53.0 68.8

EBITDA Amortization Depreciation

Common dividends Addition to retained earnings

Source: Brigham, Houston (2012), 67. Autumn Term 2013

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Statement of cash flow 











The cash flow statement represents the cash generated by a company during the given accounting period Separated into three categories: (I) operating activities, (II) investing activities, (III) financing activities The investment section illustrates how cash was spent whereas section III, financing shows how those investments were financed In the long run, cash flows from operating activities should considerably increase; investments should be equal to depreciation (plus a bit more to support stable growth) In this example, the company has an operating problem as the cash flow from operating activities is negative CAPEX = capital expenditures

Statement of Cash Flow (chf USDinmmillions)

2008 2011

Operating activities Net Income Additions Depreciation and Amortization Increase in accounts payable Increase in accruals Substractions Increase in accounts receivable Increase in inventories Net cash provided by operating activities

(60.0) (200.0) (2.5)

Long-term investing activities Cash used to acquire fixed assets (CAPEX)

(230.0)

117.5 100.0 30.0 10.0

Financing activities Increase in notes payable Increase in bonds payments of dividens Net cash provided by financing activities

50.0 170.0 (57.5) 162.5

Net decrease in cash and equivalents

(70.0)

Cash and equivalents at beginning of the year Cash and equivalents at end of the year

80.0 10.0

Source: Brigham, Houston (2012), 69. Autumn Term 2013

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Statement of retained earnings 



Changes in retained earnings occur because stockholders allow the management to retain and invest funds that otherwise would be paid out as dividend Thus, the retained earnings position is not cash and is not available for spending

Statement of retained earnings (chf USDinmmillions)

2008 2011

Balance of retained earnings as of 2007 2010 Add: Net income 2008 2011 Less: Dividend to common stockholders Balance of retained earnings as of 2008 2011

750.0 117.5 (57.5) 810.0

Source: Brigham, Houston (2012), 72.

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Important groups of financial ratios 

Liquidity ratios Is the company able to pay its debts as they become due this year?



Asset management ratios Does the amount of assets seem to be reasonable in relation to current and projected sales? And how efficiently does the company use its assets?”



Debt or financing ratios To what extent is the company using financial leverage? Risk from capital structure?



Profitability ratios How profitable is the company? How much output does the company generate in relation to a certain input?



Market value ratios How do the earnings and results appear in relation to the stock price?

Be aware – the definition of ratios may vary between different authors or users! Source: Brigham, Houston (2012), 99ff.

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Liquidity ratios Current ratio  



If a company is getting into financial difficulties, it will pay its bills more slowly, borrowing money from banks and from suppliers. This leads to increased current liabilities which causes the current ratio to decrease. If current liabilities grow faster than current assets, this is a an indication of financial difficulties. The current ratio is also known as liquidity ratio 3.

Quick ratio  



Current assets 1000   3.2x Current liabilities 310

Current assets - inventories 1000 - 615   1.2x Current liabilities 310

Inventories are a firm’s least liquid current asset and therefore most likely to suffer losses if they have to be sold in liquidation. A company should be able to pay current liabilities with current assets less inventories. The quick ratio is also known as liquidity ratio 2.

Source: Brigham, Houston (2012), 99f; Volkart (2011), 161f.

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Balance sheet and income statement Balance Sheet (chf m) USD m

Income Statement 2008 2011

2007 2010

Assets Cash and cash equivalents Accounts receivable Inventories Current assets

10 375 615 1'000

80 315 415 810

Net plant and equipment Non-current assets

1'000 1'000

870 870

Total assets

2'000

1'680

Liabilities and Equity Accounts payable Notes payable Accruals Total current liabilities Long-term bonds Total debt Common stock (50'000'000 shares) Retained earnings Total equity Total liabilities and equity

60 110 140 310

30 60 130 220

750 1'060

580 800

130 810 940

130 750 880

2'000

1'680

(chf in USD m millions)

2008 2011

2007 2010

Net Sales Operating Costs

3'000.0 (2'616.2)

2'850.0 (2'497.0)

383.8 (100.0)

353.0 (90.0)

EBIT Interest Taxes

283.8 (88.0) (78.3)

263.0 (60.0) (81.2)

Net Income

117.5

121.8

57.5 60.0

53.0 68.8

EBITDA Amortization Depreciation

Common dividends Addition to retained earnings

Source: Brigham, Houston (2012), 67.

Source: Brigham, Houston (2012), 62. Autumn Term 2013

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Liquidity ratios Current ratio  



If a company is getting into financial difficulties, it will pay its bills more slowly, borrowing money from banks and from suppliers. This leads to increased current liabilities which causes the current ratio to decrease. If current liabilities grow faster than current assets, this is a an indication of financial difficulties. The current ratio is also known as liquidity ratio 3.

Quick ratio  



Current assets 1000   3.2x Current liabilities 310

Current assets - inventories 1000 - 615   1.2x Current liabilities 310

Inventories are a firm’s least liquid current asset and therefore most likely to suffer losses if they have to be sold in liquidation. A company should be able to pay current liabilities with current assets less inventories. The quick ratio is also known as liquidity ratio 2.

Source: Brigham, Houston (2012), 99ff; Volkart (2011), 161f.

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Balance sheet and income statement Balance Sheet (chf m) USD m

Income Statement 2008 2011

2007 2010

Assets Cash and cash equivalents Accounts receivable Inventories Current assets

10 375 615 1'000

80 315 415 810

Net plant and equipment Non-current assets

1'000 1'000

870 870

Total assets

2'000

1'680

Liabilities and Equity Accounts payable Notes payable Accruals Total current liabilities Long-term bonds Total debt Common stock (50'000'000 shares) Retained earnings Total equity Total liabilities and equity

60 110 140 310

30 60 130 220

750 1'060

580 800

130 810 940

130 750 880

2'000

1'680

(chf in USD m millions)

2008 2011

2007 2010

Net Sales Operating Costs

3'000.0 (2'616.2)

2'850.0 (2'497.0)

383.8 (100.0)

353.0 (90.0)

EBIT Interest Taxes

283.8 (88.0) (78.3)

263.0 (60.0) (81.2)

Net Income

117.5

121.8

57.5 60.0

53.0 68.8

EBITDA Amortization Depreciation

Common dividends Addition to retained earnings

Source: Brigham, Houston (2012), 67.

Source: Brigham, Houston (2012), 62. Autumn Term 2013

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Asset management ratios Inventory turnover ratio 

 

Sales 3000   4.9x Inventory 615

Inventory turnover indicates whether a company (compared with peer companies) holds too much inventory, which is very unproductive and represents an investment with a low return The inventory turnover ratio can also be calculated by using “Cost of Goods Sold” instead of “Sales” Receivables Receivables 375    46 days Averagesales per day Sales / 365 3000 365 DSO shows the “average collection period” or how long customers usually take to pay their bills. The higher the DSO, the more money is lost, because the company has to finance the gap with expensive loans etc.

Days sales outstanding 



Fixed asset turnover ratio  

Sales 3000   3.0x Net fixed assets 1000

The fixed assets turnover ratio indicates how effectively the company is using its fixed assets compared with peer companies.

Source: Brigham, Houston (2012), 102ff; Volkart (2011), 163f. Autumn Term 2013

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Balance sheet and income statement Balance Sheet (chf m) USD m

Income Statement 2008 2011

2007 2010

Assets Cash and cash equivalents Accounts receivable Inventories Current assets

10 375 615 1'000

80 315 415 810

Net plant and equipment Non-current assets

1'000 1'000

870 870

Total assets

2'000

1'680

Liabilities and Equity Accounts payable Notes payable Accruals Total current liabilities Long-term bonds Total debt Common stock (50'000'000 shares) Retained earnings Total equity Total liabilities and equity

60 110 140 310

30 60 130 220

750 1'060

580 800

130 810 940

130 750 880

2'000

1'680

(chf in USD m millions)

2008 2011

2007 2010

Net Sales Operating Costs

3'000.0 (2'616.2)

2'850.0 (2'497.0)

383.8 (100.0)

353.0 (90.0)

EBIT Interest Taxes

283.8 (88.0) (78.3)

263.0 (60.0) (81.2)

Net Income

117.5

121.8

57.5 60.0

53.0 68.8

EBITDA Amortization Depreciation

Common dividends Addition to retained earnings

Source: Brigham, Houston (2012), 67.

Source: Brigham, Houston (2012), 62. Autumn Term 2013

Markus Neuhaus I Corporate Finance I [email protected]

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Asset management ratios Inventory turnover ratio 

 

Sales 3000   4.9x Inventory 615

Inventory turnover indicates whether a company (compared with peer companies) holds too much inventory, which is very unproductive and represents an investment with a low return The inventory turnover ratio can also be calculated by using “Cost of Goods Sold” instead of “Sales” Receivables Receivables 375    46 days Averagesales per day Sales / 365 3000 365 DSO shows the “average collection period” or how long customers usually take to pay their bills. The higher the DSO, the more money is lost, because the company has to finance the gap with expensive loans etc.

Days sales outstanding 



Fixed asset turnover ratio  

Sales 3000   3.0x Net fixed assets 1000

The fixed assets turnover ratio indicates how effectively the company is using its fixed assets compared with peer companies.

Source: Brigham, Houston (2012), 102ff; Volkart (2011), 163f. Autumn Term 2013

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32

Balance sheet and income statement Balance Sheet (chf m) USD m

Income Statement 2008 2011

2007 2010

Assets Cash and cash equivalents Accounts receivable Inventories Current assets

10 375 615 1'000

80 315 415 810

Net plant and equipment Non-current assets

1'000 1'000

870 870

Total assets

2'000

1'680

Liabilities and Equity Accounts payable Notes payable Accruals Total current liabilities Long-term bonds Total debt Common stock (50'000'000 shares) Retained earnings Total equity Total liabilities and equity

60 110 140 310

30 60 130 220

750 1'060

580 800

130 810 940

130 750 880

2'000

1'680

(chf in USD m millions)

2008 2011

2007 2010

Net Sales Operating Costs

3'000.0 (2'616.2)

2'850.0 (2'497.0)

383.8 (100.0)

353.0 (90.0)

EBIT Interest Taxes

283.8 (88.0) (78.3)

263.0 (60.0) (81.2)

Net Income

117.5

121.8

57.5 60.0

53.0 68.8

EBITDA Amortization Depreciation

Common dividends Addition to retained earnings

Source: Brigham, Houston (2012), 67.

Source: Brigham, Houston (2012), 62. Autumn Term 2013

Markus Neuhaus I Corporate Finance I [email protected]

33

Asset management ratios Inventory turnover ratio 

 

Sales 3000   4.9x Inventory 615

Inventory turnover indicates whether a company (compared with peer companies) holds too much inventory, which is very unproductive and represents an investment with a low return The inventory turnover ratio can also be calculated by using “Cost of Goods Sold” instead of “Sales” Receivables Receivables 375    46 days Averagesales per day Sales / 365 3000 365 DSO shows the “average collection period” or how long customers usually take to pay their bills. The higher the DSO, the more money is lost, because the company has to finance the gap with expensive loans etc.

Days sales outstanding 



Fixed asset turnover ratio  

Sales 3000   3.0x Net fixed assets 1000

The fixed assets turnover ratio indicates how effectively the company is using its fixed assets compared with peer companies.

Source: Brigham, Houston (2012), 102ff; Volkart (2011), 163f. Autumn Term 2013

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34

Balance sheet and income statement Balance Sheet (chf m) USD m

Income Statement 2008 2011

2007 2010

Assets Cash and cash equivalents Accounts receivable Inventories Current assets

10 375 615 1'000

80 315 415 810

Net plant and equipment Non-current assets

1'000 1'000

870 870

Total assets

2'000

1'680

Liabilities and Equity Accounts payable Notes payable Accruals Total current liabilities Long-term bonds Total debt Common stock (50'000'000 shares) Retained earnings Total equity Total liabilities and equity

60 110 140 310

30 60 130 220

750 1'060

580 800

130 810 940

130 750 880

2'000

1'680

(chf in USD m millions)

2008 2011

2007 2010

Net Sales Operating Costs

3'000.0 (2'616.2)

2'850.0 (2'497.0)

383.8 (100.0)

353.0 (90.0)

EBIT Interest Taxes

283.8 (88.0) (78.3)

263.0 (60.0) (81.2)

Net Income

117.5

121.8

57.5 60.0

53.0 68.8

EBITDA Amortization Depreciation

Common dividends Addition to retained earnings

Source: Brigham, Houston (2012), 67.

Source: Brigham, Houston (2012), 62. Autumn Term 2013

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Debt management ratios Total debt to total assets  

Total debt 1060   53.0% Total assets 2000

Creditors prefer a low debt to equity ratio whereas stockholders may want more leverage as it can magnify expected earnings ( pecking order theory). The optimal ratio between debt and assets is highly dependent on the firm’s business and industry.

Times - interest - earned ratio  

EBIT 284   3.2x Interest 88

The TIE ratio measures the extent to which operating profit can decline before the firm is unable to meet its interest costs. Not being able to pay interest costs will bring legal troubles and can result in bankruptcy.

Source: Brigham, Houston (2012), 105ff. Autumn Term 2013

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36

Balance sheet and income statement Balance Sheet (chf m) USD m

Income Statement 2008 2011

2007 2010

Assets Cash and cash equivalents Accounts receivable Inventories Current assets

10 375 615 1'000

80 315 415 810

Net plant and equipment Non-current assets

1'000 1'000

870 870

Total assets

2'000

1'680

Liabilities and Equity Accounts payable Notes payable Accruals Total current liabilities Long-term bonds Total debt Common stock (50'000'000 shares) Retained earnings Total equity Total liabilities and equity

60 110 140 310

30 60 130 220

750 1'060

580 800

130 810 940

130 750 880

2'000

1'680

(chf in USD m millions)

2008 2011

2007 2010

Net Sales Operating Costs

3'000.0 (2'616.2)

2'850.0 (2'497.0)

383.8 (100.0)

353.0 (90.0)

EBIT Interest Taxes

283.8 (88.0) (78.3)

263.0 (60.0) (81.2)

Net Income

117.5

121.8

57.5 60.0

53.0 68.8

EBITDA Amortization Depreciation

Common dividends Addition to retained earnings

Source: Brigham, Houston (2012), 67.

Source: Brigham, Houston (2012), 62. Autumn Term 2013

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37

Debt management ratios Total debt to total assets  

Total debt 1060   53.0% Total assets 2000

Creditors prefer a low debt to equity ratio whereas stockholders may want more leverage as it can magnify expected earnings ( pecking order theory). The optimal ratio between debt and assets is highly dependent on the firm’s business and industry.

Times - interest - earned ratio  

EBIT 284   3.2x Interest 88

The TIE ratio measures the extent to which operating profit can decline before the firm is unable to meet its interest costs. Not being able to pay interest costs will bring legal troubles and can result in bankruptcy.

Source: Brigham, Houston (2012), 105ff. Autumn Term 2013

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Balance sheet and income statement Balance Sheet (chf m) USD m

Income Statement 2008 2011

2007 2010

Assets Cash and cash equivalents Accounts receivable Inventories Current assets

10 375 615 1'000

80 315 415 810

Net plant and equipment Non-current assets

1'000 1'000

870 870

Total assets

2'000

1'680

Liabilities and Equity Accounts payable Notes payable Accruals Total current liabilities Long-term bonds Total debt Common stock (50'000'000 shares) Retained earnings Total equity Total liabilities and equity

60 110 140 310

30 60 130 220

750 1'060

580 800

130 810 940

130 750 880

2'000

1'680

(chf in USD m millions)

2008 2011

2007 2010

Net Sales Operating Costs

3'000.0 (2'616.2)

2'850.0 (2'497.0)

383.8 (100.0)

353.0 (90.0)

EBIT Interest Taxes

283.8 (88.0) (78.3)

263.0 (60.0) (81.2)

Net Income

117.5

121.8

57.5 60.0

53.0 68.8

EBITDA Amortization Depreciation

Common dividends Addition to retained earnings

Source: Brigham, Houston (2012), 67.

Source: Brigham, Houston (2012), 62. Autumn Term 2013

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Profitability ratios Net income 118   3.9% Sales 3000 The profit margin on sales shows the profit per unit of sales

Profit margin  

Return on total assets  

Stockholders want to earn a return on their money invested. This ratio indicates the profitability of a stockholders’ invested money from an accounting perspective

Basic earning power  

Net income 118   5.9% Total assets 2000

EBIT 284   14.2% Total assets 2000

This ratio shows the raw earning power of the firm’s assets excluding potential influence from interest payments or leverage effects.

Return on common equity 



Net income 118   12.5% Common equity 940

Stockholders want to earn a return on their money invested. This ratio indicates the profitability of a stockholders’ invested money from an accounting perspective

Source: Brigham, Houston (2012), 108ff. Autumn Term 2013

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Balance sheet and income statement Balance Sheet (chf m) USD m

Income Statement 2008 2011

2007 2010

Assets Cash and cash equivalents Accounts receivable Inventories Current assets

10 375 615 1'000

80 315 415 810

Net plant and equipment Non-current assets

1'000 1'000

870 870

Total assets

2'000

1'680

Liabilities and Equity Accounts payable Notes payable Accruals Total current liabilities Long-term bonds Total debt Common stock (50'000'000 shares) Retained earnings Total equity Total liabilities and equity

60 110 140 310

30 60 130 220

750 1'060

580 800

130 810 940

130 750 880

2'000

1'680

(chf USD in m millions)

2008 2011

2007 2010

Net Sales Operating Costs

3'000.0 (2'616.2)

2'850.0 (2'497.0)

383.8 (100.0)

353.0 (90.0)

EBIT Interest Taxes

283.8 (88.0) (78.3)

263.0 (60.0) (81.2)

Net Income

117.5

121.8

57.5 60.0

53.0 68.8

EBITDA Amortization Depreciation

Common dividends Addition to retained earnings

Source: Brigham, Houston (2012), 67.

Source: Brigham, Houston (2012), 62. Autumn Term 2013

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Profitability ratios Net income 118   3.9% Sales 3000 The profit margin on sales shows the profit per unit of sales

Profit margin  

Return on total assets  

Stockholders want to earn a return on their money invested. This ratio indicates the profitability of a stockholders’ invested money from an accounting perspective

Basic earning power  

Net income 118   5.9% Total assets 2000

EBIT 284   14.2% Total assets 2000

This ratio shows the raw earning power of the firm’s assets excluding potential influence from interest payments or leverage effects.

Return on common equity 



Net income 118   12.5% Common equity 940

Stockholders want to earn a return on their money invested. This ratio indicates the profitability of a stockholders’ invested money from an accounting perspective

Source: Brigham, Houston (2012), 108ff. Autumn Term 2013

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Balance sheet and income statement Balance Sheet (chf m) USD m

Income Statement 2008 2011

2007 2010

Assets Cash and cash equivalents Accounts receivable Inventories Current assets

10 375 615 1'000

80 315 415 810

Net plant and equipment Non-current assets

1'000 1'000

870 870

Total assets

2'000

1'680

Liabilities and Equity Accounts payable Notes payable Accruals Total current liabilities Long-term bonds Total debt Common stock (50'000'000 shares) Retained earnings Total equity Total liabilities and equity

60 110 140 310

30 60 130 220

750 1'060

580 800

130 810 940

130 750 880

2'000

1'680

(chf USD in m millions)

2008 2011

2007 2010

Net Sales Operating Costs

3'000.0 (2'616.2)

2'850.0 (2'497.0)

383.8 (100.0)

353.0 (90.0)

EBIT Interest Taxes

283.8 (88.0) (78.3)

263.0 (60.0) (81.2)

Net Income

117.5

121.8

57.5 60.0

53.0 68.8

EBITDA Amortization Depreciation

Common dividends Addition to retained earnings

Source: Brigham, Houston (2012), 67.

Source: Brigham, Houston (2012), 62. Autumn Term 2013

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Profitability ratios Net income 118   3.9% Sales 3000 The profit margin on sales shows the profit per unit of sales

Profit margin  

Return on total assets  

Stockholders want to earn a return on their money invested. This ratio indicates the profitability of a stockholders’ invested money from an accounting perspective

Basic earning power  

Net income 118   5.9% Total assets 2000

EBIT 284   14.2% Total assets 2000

This ratio shows the raw earning power of the firm’s assets excluding potential influence from interest payments or leverage effects.

Return on common equity 



Net income 118   12.5% Common equity 940

Stockholders want to earn a return on their money invested. This ratio indicates the profitability of a stockholders’ invested money from an accounting perspective

Source: Brigham, Houston (2012), 108ff. Autumn Term 2013

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Balance sheet and income statement Balance Sheet (chf m) USD m

Income Statement 2008 2011

2007 2010

Assets Cash and cash equivalents Accounts receivable Inventories Current assets

10 375 615 1'000

80 315 415 810

Net plant and equipment Non-current assets

1'000 1'000

870 870

Total assets

2'000

1'680

Liabilities and Equity Accounts payable Notes payable Accruals Total current liabilities Long-term bonds Total debt Common stock (50'000'000 shares) Retained earnings Total equity Total liabilities and equity

60 110 140 310

30 60 130 220

750 1'060

580 800

130 810 940

130 750 880

2'000

1'680

(chf in USD m millions)

2008 2011

2007 2010

Net Sales Operating Costs

3'000.0 (2'616.2)

2'850.0 (2'497.0)

383.8 (100.0)

353.0 (90.0)

EBIT Interest Taxes

283.8 (88.0) (78.3)

263.0 (60.0) (81.2)

Net Income

117.5

121.8

57.5 60.0

53.0 68.8

EBITDA Amortization Depreciation

Common dividends Addition to retained earnings

Source: Brigham, Houston (2012), 67.

Source: Brigham, Houston (2012), 62. Autumn Term 2013

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Profitability ratios Net income 118   3.9% Sales 3000 The profit margin on sales shows the profit per unit of sales

Profit margin  

Return on total assets  

Stockholders want to earn a return on their money invested. This ratio indicates the profitability of a stockholders’ invested money from an accounting perspective

Basic earning power  

Net income 118   5.9% Total assets 2000

EBIT 284   14.2% Total assets 2000

This ratio shows the raw earning power of the firm’s assets excluding potential influence from interest payments or leverage effects.

Return on common equity 



Net income 118   12.5% Common equity 940

Stockholders want to earn a return on their money invested. This ratio indicates the profitability of a stockholders’ invested money from an accounting perspective

Source: Brigham, Houston (2012), 108ff. Autumn Term 2013

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Balance sheet and income statement Balance Sheet (chf m) USD m

Income Statement 2008 2011

2007 2010

Assets Cash and cash equivalents Accounts receivable Inventories Current assets

10 375 615 1'000

80 315 415 810

Net plant and equipment Non-current assets

1'000 1'000

870 870

Total assets

2'000

1'680

Liabilities and Equity Accounts payable Notes payable Accruals Total current liabilities Long-term bonds Total debt Common stock (50'000'000 shares) Retained earnings Total equity Total liabilities and equity

60 110 140 310

30 60 130 220

750 1'060

580 800

130 810 940

130 750 880

2'000

1'680

(chf in USD m millions)

2008 2011

2007 2010

Net Sales Operating Costs

3'000.0 (2'616.2)

2'850.0 (2'497.0)

383.8 (100.0)

353.0 (90.0)

EBIT Interest Taxes

283.8 (88.0) (78.3)

263.0 (60.0) (81.2)

Net Income

117.5

121.8

57.5 60.0

53.0 68.8

EBITDA Amortization Depreciation

Common dividends Addition to retained earnings

Source: Brigham, Houston (2012), 67.

Source: Brigham, Houston (2012), 62. Autumn Term 2013

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Market value ratios Numbers of shares: 50m Price per share 23 Price/earnings ratio    9.8x Share price: 23 Earnings per share 118 50  This ratio shows how much an investor is willing to pay per unit of reported earnings. Thus, the P/E ratio indicates, by comparison with its peers, whether a company is regarded as being risky or expected to have poor growth.

Price per share 23.00   1.2x Book value per share 940 50 The market to book ratio typically exceeds 1.0 as the balance sheet does not reflect inflation or goodwill. In addition, this ratio provides an indication whether a company is able to earn high returns.

Market/boo k ratio  

Source: Brigham, Houston (2012), 111ff. Autumn Term 2013

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Balance sheet and income statement Balance Sheet (chf m) USD m

Income Statement 2008 2011

2007 2010

Assets Cash and cash equivalents Accounts receivable Inventories Current assets

10 375 615 1'000

80 315 415 810

Net plant and equipment Non-current assets

1'000 1'000

870 870

Total assets

2'000

1'680

Liabilities and Equity Accounts payable Notes payable Accruals Total current liabilities Long-term bonds Total debt Common stock (50'000'000 shares) Retained earnings Total equity Total liabilities and equity

60 110 140 310

30 60 130 220

750 1'060

580 800

130 810 940

130 750 880

2'000

1'680

(chf in USD m millions)

2008 2011

2007 2010

Net Sales Operating Costs

3'000.0 (2'616.2)

2'850.0 (2'497.0)

383.8 (100.0)

353.0 (90.0)

EBIT Interest Taxes

283.8 (88.0) (78.3)

263.0 (60.0) (81.2)

Net Income

117.5

121.8

57.5 60.0

53.0 68.8

EBITDA Amortization Depreciation

Common dividends Addition to retained earnings

Source: Brigham, Houston (2012), 67.

Source: Brigham, Houston (2012), 62. Autumn Term 2013

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Market value ratios Numbers of shares: 50m Price per share 23 Price/earnings ratio    9.8x Share price: 23 Earnings per share 118 50  This ratio shows how much an investor is willing to pay per unit of reported earnings. Thus, the P/E ratio indicates, by comparison with its peers, whether a company is regarded as being risky or expected to have poor growth.

Price per share 23.00   1.2x Book value per share 940 50 The market to book ratio typically exceeds 1.0 as the balance sheet does not reflect inflation or goodwill. In addition, this ratio provides an indication whether a company is able to earn high returns.

Market/boo k ratio  

Source: Brigham, Houston (2012), 111ff. Autumn Term 2013

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Balance sheet and income statement Balance Sheet (chf m) USD m

Income Statement 2008 2011

2007 2010

Assets Cash and cash equivalents Accounts receivable Inventories Current assets

10 375 615 1'000

80 315 415 810

Net plant and equipment Non-current assets

1'000 1'000

870 870

Total assets

2'000

1'680

Liabilities and Equity Accounts payable Notes payable Accruals Total current liabilities Long-term bonds Total debt Common stock (50'000'000 shares) Retained earnings Total equity Total liabilities and equity

60 110 140 310

30 60 130 220

750 1'060

580 800

130 810 940

130 750 880

2'000

1'680

(chf in USD m millions)

2008 2011

2007 2010

Net Sales Operating Costs

3'000.0 (2'616.2)

2'850.0 (2'497.0)

383.8 (100.0)

353.0 (90.0)

EBIT Interest Taxes

283.8 (88.0) (78.3)

263.0 (60.0) (81.2)

Net Income

117.5

121.8

57.5 60.0

53.0 68.8

EBITDA Amortization Depreciation

Common dividends Addition to retained earnings

Source: Brigham, Houston (2012), 67.

Source: Brigham, Houston (2012), 62. Autumn Term 2013

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Agenda: Case study Beans Incorporation vs. Garlic Incorporation

Autumn Term 2013

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Case study: Interpretation of financial statements 

Your client tells you he is interested in investing in a company from the food industry as he sees great growth potential in this industry



He has already selected two potential targets and now wants your professional advice on which company is more likely to report good results in the future



Please try to give your client your opinion based on what you have learned in this course 

Read the financial statements and calculate the ratios based on 2008 figures



Compare these ratios with those of the other company and with those of the industry average

Beans Inc.

Autumn Term 2013

vs.

Garlic Inc.

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Case study: Beans Incorporation I Beans Inc. Balance sheet

Income statement (chf m)

2011 2008

2010 2007

(chf m)

Net sales Operating sosts EBITDA Amortization Depreciation EBIT Interest EBT Taxes Net income

3780 2650 1130 0 75 1055 96 959 384 576

3500 2500 1000 0 90 910 81 829 332 497

Assets Cash and cash equivalents Accounts receivable Inventories Current assets Net plant and equipment Total assets

325 491 548 1'365 1'470 2'835

80 455 508 1'042 1'297 2'339

259 317

224 274

29.9% 27.9% 15.2% 11.51

28.6% 26.0% 14.2% 9.95

Liabilities and equity Accounts payable Notes payable Accruals Total current liabilities Long-term bonds Total debt Common stock (50'000'000 shares) Retained earnings Total equity Total liabilities and equity

302 227 75 604 590 1'194 250 1'391 1'641 2'835

263 193 70 525 490 1'015 250 1'074 1'324 2'339

Common dividends Addition to retained earnings

EBITDA margin EBIT margin Net income margin EPS

Share price Book value per share Numbers of shares (in m)

Autumn Term 2013

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2011 2008

2010 2007

152 33 50

54

Case study: Beans Incorporation II Beans Inc.

•

By analyzing its financial statements, what are the strengths and weaknesses of this company?

•

Where do you see risks or opportunities?

Statement of cash flow (chf m) Operating activities Net income Additions Depreciation and Amortization Increase in accounts payable Increase in accruals Substractions Increase in accounts receivable Increase in inventories Net cash provided by operating activities

2011 2008

576 75 40 5 (36) (41) 619

Long-term investing activities Cash used to acquire fixed assets

(248)

Financing activities Increase in notes payable Increase in bonds Payments of dividends Net cash provided by financing activities

34 100 (259) (125)

Net increase in cash and equivalents Cash and equivalents at beginning of the year Cash and equivalents at end of the year

Autumn Term 2013

245 80 325

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Case study: Garlic Incorporation I Garlic Inc. Balance sheet

Income statement (chf m)

2011 2008

2010 2007

(chf in millions)

Net sales Operating costs EBITDA Amortization Depreciation EBIT Interest EBT Taxes Net income

3180 2703 477 0 150 327 123 204 82 123

3000 2550 450 0 120 330 91 239 96 143

Assets Cash and cash equivalents Accounts receivable Inventories Current assets Net plant and equipment Total assets

148 509 541 1'198 1'318 2'516

80 480 450 1'010 1'120 2'130

55 67

65 79

15.0% 10.3% 3.9% 2.45

15.0% 11.0% 4.8% 2.87

Liabilities and equity Accounts payable Notes payable Accruals Total current liabilities Long-term bonds Total debt Common stock (50'000'000 shares) Retained earnings Total equity Total liabilities and equity

159 127 130 416 812 1'228 250 1'037 1'287 2'516

180 150 90 420 490 910 250 970 1'220 2'130

Common dividends Addition to retained earnings

EBITDA margin EBIT margin Net income margin EPS

Share price Book value per share Numbers of shares (in m)

Autumn Term 2013

Markus Neuhaus I Corporate Finance I [email protected]

2011 2008

2010 2007

32 26 50

56

Case study: Garlic Incorporation II Garlic Inc.

•

By analyzing its financial statements, what are the strengths and weaknesses of this company?

•

Where do you see risks or opportunities?

Statement of cash flow (chf m) Operating activities Net income Additions Depreciation and amortization Increase in accounts payable Increase in accruals Substractions Increase in accounts receivable Increase in inventories Net cash provided by operating activities Long-term investing activities Cash used to acquire fixed assets

2011 2008

123 150 (21) 40 (29) (91) 172

(348)

Financing activities Increase in notes payable Increase in bonds Payments of dividends Net cash provided by financing activities

(23) 322 (55) 244

Net increase in cash and equivalents

68

Cash and equivalents at beginning of the year Cash and equivalents at end of the year

Autumn Term 2013

80 148

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Case study: Solution guideline

    

Value Creation

Liquidity ratios Asset management ratios Debt ratios Profitability ratios Market value ratios

Profitability

Liquidity



Security/Risk

Try to assess whether the given company shows a healthy relation between profitability, liquidity and risk 

If a company shows high exposure to risky investments, one expects the profitability to be accordingly



Try to come to a conclusion on which company is more likely to pursue an expansive strategy and strengthen its position within the market 

In terms of ability to generate cash flows, capital structure and working capital management

Autumn Term 2013

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Case study: Solution guideline II 



Try to compare the companies with each other and put the results into perspective using the industry average values on the right Industry average figures can be seen as a guide  

Ratios Liquidity Current ratio

4.2x

Quick ratio

2.2x

Asset Management

Why is the company less profitable than

Inventory turnover

average peer companies?

Days sales outstanding Fixed assets turnover

Why does one company have such a high

Debt Management

P/E multiple and what does that mean for the

Total debt to total assets Times interest earned

operating business?

Industry average

10.9x 36 days 2.8x

40.0% 6x

Profitability



Financial statements can never fully answer

Profit margin

5.0%

Return on total assets (ROA)

9.0%

Basic earning power

18.0%

such questions. However, they can raise the

Return on common equity (ROE)

15.0%

right questions

Market Value Price / earnings (P/E) Market / book (M/B)

11.3x 1.7x

Source: Brigham, Houston (2012), 118.

Autumn Term 2013

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Contents     

Learning targets Pre-course reading Lecture „Interpreting Financial Statements“ Pre-course reading case studies / questions Solutions to case studies

Autumn Term 2013

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