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8/3/2019 CF II Interpreting FS 2009 Pre Lecture (1)
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Winter Term 2009 1Markus Neuhaus I Corporate Finance I [email protected]
Corporate FinanceInterpreting Financial Statements
Dr. Markus R. Neuhaus
Dr. Marc Schmidli, CFA
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Corporate Finance: Course overview
18.09. Fundamentals (4 hours) M. Neuhaus & M.Schmidli
25.09 Investment Management M. Neuhaus & P. Schwendener
02.10. Business Valuation (4 hours) M. Neuhaus & M. Bucher
09.10. No Lecture No Lecture
16.10. Value Management M. Neuhaus, R. Schmid & F. Monti
23.10. No Lecture No Lecture
30.10. No Lecture No Lecture
06.11. No lecture No Lecture
13.11. Mergers & Acquisitions I&II (4 hours) M. Neuhaus & D. Villiger
20.11 Tax and Corporate Finance (4 hours) Markus Neuhaus
27.11. Legal Aspects R. Watter
04.12. Financial Reporting M. Neuhaus & M. Jeger
11.12. Turnaround Management M. Neuhaus & Markus Koch
18.12. Summary, repetition M. Neuhaus
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Winter Term 2009 3Markus Neuhaus I Corporate Finance I [email protected]
Grade CEO Qualification Doctor of Law (University of Zurich), Certified Tax Expert
Career Development Joined PwC in 1985 and became Partner in 1992.
Subject-related Exp. Corporate Tax
Mergers + Acquisitions
Lecturing SFIT: Corporate Finance, University of St. Gallen: Tax Law
Multiple speeches on leadership, business, governance, commercial
and tax law
Published Literature 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.
Other professional roles: Member of the board of conomiesuisse, member of the board
and chairman of the tax chapter of the Swiss Institute of
Certified Accountants and Tax Consultants
Markus R. NeuhausPricewaterhouseCoopers AG, Zrich
Phone: +41 58 792 4000Email: [email protected]
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Winter Term 2009 4Markus Neuhaus I Corporate Finance I [email protected]
Marc SchmidliPricewaterhouseCoopers AG, Zrich
Phone: +41 58 792 15 64Email: [email protected]
Grade Director
Qualification Dr oec. HSG., CFA charterholder
Career Development Corporate Finance PricewaterhouseCoopers since July 2000
Lecturing Euroforum Valuation in M&A situations
Guest speaker at ZfU Seminars, Uni Zurich, ETH, etc.
Published Literature Finanzielle Qualitt in der schweizerischen
Elektrizittswirtschaft
Various articles in Treuhnder, HZ, etc.
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Winter Term 2009 5Markus Neuhaus I Corporate Finance I [email protected]
Contents
Learning targets
Pre-course reading
Lecture Interpreting Financial Statements
Pre-course reading case studies / questions Solutions to case studies
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Winter Term 2009 6Markus Neuhaus I Corporate Finance I [email protected]
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 andcash 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
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Winter Term 2009 7Markus Neuhaus I Corporate Finance I [email protected]
Contents
Learning targets
Pre-course reading
Lecture Interpreting Financial Statements
Pre-course reading case studies / questions Solutions to case studies
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Winter Term 2009 8Markus Neuhaus I Corporate Finance I [email protected]
Pre-course reading
Books
Mandatory reading:
Brigham, Houston (2009): Chapter 4 (pp. 84-109)
White, Sondhi, Fried (2003): Chapter 3 (pp. 74-99) Optional reading:
Brigham, Houston (2009): Chapter 3 (pp. 53-75)
Slides
Slides 1 to 11 mandatory reading
Other Slides optional reading, will be dealt within the lecture
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Winter Term 2009 9Markus Neuhaus I Corporate Finance I [email protected]
Contents
Learning targets
Pre-course reading
Lecture Interpreting Financial Statements
Pre-course reading case studies / questions Solutions to case studies
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Winter Term 2009 10Markus Neuhaus I Corporate Finance I [email protected]
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
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Winter Term 2009 11Markus Neuhaus I Corporate Finance I [email protected]
Agenda II
3. Case study
Beans Incorporation vs. Garlic Incorporation
4. Q&A and discussion
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Winter Term 2009 12Markus Neuhaus I Corporate Finance I [email protected]
Agenda: Introduction
Financial analysis
Classes of users
Need for financial statement analysis
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Winter Term 2009 13Markus Neuhaus I Corporate Finance I [email protected]
Evaluation of a firms performance and development mainly by
identifying the key drivers of a firms 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 firms development.
Financial management does not operate in a vacuum.
Financial analysis
Source: White, Sondhi, Fried (2003), 2ff.
Environment
Financial Statements
Business
Macroeconomic situation,industry, market
Balance sheet, income statement,cash flow, stockholders equity, budget
Management, products, margins,technology, knowledge base, competition
Financial
Analysis
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Winter Term 2009 14Markus Neuhaus I Corporate Finance I [email protected]
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
Classes of users
Source: White, Sondhi, Fried (2003), 4.
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Winter Term 2009 15Markus Neuhaus I Corporate Finance I [email protected]
Need for financial statement analysis
Internal:
financial statements provide the
company with information on its
performance and development over
time and are a crucial basis for mostfinancial decisions (i.e. investment,
financing)
Costs
Efficiency
Profitability
Investments
Financing (needs)
External:
financial statements facilitate the
interaction between the company
and its business environment by
providing third parties with essentialinformation on the companys
development
Creditors
Investors
Shareholders
Government
Financial analysis has great significance and impact
on a companys development as it influences
expectations on the capital markets
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Winter Term 2009 16Markus Neuhaus I Corporate Finance I [email protected]
Agenda: Ratio analysis
Significance of ratio analysis
Sources
Financial reporting systems and standards
Important groups of ratio analysis
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Winter Term 2009 17Markus Neuhaus I Corporate Finance I [email protected]
Ratio analysis
Financial statements help predict the future development of a company
Firm A has total debt of $200m whereas firm B has total debt of $2mm. Which firm isstronger, more liquid? Or which firm is more likely to generate higher cash flows?
Figures standing alone, such as total debt, 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 firms debt with its assets and (b) by comparing the
interest the company has to pay with the income it has available
Source: Brigham, Houston (2009), 103.
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Winter Term 2009 18Markus Neuhaus I Corporate Finance I [email protected]
Significance of ratio analysis
As a companys 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
help predict thefuture development
of a company
1) Details later: see page 25ff.
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Winter Term 2009 19Markus Neuhaus I Corporate Finance I [email protected]
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 providerelevant 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.
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Winter Term 2009 20Markus Neuhaus I Corporate Finance I [email protected]
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.). Both aim to
provide a true and fair viewof the companys 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 fr Rechnungslegung) which is a light form of IFRS.
Source: White, Sondhi, Fried (2003), 5ff.
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Winter Term 2009 21Markus Neuhaus I Corporate Finance I [email protected]
Balance sheet
Snapshot of the companys assets
and liabilities at a certain reporting
date
Assets = Liabilities + Equity
Balance Sheet
(chf m) 2008 2007
Assets
Cash and cash equivalents 10 80
Accounts receivable 375 315
Inventories 615 415
Current assets 1'000 810
Net plant and equipment 1'000 870
Non-current assets 1'000 870
Total assets 2'000 1'680
Liabilities and Equity
Accounts payable 60 30
Notes payable 110 60
Accruals 140 130
Total current liabilities 310 220
Long-term bonds 750 580
Total debt 1'060 800
Common stock (50'000'000 shares) 130 130
Retained earnings 810 750
Total equity 940 880
Total liabilities and equity 2'000 1'680
Source: Brigham, Houston (2009), 58.
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Winter Term 2009 22Markus Neuhaus I Corporate Finance I [email protected]
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).
Source: Brigham, Houston (2009), 61.
Income Statement
(chf in millions) 2008 2007
Net Sales 3'000.0 2'850.0
Operating Costs (2'616.2) (2'497.0)
EBITDA 383.8 353.0
Amortization - -
Depreciation (100.0) (90.0)
EBIT 283.8 263.0
Interest (88.0) (60.0)
Taxes (78.3) (81.2)
Net Income 117.5 121.8
Common dividends 57.5 53.0
Addition to retained earnings 60.0 68.8
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Winter Term 2009 23Markus Neuhaus I Corporate Finance I [email protected]
Statement of cash flow
The cash flow statement represents the cashgenerated by a company during the givenaccounting period
Separated into three categories: (I) operatingactivities, (II) investing activities, (III) financing
activities The investment section illustrates how cash was
spent whereas section III, financing shows howthose investments were financed
In the long run, cash flows from operating activitiesshould considerably increase; investments shouldbe equal to depreciation (plus a bit more tosupport stable growth)
In this example, the company has an operatingproblem as the cash flow from operating activitiesis negative
CAPEX = capital expenditures
Source: Brigham, Houston (2009), 63.
Statement of Cash Flow
(chf in millions) 2008
Operating activities
Net Income 117.5
Additions
Depreciation and Amortization 100.0
Increase in accounts payable 30.0
Increase in accruals 10.0
Substractions
Increase in accounts receivable (60.0)
Increase in inventories (200.0)
Net cash provided by operating activities (2.5)
Long-term investing activities
Cash used to acquire fixed assets (CAPEX) ( 230.0)
Financing activities
Increase in notes payable 50.0Increase in bonds 170.0
payments of dividens (57.5)
Net cash provided by financing activities 162.5
Net decrease in cash and equivalents (7 0.0)
Cash and equivalents at beginning of the year 80.0
Cash and equivalents at end of the year 10.0
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Winter Term 2009 24Markus Neuhaus I Corporate Finance I [email protected]
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
Source: Brigham, Houston (2009), 66.
Statement of retained earnings
(chf in millions) 2008
Balance of retained earnings as of 2007 750.0
Add: Net income 2008 117.5
Less: Dividend to common stockholders (57.5)
Balance of retained earnings as of 2008 810.0
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Winter Term 2009 25Markus Neuhaus I Corporate Finance I [email protected]
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?
Source: Brigham, Houston (2009), 84ff.
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Winter Term 2009 26Markus Neuhaus I Corporate Finance I [email protected]
Liquidity ratios
3.2x310
1000
sliabilitieCurrent
assetsCurrentratioCurrent !!!
1.2x310
615-1000
sliabilitieCurrent
sinventorie-assetsCurrentratioQuick !!!
Inventories are a firms 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.
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.
Source: Brigham, Houston (2009), 87f.
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Winter Term 2009 27Markus Neuhaus I Corporate Finance I [email protected]
Balance sheet and income statement
Balance Sheet
(chf m) 2008 2007
Assets
Cash and cash equivalents 10 80
Accounts receivable 375 315
Inventories 615 415
Current assets 1'000 810
Net plant and equipment 1'000 870
Non-current assets 1'000 870
Total assets 2'000 1'680
Liabilities and Equity
Accounts payable 60 30
Notes payable 110 60
Accruals 140 130
Total current liabilities 310 220
Long-term bonds 750 580
Total debt 1'060 800
Common stock (50'000'000 shares) 130 130
Retained earnings 810 750
Total equity 940 880
Total liabilities and equity 2'000 1'680
Source: Brigham, Houston (2009), 58.
Income Statement
(chf in millions) 2008 2007
Net Sales 3'000.0 2'850.0
Operating Costs (2'616.2) (2'497.0)
EBITDA 383.8 353.0
Amortization - -Depreciation (100.0) (90.0)
EBIT 283.8 263.0
Interest (88.0) (60.0)
Taxes (78.3) (81.2)
Net Income 117.5 121.8
Common dividends 57.5 53.0
Addition to retained earnings 60.0 68.8
Source: Brigham, Houston (2009), 61.
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Winter Term 2009 28Markus Neuhaus I Corporate Finance I [email protected]
Liquidity ratios
3.2x310
1000
sliabilitieCurrent
assetsCurrentratioCurrent !!!
1.2x310
615-1000
sliabilitieCurrent
sinventorie-assetsCurrentratioQuick !!!
Inventories are a firms 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.
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.
Source: Brigham, Houston (2009), 87f.
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Winter Term 2009 29Markus Neuhaus I Corporate Finance I [email protected]
Balance sheet and income statement
Balance Sheet
(chf m) 2008 2007
Assets
Cash and cash equivalents 10 80
Accounts receivable 375 315
Inventories 615 415
Current assets 1'000 810
Net plant and equipment 1'000 870
Non-current assets 1'000 870
Total assets 2'000 1'680
Liabilities and Equity
Accounts payable 60 30
Notes payable 110 60
Accruals 140 130
Total current liabilities3
1022
0
Long-term bonds 750 580
Total debt 1'060 800
Common stock (50'000'000 shares) 130 130
Retained earnings 810 750
Total equity 940 880
Total liabilities and equity 2'000 1'680
Income Statement
(chf in millions) 2008 2007
Net Sales 3'000.0 2'850.0
Operating Costs (2'616.2) (2'497.0)
EBITDA 383.8 353.0
Amortization - -Depreciation (100.0) (90.0)
EBIT 283.8 263.0
Interest (88.0) (60.0)
Taxes (78.3) (81.2)
Net Income 117.5 121.8
Common dividends 57.5 53.0
Addition to retained earnings 60.0 68.8
Source: Brigham, Houston (2009), 61.
Source: Brigham, Houston (2009), 58.
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Winter Term 2009 30Markus Neuhaus I Corporate Finance I [email protected]
Asset management ratios
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.
4.9x615
3000
Inventory
SalesratioturnoverInventory !!!
days46
365
3000
375
365/Sales
sReceivable
daypersalesAverage
sReceivablegoutstandinsalesDays !!!!
3.0x1000
3000
assetsfixedNet
SalesratioturnoverassetFixed !!!
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 fixed assets turnover ratio indicates how effectively the company is using its fixed assets
compared with peer companies.
Source: Brigham, Houston (2009), 88ff.
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Winter Term 2009 31Markus Neuhaus I Corporate Finance I [email protected]
Balance sheet and income statement
Balance Sheet
(chf m) 2008 2007
Assets
Cash and cash equivalents 10 80
Accounts receivable 375 315
Inventories 615 415
Current assets 1'000 810
Net plant and equipment 1'000 870
Non-current assets 1'000 870
Total assets 2'000 1'680
Liabilities and Equity
Accounts payable 60 30
Notes payable 110 60
Accruals 140 130
Total current liabilities310
220
Long-term bonds 750 580
Total debt 1'060 800
Common stock (50'000'000 shares) 130 130
Retained earnings 810 750
Total equity 940 880
Total liabilities and equity 2'000 1'680
Income Statement
(chf in millions) 2008 2007
Net Sales 3'000.0 2'850.0
Operating Costs (2'616.2) (2'497.0)
EBITDA 383.8 353.0
Amortization - -Depreciation (100.0) (90.0)
EBIT 283.8 263.0
Interest (88.0) (60.0)
Taxes (78.3) (81.2)
Net Income 117.5 121.8
Common dividends 57.5 53.0
Addition to retained earnings 60.0 68.8
Source: Brigham, Houston (2009), 61.
Source: Brigham, Houston (2009), 58.
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Winter Term 2009 32Markus Neuhaus I Corporate Finance I [email protected]
Asset management ratios
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.
4.9x615
3000
Inventory
SalesratioturnoverInventory !!!
days46
365
3000
375
365/Sales
sReceivable
daypersalesAverage
sReceivablegoutstandinsalesDays !!!!
3.0x1000
3000
assetsfixedNet
SalesratioturnoverassetFixed !!!
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 fixed assets turnover ratio indicates how effectively the company is using its fixed assets
compared with peer companies.
Source: Brigham, Houston (2009), 88ff.
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Winter Term 2009 33Markus Neuhaus I Corporate Finance I [email protected]
Balance sheet and income statement
Balance Sheet
(chf m) 2008 2007
Assets
Cash and cash equivalents 10 80
Accounts receivable 375 315
Inventories 615 415
Current assets 1'000 810
Net plant and equipment 1'000 870
Non-current assets 1'000 870
Total assets 2'000 1'680
Liabilities and Equity
Accounts payable 60 30
Notes payable 110 60
Accruals 140 130
Total current liabilities310
220
Long-term bonds 750 580
Total debt 1'060 800
Common stock (50'000'000 shares) 130 130
Retained earnings 810 750
Total equity 940 880
Total liabilities and equity 2'000 1'680
Income Statement
(chf in millions) 2008 2007
Net Sales 3'000.0 2'850.0
Operating Costs (2'616.2) (2'497.0)
EBITDA 383.8 353.0
Amortization - -Depreciation (100.0) (90.0)
EBIT 283.8 263.0
Interest (88.0) (60.0)
Taxes (78.3) (81.2)
Net Income 117.5 121.8
Common dividends 57.5 53.0
Addition to retained earnings 60.0 68.8
Source: Brigham, Houston (2009), 61.
Source: Brigham, Houston (2009), 58.
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Winter Term 2009 34Markus Neuhaus I Corporate Finance I [email protected]
Asset management ratios
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.
4.9x615
3000
Inventory
SalesratioturnoverInventory !!!
days46
365
3000
375
365/Sales
sReceivable
daypersalesAverage
sReceivablegoutstandinsalesDays !!!!
3.0x1000
3000
assetsfixedNet
SalesratioturnoverassetFixed !!!
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 fixed assets turnover ratio indicates how effectively the company is using its fixed assets
compared with peer companies.
Source: Brigham, Houston (2009), 88ff.
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Winter Term 2009 35Markus Neuhaus I Corporate Finance I [email protected]
Balance sheet and income statement
Balance Sheet
(chf m) 2008 2007
Assets
Cash and cash equivalents 10 80
Accounts receivable 375 315
Inventories 615 415
Current assets 1'000 810
Net plant and equipment 1'000 870
Non-current assets 1'000 870
Total assets 2'000 1'680
Liabilities and Equity
Accounts payable 60 30
Notes payable 110 60
Accruals 140 130
Total current liabilities310
220
Long-term bonds 750 580
Total debt 1'060 800
Common stock (50'000'000 shares) 130 130
Retained earnings 810 750
Total equity 940 880
Total liabilities and equity 2'000 1'680
Income Statement
(chf in millions) 2008 2007
Net Sales 3'000.0 2'850.0
Operating Costs (2'616.2) (2'497.0)
EBITDA 383.8 353.0
Amortization - -Depreciation (100.0) (90.0)
EBIT 283.8 263.0
Interest (88.0) (60.0)
Taxes (78.3) (81.2)
Net Income 117.5 121.8
Common dividends 57.5 53.0
Addition to retained earnings 60.0 68.8
Source: Brigham, Houston (2009), 61.
Source: Brigham, Houston (2009), 58.
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Winter Term 2009 36Markus Neuhaus I Corporate Finance I [email protected]
Debt or financing ratios
53.0%2000
1060
assetsTotal
debtTotalassetstotaltodebtTotal !!!
3.2x88
284
Interest
EBITratioearned-interest-Times !!!
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 firms business and industry.
The TIE ratio measures the extent to which operating costs 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 (2009), 91ff.
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Winter Term 2009 37Markus Neuhaus I Corporate Finance I [email protected]
Balance sheet and income statement
Balance Sheet
(chf m) 2008 2007
Assets
Cash and cash equivalents 10 80
Accounts receivable 375 315
Inventories 615 415
Current assets 1'000 810
Net plant and equipment 1'000 870
Non-current assets 1'000 870
Total assets 2'000 1'680
Liabilities and Equity
Accounts payable 60 30
Notes payable 110 60
Accruals 140 130
Total current liabilities310
220
Long-term bonds 750 580
Total debt 1'060 800
Common stock (50'000'000 shares) 130 130
Retained earnings 810 750
Total equity 940 880
Total liabilities and equity 2'000 1'680
Income Statement
(chf in millions) 2008 2007
Net Sales 3'000.0 2'850.0
Operating Costs (2'616.2) (2'497.0)
EBITDA 383.8 353.0
Amortization - -Depreciation (100.0) (90.0)
EBIT 283.8 263.0
Interest (88.0) (60.0)
Taxes (78.3) (81.2)
Net Income 117.5 121.8
Common dividends 57.5 53.0
Addition to retained earnings 60.0 68.8
Source: Brigham, Houston (2009), 61.
Source: Brigham, Houston (2009), 58.
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Winter Term 2009 38Markus Neuhaus I Corporate Finance I [email protected]
Debt or financing ratios
53.0%2000
1060
assetsTotal
debtTotalassetstotaltodebtTotal !!!
3.2x88
284
Interest
EBITratioearned-interest-Times !!!
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 firms business and industry.
The TIE ratio measures the extent to which operating costs 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 (2009), 91ff.
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Winter Term 2009 39Markus Neuhaus I Corporate Finance I [email protected]
Balance sheet and income statement
Balance Sheet
(chf m) 2008 2007
Assets
Cash and cash equivalents 10 80
Accounts receivable 375 315
Inventories 615 415
Current assets 1'000 810
Net plant and equipment 1'000 870
Non-current assets 1'000 870
Total assets 2'000 1'680
Liabilities and Equity
Accounts payable 60 30
Notes payable 110 60
Accruals 140 130
Total current liabilities 310 220
Long-term bonds 750 580
Total debt 1'060 800
Common stock (50'000'000 shares) 130 130
Retained earnings 810 750
Total equity 940 880
Total liabilities and equity 2'000 1'680
Income Statement
(chf in millions) 2008 2007
Net Sales 3'000.0 2'850.0
Operating Costs (2'616.2) (2'497.0)
EBITDA 383.8 353.0
Amortization - -Depreciation (100.0) (90.0)
EBIT 283.8 263.0
Interest (88.0) (60.0)
Taxes (78.3) (81.2)
Net Income 117.5 121.8
Common dividends 57.5 53.0
Addition to retained earnings 60.0 68.8
Source: Brigham, Houston (2009), 61.
Source: Brigham, Houston (2009), 58.
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Winter Term 2009 40Markus Neuhaus I Corporate Finance I [email protected]
Profitability ratios
3.9%3000
118
Sales
incomeNetsalesonmarginprofit(Net) !!!
14.2%2000
284
assetsTotal
EBITpowerearningBasic !!!
The profit margin on sales shows the profit per unit of sales
12.5%940
118
equityCommon
incomeNetequitycommononReturn !!!
Stockholders want to earn a return on their money invested. This ratio indicates the profitability of a
stockholders invested money from an accounting perspective
This ratio shows the raw earning power of the firms assets excluding potential influence from interest
payments or leverage effects.
Source: Brigham, Houston (2009), 95ff.
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Winter Term 2009 41Markus Neuhaus I Corporate Finance I [email protected]
Balance sheet and income statement
Balance Sheet
(chf m) 2008 2007
Assets
Cash and cash equivalents 10 80
Accounts receivable 375 315
Inventories 615 415
Current assets 1'000 810
Net plant and equipment 1'000 870
Non-current assets 1'000 870
Total assets 2'000 1'680
Liabilities and Equity
Accounts payable 60 30
Notes payable 110 60
Accruals 140 130
Total current liabilities 310 220
Long-term bonds 750 580
Total debt 1'060 800
Common stock (50'000'000 shares) 130 130
Retained earnings 810 750
Total equity 940 880
Total liabilities and equity 2'000 1'680
Income Statement
(chf in millions) 2008 2007
Net Sales 3'000.0 2'850.0
Operating Costs (2'616.2) (2'497.0)
EBITDA 383.8 353.0
Amortization - -Depreciation (100.0) (90.0)
EBIT 283.8 263.0
Interest (88.0) (60.0)
Taxes (78.3) (81.2)
Net Income 117.5 121.8
Common dividends 57.5 53.0
Addition to retained earnings 60.0 68.8
Source: Brigham, Houston (2009), 61.
Source: Brigham, Houston (2009), 58.
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Winter Term 2009 42Markus Neuhaus I Corporate Finance I [email protected]
Profitability ratios
3.9%3000
118
Sales
incomeNetsalesonmarginprofit(Net) !!!
14.2%2000
284
assetsTotal
EBITpowerearningBasic !!!
The profit margin on sales shows the profit per unit of sales
12.5%940
118
equityCommon
incomeNetequitycommononReturn !!!
Stockholders want to earn a return on their money invested. This ratio indicates the profitability of a
stockholders invested money from an accounting perspective
This ratio shows the raw earning power of the firms assets excluding potential influence from interest
payments or leverage effects.
Source: Brigham, Houston (2009), 95ff.
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Winter Term 2009 43Markus Neuhaus I Corporate Finance I [email protected]
Balance sheet and income statement
Balance Sheet
(chf m) 2008 2007
Assets
Cash and cash equivalents 10 80
Accounts receivable 375 315
Inventories 615 415
Current assets 1'000 810
Net plant and equipment 1'000 870
Non-current assets 1'000 870
Total assets 2'000 1'680
Liabilities and Equity
Accounts payable 60 30
Notes payable 110 60
Accruals 140 130
Total current liabilities 310 220
Long-term bonds 750 580
Total debt 1'060 800
Common stock (50'000'000 shares) 130 130
Retained earnings 810 750
Total equity 940 880
Total liabilities and equity 2'000 1'680
Income Statement
(chf in millions) 2008 2007
Net Sales 3'000.0 2'850.0
Operating Costs (2'616.2) (2'497.0)
EBITDA 383.8 353.0
Amortization - -Depreciation (100.0) (90.0)
EBIT 283.8 263.0
Interest (88.0) (60.0)
Taxes (78.3) (81.2)
Net Income 117.5 121.8
Common dividends 57.5 53.0
Addition to retained earnings 60.0 68.8
Source: Brigham, Houston (2009), 61.
Source: Brigham, Houston (2009), 58.
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Winter Term 2009 44Markus Neuhaus I Corporate Finance I [email protected]
Profitability ratios
3.9%3000
118
Sales
incomeNetsalesonmarginprofit(Net) !!!
14.2%2000
284
assetsTotal
EBITpowerearningBasic !!!
The profit margin on sales shows the profit per unit of sales
12.5%940
118
equityCommon
incomeNetequitycommononReturn !!!
Stockholders want to earn a return on their money invested. This ratio indicates the profitability of a
stockholders invested money from an accounting perspective
This ratio shows the raw earning power of the firms assets excluding potential influence from interest
payments or leverage effects.
Source: Brigham, Houston (2009), 95ff.
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Winter Term 2009 45Markus Neuhaus I Corporate Finance I [email protected]
Balance sheet and income statement
Balance Sheet
(chf m) 2008 2007
Assets
Cash and cash equivalents 10 80
Accounts receivable 375 315
Inventories 615 415
Current assets 1'000 810
Net plant and equipment 1'000 870
Non-current assets 1'000 870
Total assets 2'000 1'680
Liabilities and Equity
Accounts payable 60 30
Notes payable 110 60
Accruals 140 130
Total current liabilities 310 220
Long-term bonds 750 580
Total debt 1'060 800
Common stock (50'000'000 shares) 130 130
Retained earnings 810 750
Total equity 940 880
Total liabilities and equity 2'000 1'680
Income Statement
(chf in millions) 2008 2007
Net Sales 3'000.0 2'850.0
Operating Costs (2'616.2) (2'497.0)
EBITDA 383.8 353.0
Amortization - -Depreciation (100.0) (90.0)
EBIT 283.8 263.0
Interest (88.0) (60.0)
Taxes (78.3) (81.2)
Net Income 117.5 121.8
Common dividends 57.5 53.0
Addition to retained earnings 60.0 68.8
Source: Brigham, Houston (2009), 61.
Source: Brigham, Houston (2009), 58.
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Winter Term 2009 46Markus Neuhaus I Corporate Finance I [email protected]
Market value ratios
9.8x
50
118
23
shareperEarnings
shareperPriceratioingsPrice/earn !!!
5.3
50
100118
23.00
shareperflowCash
shareperPriceratioflowPrice/cash !
!!
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.
1.2x
50
940
23.00
sharepervalueBook
shareperPriceratiokMarket/boo !!!
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.
Depending on the industry, a firms stock price is tied more closely to cash flow than net income.
Remember: Net income + D&A = cash flow
Numbers of shares:50m
Share price: 23
Cash flow = net income + D&A
Source: Brigham, Houston (2009), 98ff.
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Winter Term 2009 47Markus Neuhaus I Corporate Finance I [email protected]
Balance sheet and income statement
Balance Sheet
(chf m) 2008 2007
Assets
Cash and cash equivalents 10 80
Accounts receivable 375 315
Inventories 615 415
Current assets 1'000 810
Net plant and equipment 1'000 870
Non-current assets 1'000 870
Total assets 2'000 1'680
Liabilities and Equity
Accounts payable 60 30
Notes payable 110 60
Accruals 140 130
Total current liabilities 310 220
Long-term bonds 750 580
Total debt 1'060 800
Common stock (50'000'000 shares) 130 130
Retained earnings 810 750
Total equity 940 880
Total liabilities and equity 2'000 1'680
Income Statement
(chf in millions) 2008 2007
Net Sales 3'000.0 2'850.0
Operating Costs (2'616.2) (2'497.0)
EBITDA 383.8 353.0
Amortization - -Depreciation (100.0) (90.0)
EBIT 283.8 263.0
Interest (88.0) (60.0)
Taxes (78.3) (81.2)
Net Income 117.5 121.8
Common dividends 57.5 53.0
Addition to retained earnings 60.0 68.8
Source: Brigham, Houston (2009), 61.
Source: Brigham, Houston (2009), 58.
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Winter Term 2009 48Markus Neuhaus I Corporate Finance I [email protected]
Market value ratios
9.8x
50
118
23
shareperEarnings
shareperPriceratioingsPrice/earn !!!
5.3
50
100118
23.00
shareperflowCash
shareperPriceratioflowPrice/cash !
!!
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.
1.2x
50
940
23.00
sharepervalueBook
shareperPriceratiokMarket/boo !!!
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.
Depending on the industry, a firms stock price is tied more closely to cash flow than net income.
Remember: Net income + D&A = cash flow
Numbers of shares:50m
Share price: 23
Cash flow = net income + D&A
Source: Brigham, Houston (2009), 98ff.
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Winter Term 2009 49Markus Neuhaus I Corporate Finance I [email protected]
Balance sheet and income statement
Balance Sheet
(chf m) 2008 2007
Assets
Cash and cash equivalents 10 80
Accounts receivable 375 315
Inventories 615 415
Current assets 1'000 810
Net plant and equipment 1'000 870
Non-current assets 1'000 870
Total assets 2'000 1'680
Liabilities and Equity
Accounts payable 60 30
Notes payable 110 60
Accruals 140 130
Total current liabilities 310 220
Long-term bonds 750 580
Total debt 1'060 800
Common stock (50'000'000 shares) 130 130
Retained earnings 810 750
Total equity 940 880
Total liabilities and equity 2'000 1'680
Income Statement
(chf in millions) 2008 2007
Net Sales 3'000.0 2'850.0
Operating Costs (2'616.2) (2'497.0)
EBITDA 383.8 353.0
Amortization - -Depreciation (100.0) (90.0)
EBIT 283.8 263.0
Interest (88.0) (60.0)
Taxes (78.3) (81.2)
Net Income 117.5 121.8
Common dividends 57.5 53.0
Addition to retained earnings 60.0 68.8
Source: Brigham, Houston (2009), 61.
Source: Brigham, Houston (2009), 58.
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Winter Term 2009 50Markus Neuhaus I Corporate Finance I [email protected]
Market value ratios
9.8x
50
118
23
shareperEarnings
shareperPriceratioingsPrice/earn !!!
5.3
50
100118
23.00
shareperflowCash
shareperPriceratioflowPrice/cash !
!!
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.
1.2x
50
940
23.00
sharepervalueBook
shareperPriceratiokMarket/boo !!!
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.
Depending on the industry, a firms stock price is tied more closely to cash flow than net income.
Remember: Net income + D&A = cash flow
Numbers of shares:50m
Share price: 23
Cash flow = net income + D&A
Source: Brigham, Houston (2009), 98ff.
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Winter Term 2009 51Markus Neuhaus I Corporate Finance I [email protected]
Balance sheet and income statement
Balance Sheet
(chf m) 2008 2007
Assets
Cash and cash equivalents 10 80
Accounts receivable 375 315
Inventories 615 415
Current assets 1'000 810
Net plant and equipment 1'000 870
Non-current assets 1'000 870
Total assets 2'000 1'680
Liabilities and Equity
Accounts payable 60 30
Notes payable 110 60
Accruals 140 130
Total current liabilities 310 220
Long-term bonds 750 580
Total debt 1'060 800
Common stock (50'000'000 shares) 130 130
Retained earnings 810 750
Total equity 940 880
Total liabilities and equity 2'000 1'680
Income Statement
(chf in millions) 2008 2007
Net Sales 3'000.0 2'850.0
Operating Costs (2'616.2) (2'497.0)
EBITDA 383.8 353.0
Amortization - -Depreciation (100.0) (90.0)
EBIT 283.8 263.0
Interest (88.0) (60.0)
Taxes (78.3) (81.2)
Net Income 117.5 121.8
Common dividends 57.5 53.0
Addition to retained earnings 60.0 68.8
Source: Brigham, Houston (2009), 61.
Source: Brigham, Houston (2009), 58.
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Winter Term 2009 52Markus Neuhaus I Corporate Finance I [email protected]
Agenda: Case study
Beans Incorporation vs. Garlic Incorporation
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Winter Term 2009 53Markus Neuhaus I Corporate Finance I [email protected]
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. Garlic Inc.vs.
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Winter Term 2009 54Markus Neuhaus I Corporate Finance I [email protected]
Case study: Beans Incorporation I
Beans Inc.
Balance sheet
(chf m) 2008 2007
Assets
Cash and cash equivalents 325 80
Accounts receivable 491 455
Inventories 548 508
Current assets 1'365 1'042
Net plant and equipment 1'470 1'297
Total assets 2'835 2'339
Liabilities and equity
Accounts payable 302 263
Notes payable 227 193
Accruals 75 70
Total current liabilities 604 525
Long-term bonds 590 490
Total debt 1'194 1'015
Common stock (50'000'000 shares) 250 250
Retained earnings 1'391 1'074
Total equity 1'641 1'324Total liabilities and equity 2'835 2'339
Share price 152
Book value per share 33
Numbers of shares (in m) 50
Income statement
(chf m) 2008 2007
Net sales 3780 3500
Operating sosts 2650 2500
EBITDA 1130 1000
Amortization 0 0
Depreciation 75 90
EBIT 1055 910
Interest 96 81
EBT 959 829
Taxes 384 332
Net income 576 497
Common dividends 259 224
Addition to retained earnings 317 274
EBITDA margin 29.9% 28.6%
EBIT margin 27.9% 26.0%
Netincome margin 15.2% 14.2%
EPS 11.51 9.95
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Winter Term 2009 55Markus Neuhaus I Corporate Finance I [email protected]
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) 2008
Operating activities
Net income 576
Additions
Depreciation and Amortization 75
Increase in accounts payable 40
Increase in accruals 5
Substractions
Increase in accounts receivable (36)
Increase in inventories (41)
Net cash provided by operating activities 619
Long-term investing activities
Cash used to acquire fixed assets ( 248)
Financing activitiesIncrease in notes payable 34
Increase in bonds 100
Payments of dividends (259)
Net cash provided by financing activities (125)
Netincrease in cash and equivalents 245
Cash and equivalents at beginning of the year 80
Cash and equivalents at end of the year 325
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Winter Term 2009 56Markus Neuhaus I Corporate Finance I [email protected]
Case study: Garlic Incorporation I
Garlic Inc.
Balance sheet
(chf in millions) 2008 2007
Assets
Cash and cash equivalents 148 80
Accounts receivable 509 480
Inventories 541 450
Current assets 1'198 1'010
Net plant and equipment 1'318 1'120
Total assets 2'516 2'130
Liabilities and equity
Accounts payable 159 180
Notes payable 127 150
Accruals 130 90
Total current liabilities 416 420
Long-term bonds 812 490
Total debt 1'228 910
Common stock (50'000'000 shares) 250 250
Retained earnings 1'037 970
Total equity 1'287 1'220Total liabilities and equity 2'516 2'130
Share price 32
Book value per share 26
Numbers of shares (in m) 50
Income statement
(chf m) 2008 2007
Net sales 3180 3000
Operating costs 2703 2550EBITDA 477 450
Amortization 0 0
Depreciation 150 120
EBIT 327 330
Interest 123 91
EBT 204 239
Taxes 82 96
Net income 123 143
Common dividends 55 65
Addition to retained earnings 67 79
EBITDA margin 15.0% 15.0%
EBIT margin 10.3% 11.0%
Netincome margin 3.9% 4.8%
EPS 2.45 2.87
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Winter Term 2009 57Markus Neuhaus I Corporate Finance I [email protected]
Case study: Garlic Incorporation II
Garlic Inc.
Statement of cash flow
(chf m) 2008
Operating activities
Net income 123
Additions
Depreciation and amortization 150
Increase in accounts payable (21)
Increase in accruals 40
Substractions
Increase in accounts receivable (29)
Increase in inventories (91)
Net cash provided by operating activities 172
Long-term investing activities
Cash used to acquire fixed assets (348)
Financing activitiesIncrease in notes payable (23)
Increase in bonds 322
Payments of dividends (55)
Net cash provided by financing activities 244
Net increase in cash and equivalents 68
Cash and equivalents at beginning of the year 80
Cash and equivalents at end of the year 148
By analyzing its financial
statements, what are the
strengths and weaknesses of this
company?
Where do you see risks or
opportunities?
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Winter Term 2009 58Markus Neuhaus I Corporate Finance I [email protected]
Case study: Solution guideline
Liquidity ratios
Asset management ratios
Debt ratios
Profitability ratios
Market value ratios
Value Creation
Liquidity Security/Risk
Profitability
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 beaccordingly
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
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Winter Term 2009 59Markus Neuhaus I Corporate Finance I [email protected]
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
Why is the company less profitable than
average peer companies?
Why does one company have such a high
P/E multiple and what does that mean for the
operating business?
Financial statements can never fully answersuch questions. However, they can raise the
right questions
Ratios Industry average
Liquidity
Current ratio 4.2x
Quick ratio 2.2x
Asset Management
Inventory turnover 10.9x
Days sales outstanding 36 days
Fixed assets turnover 2.8x
Debt Management
Total debt to total assets 40.0%
Times-interest-earned 6x
EBITDA coverage 4.3x
Profitability
Sales margin 5.0%
Return on total assets 9.0%
Basic earning power 18.0%
Return on common equity
Market Value
Price / EPS 11.3x
Price / cash flow 5.4x
Market / book 1.7x
Source: Brigham, Houston (2009), 103.
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Winter Term 2009 60Markus Neuhaus I Corporate Finance I [email protected]
Contents
Learning targets
Pre-course reading
Lecture Interpreting Financial Statements
Pre-course reading case studies / questions
Solutions to case studies
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Solutions to Case Study
Will be distributed after lecture