Essential Learning for CTP Candidates...Session #7 (Thur., 9/03, 10:00 –11:00 am) Overview of Basic CTP Math from ETM6 Chap 07: Earnings Credits Chap 11: Working Capital

TEXPO Conference 2020:

Essential Learning for CTP CandidatesSession #7 (Thur., 9/03, 10:00 – 11:00 am)

❖ Overview of Basic CTP Math from ETM6

❖ Chap 07: Earnings Credits

❖ Chap 11: Working Capital

❖ Chap 08: Fin. Statements

❖ Chap 09: Financial Analysis

© 2020 - The Treasury Academy, Inc. - All Rights Reserved 1

Essentials of Treasury Management, 6th Ed. (ETM6) is published by the AFP

which holds the copyright and all rights to the related materials.

As a prep course for the CTP exam, significant portions of these lectures are

based on materials from the Essentials text.

ETM6: Calculations

Chapters 7, 11 , 8 & 9

These slides cover most of the basic calculations in ETM6 – Examples include both those from the text and additional problems.

2© 2020 - The Treasury Academy, Inc. - All Rights Reserved

Due to time constraints, we will

NOT be able to cover all of the

examples in this session.

Students are encouraged to

spend some time on their own

reviewing these problems at a

later date.

ETM6: Chapter 7 CalculationsManaging Relationships with Service Providers

Earnings CreditCollected Balance Required


Earnings Credit

Where:

EC = Earnings credit

CB = Average collected balances

RR = Reserve requirement

ECR = Earnings credit rate

D = Number of days in the month

−

DEC = CB × (1 RR) × ECR

365


Earnings CreditAssume the following scenario:

Average ledger balance $250,000Deposit float $ 30,000Reserve requirement 10%Earnings credit rate 1%Service charges for the month $ 1,000Days in month 30

Average Collected Balance Calculation:

Average ledger balance $250,000Less: Deposit float ($30,000)Equals: Average collected balance $220,000

−

−


365

30= $220,000 × (1 0.10) × 0.01

365

= $220,000 × 0.90 × 0.00082192 = $162.76


Source: ETM6 - © AFP

Collected/Available Balances Required

Where:

CB = Average collected balances required to pay service charges

AB = Average available balances required to pay service charges

SC = Service charges

ECR= Earnings credit rate

RR = Reserve requirement

D = Number of days in the month

−

SCCB =

DECR × × (1 RR)

365

SCAB =

DECR ×

365



Assume the following scenario:

Monthly service charges $1,000

Earnings credit rate 1%

Reserve requirement 10%

Days in month 30



−

−

SCCB =

DECR × × (1 RR)

365

$1,000=

300.01 × × (1 0.10)

365

=$1,000

= $1,351,716.68(0.0007398)

ETM6: Chapter 7Managing Relationships with Service Providers

Additional Calculations


Assume ledger balance = $1.2M,

deposit float = $0.4M, R/R = 10%, ECR

= 0.5%, 31 days in the month. Calculate

the earnings credits.

A. $295.89

B. $305.75

C. $339.73

D. $3,057.53

© 2013 - The Treasury Academy, Inc. - All Rights Reserved 9© 2020 - The Treasury Academy, Inc. - All Rights Reserved 9

Earnings CreditAssume the following scenario:

Average ledger balance $1,200,000Deposit float $ 400,000Reserve requirement 10%Earnings credit rate 0.5%Days in month 31

Average Balance Calculations:

Average ledger balance $1,200,000Less: Deposit float ($400,000)Equals: Average collected balance $800,000

Less: Reserve Requirement ($80,000)Equals: Average available balance $720,000

−

−


365

31= $800,000 × (1 0.10) × 0.005

365

= $305.75

DEC = AB × ECR

365

31= $720,000 × 0.005

365

= $305.75


Assume ledger balance = $1.2M,

deposit float = $0.4M, R/R = 10%, ECR

= 0.5%, 31 days in the month. Calculate

the earnings credits.

A. $295.89

B. $305.75

C. $339.73

D. $3,057.53

No reserve requirement

30 days rather than 31

Used 5% rather than 0.5%


Assume R/R = 10%, ECR = 0.4%, 30 days in

the month. Calculate the collected balance

required to support $1,200 in services.

A. $392,473

B. $405,555

C. $3,650,000

D. $4,055,555



Assume the following scenario:

Monthly service charges $1,200

Earnings credit rate 0.4%

Reserve requirement 10%

Days in month 30

−

−

SCCB =

DECR × × (1 RR)

365

$1,200=

300.004 × × (1 0.10)

365

= $4,055,555

SCAB =

DECR ×

365

$1,200=

300.004 ×

365

= $3,650,000


Assume R/R = 10%, ECR = 0.4%, 30 days in

the month. Calculate the collected balance

required to support $1,200 in services.

A. $392,473

B. $405,555

C. $3,650,000

D. $4,055,555

Calculated Available Balance

Used 4% rather than 0.4%

Used 4% rather than 0.4% & 31 days


Practicing the Calculations

❖The more times you work through a

calculation, the more comfortable you

will be with it

❖Develop your own versions of the

calculations and double check your math

❖Share calculations with others that are

studying for the exam

❖Make a list of Study Buddies!!


ETM6: Chapter 11 CalculationsWorking Capital Metrics

Float Neutral CalculationCost of DiscountCash Conversion Cycle (CCC)Days Sales OutstandingAging ScheduleA/R Balance Pattern


Focus of Treasury on Cash Flow

Timeline

❖Treasury focus is on the payment portion of the cycle

❖Calculation: Float Neutral Calculation

▪ TD = total days difference in payment timing

▪ r = Opportunity cost as an annual rate


= − +

1Discount 1

r1 TD

365

Float Neutral Calculation Assume r = 12% and TD = 3 days


1Discount 1

12%1 3

365

11 1 0.99901467

1.0009863

0.00098533

0.001 (Rounded) or 0.10%

= − +

= − = −

=

=

If the buyer is allowed to take a discount of 0.10 %, they would be

indifferent (in present value terms) between paying by check or by

electronic transfer (a speedup of 3 days in loss of value)

Cost of a Buyer Not Taking a Cash Discount


( ) ( )

( ) ( )

− −

− −

D 365Discount Cost =

100 D N T

2 365=

100 2 30 10

2 365= = .0204 18.25 =.3723 or 37.23%

98 20Where

D = Discount percentage is 2%

N = Net period is 30 days

T = Discount period is 10 days

The cost of not taking the discount can be compared with the

organization’s opportunity cost to borrow short-term funds. If we

assume a rate of 8% for this example, then borrowing cost would

be less than the cost of not taking the discount – so the

organization should borrow the funds and take the discount.


When Should a Buyer Forgo an

Offered Discount?

❖Short-term investment rates

above annualized discount rate

❖Buyer’s cost of short-term

borrowing greater than

annualized discount rate

❖Buyer can “stretch” payables

enough to sufficiently lower

annualized discount rate


Benefit to Seller of Offering a Cash Discount

© 2020 - The Treasury Academy, Inc. - All Rights Reserved

( )Disc Pmt

Total Amount of Full Pmt × 1 Disc RatePV

Annual Opp Cost1 Days in Disc Period ×

365

− = +

( )

( )

− = =

+ +

= =

Disc Pmt

$1,000 1 .02 $980PV

1 .00137.051 10

365

$980$978.66

1.00137

Assume credit terms of 2/10, net 30 and opp. cost = 5%

Present Value of Receiving Discounted Payment Amount

21Source: ETM6 - © AFP

Benefit to Seller of Offering a Cash Discount


Assume credit terms of 2/10, net 30 and opp. cost = 5%

Present Value of Receiving Full Payment Amount

Full Pmt

Total Amount of Full PmtPV

Annual Opp Cost1 Days in Net Period ×

365

= +

( )Full Pmt

$1,000 $1,000PV

1 .00411.051 30

365

$1,000$995.91

1.00411

= = + +

= =

NPV = PVDay 10 – PVDay 30 = $978.66 – $995.91 = – $17.25

22

Source: ETM6 © AFP

Cash Conversion Cycle (CCC)

❖Days’ Inventory

❖Days’ Receivables

❖Days’ Payables

❖Calculations of the Cash Conversion

Cycle (CCC)

❖Cash Turnover Ratio


Days’ Inventory Days’ Receivables

Days’ Payables Cash Conversion Cycle

“Working Capital Gap”

Cash Conversion Cycle

Elements in the cash

conversion cycle:

Days’ Inventory

Days’

Receivables

Days’ Payables

Inventory

365Cost of Goods Sold

Accounts Receivable

365Sales

Accounts Payable

365Cost of Goods Sold



Elements in the cash

conversion cycle:

Days’

Inventory

Days’

Receivables

Days’

Payables

Days 103.15 3659,200

2,600 365

COGS

Inv==

Days 41.36 36515,000

1,700 365

Sales

A/R==

Days 63.48 3659,200

1,600 365

COGS

A/P==



Cash Conversion Cycle (CCC)

Calculates the time required

to convert cash outflows

(necessary to produce

goods) into cash inflows

(through the collection of

accounts receivable)

CCC Days' Inv. Days' Rec. - Days' Pay.

103.15 41.36 63.48 81.03 Days

= +

= + − =



365 DaysCash Turnover =


365= = 4.5 Times

81.03 Days

Days’ Sales Outstanding (DSO) Assume that a company has outstanding

receivables of $285,000 at the end of the

first quarter and credit sales of $310,000 for

the quarter. Using a 90-day averaging

period, the DSO for this company can be

computed as follows:

Sales During Period $310,000Avg. Daily Credit Sales = = = $3,444.44

Number of Days in Period 90

Outstanding A/R $285,000DSO = = = 82.74 Days

Avg. Daily Credit Sales $3,444.44

−

−

Average Past Due = DSO Avg. Days of Credit Terms

= 82.74 Days 30 Days = 52.74 Days

If the company’s credit terms are net 30, the average past due is

computed as follows:



Aging Schedule

Separates A/R into current and past-due receivables in

30-day increments (on a customer or aggregate basis)

and can determine the percent past due

Age of A/R Amount of A/R % of Total A/R

Current $1,750,000 70%

1-30 Days Past Due 375,000 15%

31-60 Days Past Due 250,000 10%

Over 60 Days Past Due 125,000 5%

Total $2,500,000 100%



A/R Balance Pattern for March

29© 2020 - The Treasury Academy, Inc. - All Rights Reserved Source: ETM6 - © AFP

ETM6: Chapter 11 CalculationsWorking Capital Metrics



Assume a company is offered a 1.3%

discount for paying on day 30 rather

than day 90. At what opportunity cost

would the company be indifferent

between these two payment dates?

A. 4%

B. 6%

C. 8%

D. 10%


Assume a company is offered a 1.3%

discount for paying on day 30 rather

than day 90. At what opportunity cost

would the company be indifferent

between these two payment dates?

A. 4%

B. 6%

C. 8%

D. 10%

Example of just trying all

the answers to find the

correct one.

Alternative approach is

to use discount cost

formula


Float Neutral Calculation Assume: r = 8% and TD = 60 days


1Discount 1

8%1 60

365

11 1 0.98702

1.01315

0.01298 = 1.3% (Rounded)

= − +

= − = −

=

If the buyer is allowed to take a discount of 1.3 %, they would be

indifferent (in present value terms) between paying electronically

today or on day 60 by check (a speedup of 60 days in loss of value)

A company is offered terms of 1/10,

Net 40, but routinely takes 50 days to

pay without incurring any penalties.

What is the cost of not taking this

discount?

A. 7.4%

B. 7.9%

C. 9.2%

D. 12.3%


Cost of a Buyer Not Taking a Cash

Discount


( ) ( )

( ) ( )

− −

− −

D 365Discount Cost =

100 D N T

1 365=

100 1 50 10

1 365= = .0101 9.125 = .09216 or 9.2%

99 40Where

D = Discount percentage is 1%

N = Net period is 50 days

T = Discount period is 10 days

The cost of not taking the discount can be compared with the

organization’s opportunity cost to borrow short-term funds. If we

assume a rate of 8% for this example, then borrowing cost would

be less than the cost of not taking the discount – so the

organization should borrow the funds and TAKE the discount.

A company is offered terms of 1/10,

Net 40, but routinely takes 50 days to

pay without incurring any penalties.

What is the cost of not taking this

discount?

A. 7.4%

B. 7.9%

C. 9.2%

D. 12.3%

Example of being sure to

read the problem. Use

the actual days taken,

not the stated terms.

Used 40 day net period

Did not take out discount period


ETM6: Chapter 8

Financial Accounting & Reporting


Sample Balance Sheet

“Snapshot”

Assets:Current assets

Fixed assets

Depreciable fixed

assets

Intangible assets

Liabilities:Current liabilities

Long-term

liabilities

Equity

Assets = Liabilities +

Shareholders’

Equity

© 2020 - The Treasury Academy, Inc. - All Rights Reserved 38Source: ETM6 - © AFP

Sample Income Statement

A record of

revenues and

expenses

Shows the net

change in

shareholders’

equity from

operations over

a specified

period


Sample Statement of Cash Flows

Shows sources and

uses of cash

Sections:

Operating

Investing

Financing

Cash from

operations

calculated by

adding back non-

cash charges

(e.g.,

depreciation)

Cash, not earnings,

repays debt

This example shows

the indirect format


ETM6: Chapter 9 CalculationsFinancial Planning and Analysis

Time Value (PV & FV)

Breakeven Point

NPV, IRR, PI

Ratios & Ratio Analysis

Liquidity, Efficiency, Debt Management,

Performance, DuPont

Return vs. Residual Income Measures

Operating and Financial Leverage


Future Value

n

2

Future Value = PV × (1 + i)

= $100 × (1 + .10)

= $100 × 1.21 = $121

What is the future value of $100 if it can be invested for

two years, compounded annually, at a rate of 10% per

year?

Where:

FV = Future value

PV = Present value

i = Periodic interest rate

n = Number of periods


Alt Example: $100, 5 yrs, 10%

$100 x (1.10)5

$100 x (1.10)(1.10)(1.10)(1.10)(1.10)

$100 x 1.61051 = $161.05

Present Value

What is the present value of $2,382 to be received after

three years, discounted at a rate of 6.00% annually?

Where:

FV = Future value

i = Periodic interest rate

n = Number of periods

( ) ( )n 3

$2,382FVPresent Value = =

1 + i 1 + 0.06

$2,382= = $2,000

1.191


PV of a Stream of Payments


31 2 n

1 2 3 n

CC C CPV ... ...

(1 i) (1 i) (1 i) (1 i)= + + + +

+ + + +

1 2 3

$200 $400 $600PV

(1 .12) (1 .12) (1 .12)

$200 $400 $600

1.12 1.2544 1.4049

$178.57 $318.88 $427.08 $924.53

= + ++ + +

= + +

= + + =

As an example, assume the following annual cash

flows: $200 in year one, $400 in year two and $600

in year three. If the appropriate discount rate is

12%, then the PV of the stream would be:

Breakeven Analysis

−

−

Fixed CostsUnit B /E Point =

Selling Price Per Unit Variable Cost Per Unit

$10,000=

$10 $6

= 2,500 Units

Breakeven point: Level of activity for

an operation at which costs exactly

equal benefits



Net Present Value (NPV)

Evaluates the present value

(PV) of all inflows and

outflows of a project using

the weighted average cost of

capital as a discount rate

If the only cash outflow takes place in the present

:

−NPV = PV of Cash Inflows PV of Cash Outflows

−

−31 2 n

1 2 3 n

NPV = PV of Cash Inflows Cash Cost

CC C CNPV = + + + ... + Cost

(1+ i) (1+ i) (1+ i) (1+ i)© 2020 - The Treasury Academy, Inc. - All Rights Reserved 46

Net Present Value (NPV)

−

−

A 1 2 3 4 5

B 1 2 3 4 5

$300 $300 $400 $100 $100NPV = + + + + $1,000

(1 + .10) (1 + .10) (1 + .10) (1 + .10) (1 + .10)

= $ 48.42

$1,000 $1,000$300 $300 $400NPV = + + + +

(1 + .10) (1 + .10) (1 + .10) (1 + .10) (1 + .10) − $1,000

= $1,124.98

Year 1 Year 2 Year 3 Year 4 Year 5

Project A $300 $300 $400 $100 $100

Project B $300 $300 $400 $1,000 $1,000

Assume an initial outlay of $1,000 and a cost of capital of 10%



Profitability Index (PI)

Present Value of Cash InflowsProfitability Index =

Present Value of Cash Outflows

Ratio of the PV gained to the cost required to

obtain that value; shows value gained per

dollar of investment

If the only cash outflow is in the present (period 0):

A

B

$951.57PI = = 0.952

$1,000

$2,124.98PI = = 2.125

$1,000


Internal Rate of Return (IRR)

Discount rate (i) for NPV = 0

or

PV of Cash Inflows = PV of Cash Outflows

=

−

−

A 1 2 3 4 5

B 1 2

NPV = PV of Cash Inflow Cost = 0

$300 $300 $400 $100 $100NPV = + + + + $1,000 0

(1 + i) (1 + i) (1 + i) (1 + i) (1 + i)

i = 7.7%

$300 $300 $400NPV = + +

(1 + i) (1 + i) (1 + i = −

3 4 5

$1,000 $1,000+ + $1,000 0

) (1 + i) (1 + i)

i = 38.1%



Capital Expenditure Analysis Summary

Method

Project

Acceptance

Criterion

Project A Project B

Net Present

Value (NPV)NPV > 0 $ – 48.43 $1.124.98

Profitability

Index (PI)PI > 1 0.952 2.2125

Internal

Rate of

Return

(IRR)

IRR > WACC* 7.7% 38.1%

* Weighted Average Cost of Capital (WACC) = 10% in the example


Source: ETM6 © AFP

Liquidity or Working Capital

Current Ratio

Measures the degree to

which current

obligations are covered

by current assets

Total Current AssetsCurrent Ratio =

Total Current Liabilities

$8,000= = 2.35

$3,400



Liquidity or Working Capital:

Quick Ratio

Measures the degree to

which a company’s current

liabilities are covered by its

most liquid current assets

(Cash) + (S-T Investments) + (A/R)Quick Ratio =


($1,500 + $1,300 + $1,700)= = 1.32

$3,400



Liquidity or Working Capital:

Working Capital

Indicates the dollar amount by which

current assets exceed current liabilities

−

−

Working Capital = Current Assets Current Liabilities

= $8,000 $3,400 = $4,600



Days Cash Held

Provides a measure of a firm’s liquidity as it

shows how long a firm can continue to pay

operating expenses without any additional

revenue



= =−

CashDays Cash Held =

Operating Expenses - Noncash Expenses

365

$1,500144 Days

$4,000 $200

365

New to ETM6

Efficiency and Asset Management:

Total Asset Turnover

RevenuesTotal Asset Turnover =

Total Assets

$15,000= = 0.938 Times

$16,000

Measures how many

times the asset base

is turned over with

the flow of revenue



Fixed Asset Turnover

RevenueFixed Asset Turnover =

Net Property, Plant & Equip

$15,000= = 2.0 Times

$7,500

Focuses on how

efficiently fixed

assets, or plant

and equipment,

are used



Current Asset Turnover

RevenuesCurrent Asset Turnover =

Current Assets

$15,000= = 1.88 Times

$8,500

Measures how many

times the stock of

most liquid assets is

turned over with the

flow of revenue




Cash Conversion Efficiency

Cash ConversionCash Flow from Operations

Efficiency = Sales

$550=

$15,000

= 0.37 or 3.7%

Measures the efficiency

with which a company

converts sales into

cash


Debt Management:

Total Liabilities to Total Assets

Total LiabilitiesTotal Liabilities to Total Assets =

Total Assets

$7,300= = .456 or 45.6%

$16,000

Measures the

percentage of

all liabilities

relative to total

investments or

total assets


Debt Management:

Long-Term Debt to Capital

( ) ( )

( )

-

-

Long Term DebtL / T Debt to Capital =

Long Term Debt + Equity

$3,900= = .310 or 31.0%

$3,900 + $8,700

Measures the percentage

of a company’s

capitalization that is

provided by long-term

debt


Debt Management:

Debt to Equity

Total DebtDebt to Equity =

Total Equity

$1,800 + $3,900= = .655 or 65.5%

$8,700

Measures the degree of

debt financing used per

dollar of equity capital


Debt Management:

Debt to Tangible Net Worth

( )

( )

( )

−

−

Total DebtDebt to Tangible N/W =

Total Equity Intangible Assets

$1,800 + $3,900= = .695 or 69.5%

$8,700 $500

Measures a

company’s debt as a

percentage of its

tangible net worth



Debt Management/Coverage:

Times Interest Earned (TIE) Ratio

Operating ProfitTIE =

Interest Expense

EBIT =

Interest Expense

$1,600= = 5.33 Times

$300

Measures a firm’s ability to service debt

through interest payments



Debt Management/Coverage:

Fixed Charge Coverage Ratio

EBIT + Lease PmtsFixed Charge Coverage =

Interest Expense + Lease Pmts

$1,600 + $500 $2,100= = = 2.625 Times

$300 + $500 $800

Measures a firm’s ability to

service all fixed-charge

items with operating

profits

* Assuming $500 of annual lease payments



Profitability: Gross Profit Margin

Gross Profit $5,800Gross Profit Margin = =

Revenues $15,000

= .387 or 38.7%

Measures the

percentage of

revenues remaining

after the cost of goods

sold is deducted from

revenue – it is also a

typical common-size

ratio measure

© 2020 – The Treasury Academy - All Rights Reserved 65Source: ETM6 - © AFP

Profitability:

Operating & EBITDA Profit Margins

EBITOperating Profit Margin =

Revenues

$1,600= = 0.107 or 10.7%

$15,000

Measures the flow of commonly

used operating income

measures in relation to the flow

of revenue

EBITDAEBITDA Margin =

Revenues

$1,800= = 0.120 or 12.0%

$15,000


Profitability:

Net Profit Margin

Net IncomeNet Profit Margin =

Revenues

$850=

$15,000

= .057 or 5.7%

Measures the flow of

net income in

relation to the flow

of revenue


Profitability:

Return on Assets (ROA)

𝑹𝒆𝒕𝒖𝒓𝒏 𝒐𝒏 𝑨𝒔𝒔𝒆𝒕𝒔 =𝑵𝒆𝒕 𝑰𝒏𝒄𝒐𝒎𝒆

𝑻𝒐𝒕𝒂𝒍 𝑨𝒔𝒔𝒆𝒕𝒔

=$𝟖𝟓𝟎

$𝟏𝟔, 𝟎𝟎𝟎

= . 𝟎𝟓𝟑 𝒐𝒓 𝟓. 𝟑%

Measures net income in relation to

the stock of assets

© 2020 – The Treasury Academy - All Rights Reserved 68


Profitability:

Return on Equity (ROE)

( )

( )

Net IncomeReturn on Equity =

Total Equity

$850= = 0.098 or 9.8%

$8,700

Measures earnings shareholders and is

therefore a measure of the profitability of the

company.



Profitability:

Return on Common Equity (ROCE)

( )

( )

( )

( )

−

−

−

−

Earnings Avail. to Common S / HsReturn on Common Equity =

Common Equity

Net Income Preferred Dividends=

Total Equity Preferred Stock

$850 0= = 0.098 or 9.8%

$8,700 0

Measures earnings available to common

shareholders (net income less any preferred

stock dividends) expressed as a percentage

of common equity



Integrated Ratio Analysis: DuPont

Approach

ROE = Return on Sales Asset Turnover Equity Multiplier

Net Income Revenues Avg. Total Assets =

Revenues Avg. Total Assets Avg. Equity

= 0.057 0.938 1.84 = 0.098 = 9.8%

Deconstructs ROE into three key

components for more detailed analysis



Performance Measurement

Return on Invested Capital

(ROIC)

Residual Income (RI)

Economic Value Added (EVA)

Free Cash Flow (FCF)

72© 2020 – The Treasury Academy - All Rights Reserved

Performance Measurement

Return on Invested Capital (ROIC)

◦ ROIC does not include charge for cost of capital.

◦ Positive NPV project can be rejected if it lowers

overall ROIC

◦ ROIC over a partial period may be misleading.

( ) ( )

( ) ( )

Net Income Net IncomeROIC = =

Invested Capital Long-Term Debt + Equity

$850 $850= = = 0.0675 or 6.75%

$3,900 + $8,700 $12,600


Residual Income (RI)

Overcomes two of the limitations of ROIC

◦ It assigns a charge to the invested capital

◦ It is an amount of profit (or loss), whereas ROIC is just a rate of

return

Assume:

◦ Net Income = $850

◦ Invested Capital = $12,600

◦ Cost of Capital = 10%

74© 2020 – The Treasury Academy - All Rights Reserved

−

−

RI = Net Income - (Invested Capital x Cost of Capital)

= $850 ($12,600 x 0.10)

= $850 $1,260 = - $410

More on EVA

EVA is a true measure of

economic profit or loss, and

is accepted in the professional

financial community

There are three generic ways in which EVA can

be increased through intelligent asset

management:◦ Improve operating efficiency so that more EBIT is

generated on the existing asset base

◦ Invest additional capital in assets that earn a rate of

return that exceeds the cost of capital

◦ Eliminate assets that earn a rate of return that is

less than the cost of capital


Economic Value Added (EVA)A measure of the incremental value that a

company’s investments add.

What is the EVA for the following company?

▪ Long-term debt of $3,900,000

▪ Equity of $8,700,000

▪ Marginal tax rate of 34.615%

▪ Weighted average cost of capital (WACC) of 9%

▪ Operating income (EBIT) of $1,600,000

− −

− −

−

− −

EVA = EBIT x (1 Tax Rate) (WACC) x (Long-term Debt + Equity)

= $1,600 x (1 .34615) (.09) x ($3,900 + $8,700)

= $1,046 (.09)($12,600)

= $1,046 $1,134 = $88


Performance Measurement:

Basic Free Cash Flow

Free Cash Flow (FCF)◦ Indicates how much cash generated during the

period is available to shareholders and creditors

◦ FCF adjusts net income for noncash charges (i.e.

depreciation and amortization) as well as working

capital and capital expenditures

◦ A commonly used measure of FCF is below

−

− −

FCF = Cash Flow from Operating Activities CapEx

= $550 $900 = $350


Other Measures for

Free Cash Flow

Free Cash Flow to the Firm (FCFF)◦ Represents cash flow that is available to all

providers of long-term capital

Free Cash Flow to Equity (FCFE)◦ Represents cash flow that is available to the

shareholders only


− −

− −

FCFF = CF from Op. Activities + (Interest Exp x (1 Tax Rate)) CapEx

FCFE = FCFF (Interest Exp x (1 Tax Rate)) + Change in Total Debt

Operating and Financial Leverage


Source: ETM6 – Exhibit 9.7 - © AFP

Operating Risk and Leverage (DOL)

Operating risk is a function of the mix of

variable and fixed costs in a company’s

operations

It is assessed by looking at the changes

in a company’s EBIT for given change in

sales


% Change in EBITDegree of Operating Leverage =

% Change in Sales

33%Degree of Operating Leverage = = 1.65 Times

20%

Using the information from the text Exhibit 9.7


Financial Risk and Leverage (DFL)

Financial risk is a function of the

mix of capital sources used to

finance the company

It is assessed by looking at the

changes in a company’s net

income for given change in EBIT


% Change in Net IncomeDegree of Fin. Leverage =

% Change in EBIT

50%Degree of Fin. Leverage = = 1.515 Times

33%

Using the information from the text Exhibit 9.7


Total Leverage (DTL) This is a measure of the total risk of

the company

It is assessed by looking at the relationship between Net Income and Sales

It can also be calculated as:DTL = DOL X DFL


% Change in Net IncomeDegree of Total Leverage =

% Change in Sales

50%Degree of Total Leverage = = 2.5 Times

20%

or

DTL = DOL X DFL = 1.650 X 1.515 = 2.5 Times


ETM6: Chapter 9Financial Planning and Analysis



Liquidity or Working Capital: Quick Ratio

Measures the degree to which a company’s current

liabilities are covered by its most liquid current assets

A company currently has Cash of $200,000, ST

Investments of $500,000, A/R of $600,000, and

Inventory of $700,000. If their bank has imposed a

loan covenant which requires the company

maintain a quick ratio of 1.5 or better, what is the

maximum level of current liabilities they can have?

A. $666,667

B. $866,667

C. $1,333,333

D. $2,000,000



(Cash) + (S-T Investments) + (A/R)Quick Ratio =


($200,000 + $500,000 + $600,000)= = 1.50


$1,300,0001.50 =


1.50 (Total CL) = $1,300,000

$1,300,000Total CL = = $866,667

1.50



Measures the degree to which a company’s current

liabilities are covered by its most liquid current assets

A company currently has Cash of $200,000, ST

Investments of $500,000, A/R of $600,000, and

Inventory of $700,000. If their bank has imposed a

loan covenant which requires the company

maintain a quick ratio of 1.5 or better, what is the

maximum level of current liabilities they can have?

A. $666,667

B. $866,667

C. $1,333,333

D. $2,000,000


Included Inventory

Subtracted Cash from Result B

Just added all items in problem

Practice Calculation

A company has a Return on Total Assets of 20%, Return on Sales of 10% and Net Income of $100,000. What is the level of Total Assets for this company?

A. $ 250,000B. $ 500,000C. $ 750,000D. $1,000,000


Practice Calculation

A company has a Return on Total Assets of 20%, Return on Sales of 10% and Net Income of $100,000. What is the level of Total Assets for this company?

A. $ 250,000B. $ 500,000C. $ 750,000D. $1,000,000


Integrated Ratio Analysis: DuPont Equation

Return on Total Assets = Return on Sales Total Asset Turnover

Net Income Total Revenues =

Total Revenues Total Assets

$100,000 Total Revenues 20% =

Total Revenues Total Assets

20% = 0.10 TATO =>

= =

TATO = 2.0

$100,000 Return on Sales = 0.10 =

Total Revenues

Total Revenues = $1,000,000

Total Revenues $1,000,000 TATO = 2.0

Total Assets Total Assets

Total Assets = $500,00089© 2020 - The Treasury Academy, Inc. - All Rights Reserved

Session Wrap-up

90

What did we learn in this session?

What topics do we need to learn more about?


TEXPO Conference 2020

Essential Learning for CTP Candidates

End of This Session

We will reconvene at 1:30 pm today.

The topic will be

Let’s Go to the MarketsMoney Markets

Capital Markets


Documents

Essential Learning for CTP Candidates...Session #7 (Thur., 9/03, 10:00 –11:00 am) Overview of Basic CTP Math from ETM6 Chap 07: Earnings Credits Chap 11: Working Capital