Finance 101 Interactive Presentation, please ask questions

at any time

Discuss types of Financial Statements

Types of Financial Statements

A business’ financial performance is measured using three related financial statements:

• Balance Sheet

• Income Statement

• Statement of Cash Flow

We will discuss all three!

Balance Sheet

Assets = Liabilities + Stockholders’ Equity

Balance Sheet

The balance sheet (also called the Statement of Financial Position) reports the assets, liabilities, and equity of a business at a given point in time.

• Assets = The things of value that a company owns.

• Liabilities (Creditors) + Stockholders’ Equity (Owners/Shareholders) = Claims against an entity’s assets.

AssetsCurrent assets

CashMarketable securitiesAccounts and notes receivableInventoriesPrepaid expenses

Property, plant & equipmentLess: accumulated depreciation

Other assetsTotal assets

LiabilitiesCurrent liabilities

Accounts payableShort term borrowingIncome taxes payableOther accrued current liabilities

Long term borrowingDeferred taxesOther liabilities

Total liabilities Stockholders’ equity

Preferred stockCommon stockAdditional paid in capitalRetained earnings

Total stockholders’ equity

AssetsAssets

LiabilitiesLiabilities

Stockholders’ Equity

Stockholders’ Equity

Balance Sheet Format

Balance Sheet - Definitions

Assets - Resources owned or controlled by the company. They include monetary assets (cash, marketable securities and receivables) and non-monetary assets (inventories, prepaid expenses and equipment).

Current Assets - Cash plus those assets which are expected to be converted to cash or consumed during the coming year.

Liabilities - Outsider claims against company resources. Examples include accounts payable and bank loans.

Current liabilities - Liabilities that mature within the coming fiscal year.

Net Working capital - current assets less current liabilities.

Stockholders’ equity - The contributed capital plus any other increments in capital from profitable operations.

Retained earnings - Net earnings that remain in the business (as part of stockholders’ equity) after the payment of dividends

Working Capital Example

WORKING CAPITAL = ACCOUNTS RECEIVABLE + INVENTORIES - ACCOUNTS PAYABLE

2009 2010 Delta

Accounts Receivable $200,000 $150,000 -$50,000 Positive

Inventories $100,000 $80,000 -$20,000 Positive

Accounts Payable $100,000 $80,000 -$20,000 Negative

Working Capital $200,000 $150,000 -$50,000 Positive

Liabilities Days payable outstanding (DPO) Liquidity ratios Debt ratio

Performance ratios help put our financial data into perspectiveUse performance ratios to:• review for trends• compare to competitors, industry benchmarks and business unit objectives

Assets Days Sales Outstanding (DSO)

Inventory Days Supply (IDS)

Working Capital Turnover

Permanent Investment Turnover

Return on Net Assets

Equity Return on Equity

Operating Performance Ratios

What does this mean?

Means a company generates enough cash to service its debt, fund operations, pay a dividend to shareholders and invest for the future.

Gives a company staying power to weather difficult economic cycles.

Balance Sheet Strength

Income Statement

Income Statement

Revenues (Sales and other income) - The amounts invoiced to outside customers for the sale of products or services less returns, allowances and discounts; and non-sales income such as royalties, gain/loss on asset sales, interest income

Expenses - An outflow or other using up of assets -- or incurring of liabilities -- from the rendering of goods or services

Variable Costs - A cost which is constant per unit, but which varies in total directly and proportionately with production or sales volume.

Fixed Costs - A cost which does not vary significantly with changes in volume within a relevant time period (one year) and range of activity.

Two Ways to Account For It:

(1) Cash System

(2) Accrual System

What is Revenue?

Checks Received

Revenue is recorded when it is earned

What is Expense?

Checks Written

Cost of raw materials is expensed when product is sold, not when materials are purchased

Cost of buildings and equipment is expensed over time as facilities are utilized (depreciated), not when initially paid for

Other expenses recorded when the liability is incurred

Accrual Accounting

Revenues and expenses are recorded in the period in which they are earned and incurred, whether or not such transactions have been finally settled by the receipt or payment of cash or its equivalent .

Sales Growth Rate

Variable Contribution Margin = (Sales revenue less variable costs) / Sales Revenue

• Must be sufficient to cover fixed costs plus provide a profit

ATOI Margin Percent = ATOI / Sales

Financial Metrics

Cash Flow

Why Cash Flow?

Cash is a strategic resource used to pay company obligations and a return to shareholders:• Purchases

• Salaries

• Taxes

• Dividends

Earnings is one element of cash flow, but it includes depreciation which is a non-cash charge

Cash may come in or go out for reasons not reflected on the income statement

Cash Flow– Our “Bank Account”

We begin with earnings

We “add-back” the non-cash cost of depreciation

We account for changes in working capital - we can either use cash to increase working capital or recover cash by decreasing working capital. Therefore it is the working capital changes that impact cash flow

We account for cash spent on new permanent investment: capital expenditures

We account for cash required for financing costs: corporate dividends and interest

What Cash Flow Tells Us

Cash flow could be either positive or negative, depending on the mission of the business.

Cash flow information tells us how much financing is required to ensure operations can continue.

Positive cash flow indicates that funds may be available for future investment.

Cash Flow And The Product Life Cycle

Growth businesses

• Negative cash flow due to high capital expenditures

Mature

• Positive cash flow – earnings plus depreciation exceed capital expenditures

Declining

• Positive to negative cash flow – earnings are not growing and capital expenditures are small - is it sustainable?

Sample Cash Flow Statement

ATOI Depreciation & AmortizationWorking Capital (Increase) DecreaseCASH FLOW FROM OPERATIONSCapital ExpendituresFREE CASH FLOW

Investment Analysis Concepts

Investment Analysis Terms

Net Present Value (NPV) - The difference between the present value of

cash inflows and the present value of cash outflows. NPV is used to

analyze the profitability of an investment or project.

Discounted cash flow (DCF) analysis – Used to evaluate investment

opportunities by projecting free cash flow and then discounting (using

cost of capital) to arrive at a present value.

Terminal Value (TV) - used to determine the value of a project for all the

years beyond the reliable discount cash flow projections..

IRR (Internal Rate of Return) - The discount rate used in evaluating

investment opportunities which makes the net present value of all

cash flows from a particular project equal to zero.

 CAGR – Compounded Annual Growth Rate

Cost of Capital (COC)

• Weighted average cost of financing from all sources - debt (outside borrowing) and equity (shareholders)

• Example

Equity 13.5% x 85% = 11.475%

Debt 4.5% x 15% = .675%

COC (Wt. Avg.) = 12.150%

• Discounting at the COC allows us to compare the value of future cash flows

Decision Making Metrics

Net Present Value - the difference between discounted cash inflows & outflows

Highlights -

• Considers time value

• Analyzes investment’s entire life

• Reflects shareholder value added

• Impacted by size of investment

Decision Making Metrics

Discounted Payback Period - time it takes to recoup an investment’s cost - using discounted cash flow

Highlights -Easy to compute - discounted flowsUnderstandableMeasure of time funds are at riskDoes not consider benefits past the payback period

Decision Making MetricsInternal Rate of Return - The “true” return of an investment - the DR where NPV = Zero

Represents the percentage yield of an investment

The discount rate which equates the present value of cash inflows with the present value of outflows ~ NPV = zero

The after-tax interest rate an investor could pay for funds and

breakeven

Allows comparison without bias of size

Does not account for risk

Biased towards investment with quick payback

Doesn’t account for $$ size

Decision Making Metrics

Profitability Index (PI) - a ratio of discounted cash inflows and outflows.

PI = DCI/DCO where: DCI = the sum of the disc. cash inflows DCO = the sum of the disc. cash outflows

Values of PI are positive!PI > 1, then investment’s return > COCPI < 1, then investment’s return < COCPI = 1, then investment’s return = COC

• Productivity measure• More reliable than IRR • Good tool for ranking projects

Determining Cash Flows for NPV

Inflows Sales revenue Decrease in working

capital …

Outflows COGP Marketing and distribution

expense R&D expense General admin expense Capital Increase in working

capital …

2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Term. ValueSales

Volume (MT) - 100 105 110 116 139 167 200 240 288

Selling Prices ($/kg) $ - $4.00 $4.00 $4.00 $4.20 $4.20 $4.20 $4.20 $4.20 $4.20 Sales Revenue - 400 420 441 486 583 700 840 1,008 1,210

COGSCOGP($/kg) $ - $2.00 $2.00 $2.00 $2.18 $2.18 $2.18 $2.18 $2.18 $2.18 COGP - 200 210 221 253 303 364 437 524 629

COGS - 200 210 221 253 303 364 437 524 629

Gross Profit - 200 210 221 233 280 336 403 484 581 % of Sales 50% 50% 50% 48% 48% 48% 48% 48% 48%

SG&A 350 200 100 50 50 50 50 50 50 50

PTOI (350) - 110 171 183 230 286 353 434 531 Income Taxes (133) - 42 65 70 87 109 134 165 202 ATOI (217) - 68 106 114 143 177 219 269 329 1,371

% of Sales 0% 16% 24% 23% 24% 25% 26% 27% 27%

Cash Inflow (217) - 68 106 114 143 177 219 269 329 1,371

Cash Outflow

Change in Working Capital 72 4 4 9 18 21 26 31 37

Cash Outflow - 72 4 4 9 18 21 26 31 37 153

Net Cash Flow (217) (72) 65 102 105 125 156 194 238 292 1,218 DCF (217) (72) 58 81 75 79 89 98 108 118 439 Cumulative DCF (217) (289) (232) (150) (76) 4 92 190 298 416 855

FINANCIAL VALUATION NPV   855

Marketing ProjectT.V. % of NPV 51.3%

(000's)

FINANCIAL VALUATION NPV   119 Capital Project T.V. % of NPV 83%(000's)

2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 Terminal

Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10 Value

Revenue 100.0 150.0 200.0 220.0 300.0 350.0 350.0 400.0 425.0 425.0

Growth Rate 50.0% 33.3% 10.0% 36.4% 16.7% 0.0% 14.3% 6.3% 0.0%

COGP 80.0 105.0 140.0 158.4 216.0 252.0 252.0 288.0 306.0 306.0

Depreciation 10.0 10.0 10.0 10.0 14.0 14.0 16.0 17.0 17.0

Gross Profit 20.0 35.0 50.0 51.6 74.0 84.0 84.0 96.0 102.0 102.0

Gross Margin % 20.0% 23.3% 25.0% 23.5% 24.7% 24.0% 24.0% 24.0% 24.0% 24.0%

SG&A 10.0 10.0 10.0 10.0 10.0 10.0 10.0 10.0 10.0 10.0

EBIT 10.0 25.0 40.0 41.6 64.0 74.0 74.0 86.0 92.0 92.0

ATOI (After-Tax Earnings) 6.2 15.5 24.8 25.8 39.7 45.9 45.9 53.3 57.0 57.0

% of Sales 6.2% 10.3% 12.4% 11.7% 13.2% 13.1% 13.1% 13.3% 13.4% 13.4%

Depreciation - 10.0 10.0 10.0 10.0 14.0 14.0 16.0 17.0 17.0

Cash Inflow 6.2 25.5 34.8 35.8 49.7 59.9 59.9 69.3 74.0 74.0

Capital Expenditures 200.0 - - - - - - - - -

Change in Working Capital - 7.5 8.1 3.5 13.0 8.1 - 8.1 4.1 -

Cash Outflow 200.0 7.5 8.1 3.5 13.0 8.1 - 8.1 4.1 -

Net Cash Flow (193.8) 18.0 26.7 32.3 36.7 51.7 59.9 61.2 70.0 74.0 308.5

DCF (193.8) 16.0 21.3 23.0 23.3 29.4 27.1 24.7 25.2 23.8 99.3

Cumulative DCF (193.8) (177.8) (156.5) (133.5) (110.2) (80.8) (53.7) (29.0) (3.8) 20.1 119.4

What Applications Can You See for These Discounted Metrics?

Construction/equipment projects Acquisitions (max purchase price) Divestitures (min selling price) Business strategy analysis

• Advertising spending

• Prioritizing R&D projects

• New markets

• Developing sales contracts

• Lease vs buy

Project Sensitivity Analysis

Base

Value

0.03

0

0

1.21

0.03

0

4.7

0.07

0.03

0.03

3.76

0.5

% Swing

Explained

53.4

11.0

10.8

7.5

5.5

4.6

4.0

1.6

0.8

0.6

0.2

0.1

Price annual growth rate

Capital Sensitivities - Project

Year 1 Market Size - Sensitivity

COGP - Project

COGS annual growth rate

Market Growth Rates - Sensitivity

MLA Price/kg

Selling Expense

Capital Maintenance, Parts and Upgrades

R&D Expense

Price/kg

Competitive Effect - Growth Rate Reduction

Value

0 100 200 300 400 500

Base Value: 293MM

0.01 0.04

0.3 –0.3

–0.25 0.25

1.452 1.089

0.04 0.02

–0.5 0.2

4.5 5

0.1 0.05

0.04 0.02

0.05 0.02

3.525 4.7

0.8 0.3

• Shows that >75% of the variability is associated with the top three sensitivities• Shows targets for further analysis

Determining Cash Flows for NPV

Pre-Launch Pre-Launch Launch Post-Launch Post-LaunchYear Year Year Year Year

1 2 3 4 5Revenue ($ in 000) 189,945$ -$ 7,035$ 12,060$ 18,090$ 18,090$ Gross Profit ($ in 000) -$ -$ 39,828$ 60,276$ 60,276$ Gross Profit as % of Revenue 0.0% 66.0% 66.6% 66.6%Operating Profit ($ in 000) -$ -$ 37,028$ 58,464$ 58,464$ Operating Profit as % of Revenue 0.0% 0.0% 61.4% 64.6% 64.6%Operating Cash Flow ($ in 000) (320)$ (326)$ 23,352$ 37,870$ 37,870$ Net Cash Flow ($ in 000) (3,706)$ (3,712)$ 7,316$ 29,076$ 29,076$ NPV 125,431$ NPV with Terminal 192,873$ IRR 127.9%Discounted Payback 4.00 Profitability Index 3.18 R&D Spend ($ in 000) 1,700$ 500.0$ 500.0$ 500.0$ -$ -$ Capital Spend ($ in 000) 16,929$ 3,385.8$ 3,385.8$ 10,157.4$ -$ -$

A Project example using a discounted cash flow analysis and specific assumptions (e.g. 12% cost of capital)

Based on a ten year time horizon post launch