Value-Based Management

Transcription

1 Value-Based Management Handout Problem Set 1 Financial Statements and Financial Ratio Analysis Lehrstuhl für BWL Controlling Prof. Dr. Gunther Friedl for questions and comments: iris.pfeiffer@tum.de

2 Review on last week s lecture: Purpose and use of ratio analysis Financial ratios are used to compare the risk and return of different firms Ratios can also provide a profile of a firm, its economic characteristics and competitive strategies, and its unique operating, financial, and investment characteristics Activity analysis Evaluates revenue/output generated by the firm s assets Describes relationship between operations and assets Liquidity analysis Measures the adequacy of a firm s cash resources to meet its nearterm cash obligations Long-term debt / solvency analysis Examines the firm s capital structure, financing sources and the ability of the firm to satisfy its long-term debt Profitability analysis Measures the income of the firm relative to its revenues and invested capital Handout Problem Set 1: Financial Ratios 2

3 1. Ratios for activity analysis: Short-term (operating) activity ratios Inventory turnover ratios Inventory Turnover Cost of Goods Sold AverageInventory AverageNo.Days Inventory In Stock 365 Inventory Turnover Efficiency of the firm s inventory management Receivables turnover ratios Receivables Turnover Average Trade Receivables Average No.Days Receivables Outstanding Effectiveness of the firm s credit policies 365 Receivables Turnover Accounts payable turnover ratios Payables Turnover Purchases Average Accounts Payable * Purchases cost of sales Δinventory Average No.Days Payables Outstanding 365 Payables Turnover Important source of financing Handout Problem Set 1: Financial Ratios 3

4 volume Units of plant capacity Turnover 1. Ratios for activity analysis: Long-term (investment) activity ratios Fixed asset turnover ratio Fixed Asset Turnover Level of sales generated by investments in productive AverageFixed Assets capacity Problems: growth is continuous, investments in capacity are discrete. That gives management discretionary power over timing, form, and financial reporting of the acquisition of incremental capacity. Timing of a firm s asset purchases: Company/product cycle Plant capacity required Fixed asset turnover Startup Growth Maturity Decline Startup Growth Maturity Decline Startup Growth Maturity Decline Accumulation of depreciation expense improves turnover ratio without corresponding improvement in efficiency. Newer assets are generally more efficient (new technology) but might decrease the turnover ratio because inflation makes them more expensive. Total asset Total Asset Turnover Measure of overall investment turnover ratio Average Total Assets efficiency Handout Problem Set 1: Financial Ratios 4

5 1. Question 1: Calculate the following activity ratios for Pfizer Pfizer Inventory turnover No. of days Accounts receivable turnover No. of days Accounts payable turnover No. of days Fixed assets turnover Total assets turnover Handout Problem Set 1: Financial Ratios 5

6 2. Liquidity analysis: Length of cash cycle Operating cycle of a merchandising firm: number of days it takes to sell inventory + number of days until the resulting receivables are converted to cash Acquisition of inventory Inventory storage Cash cycle: Number of days a company s cash is tied up by its current operating cycle Days payables outstanding Merchandising firm only finished goods inventory Manufacturing firm inventory held through three stages: raw material work in progress Cash collection Sale finished goods Handout Problem Set 1: Financial Ratios 6

7 2. Cash cycle for Dell computers: Negative cash cycles Dell has a negative cash cycle: Dell manufactures and ships directly to its customers only after an order is received minimal inventory days Its customers pay on time low receivable collection period Dell takes its time in paying its suppliers because of its market power longer period of days in accounts payable Fiscal Year Ended 2/3/06 1/28/05 1/30/04 Days of sales in accounts receivables Days of supply in inventory Days in accounts payable (77) (73) (70) Cash cycle (44) (42) (40) Handout Problem Set 1: Financial Ratios 7

8 2. Ratios for liquidity analysis: working capital ratios Cash and cash equivalents Marketable securities Accounts receivable Inventories Prepaid expenses Current assets Current liabilities Short-term debt Accounts payable Accrued liabilities Ratios for cash obligations Current Ratio Current Assets Current Liabilities Cash MarketableSecurities Accounts Receivable Quick Ratio Current Liabilities More conservative Cash MarketableSecurities CashRatio Current Liabilities Most conservative Cash flow from operations Cash Flow from Operations Ratio CashFlow from Operations Current Liabilities Actual cash flows Handout Problem Set 1: Financial Ratios 8

9 2. Question 1: Calculate the cash cycle and the following liquidity ratios for Pfizer Pfizer Average no. of days inventory in stock (plus) Days of receivables outstanding Length of operating cycle (minus) Payables outstanding Length of cash cycle Current ratio Quick ratio Cash ratio Cash from operations ratio Handout Problem Set 1: Financial Ratios 9

10 3. Ratios for long-term debt and solvency analysis Debt ratios Total Debt (Current Long - Term) Debt to Total Capital Total Capital(Debt Equity) Total Debt Debt to Equity Total Equity Level of risk borne by a firm Interest coverage ratios Earnings Before Interest and Taxes (EBIT) Times Interest Earned Interest Expense Ability to meet interest payments Capital expenditure and CFO-todebt ratios Capital Expenditure Ratio CFO to Debt CFO TotalDebt Cash from Operations (CFO) CapitalExpenditures Ability to finance investments and generate cash for debt repayment Handout Problem Set 1: Financial Ratios 10

11 3. Question 1: Calculate the following debt ratios for Pfizer Pfizer Short-term debt + Long-term debt = Total debt + Total equity = Total capital Debt to equity Debt to capital Times interest earned Capital expenditure ratio Cash flow from operations(cfo) to debt All numbers in $ millions Handout Problem Set 1: Financial Ratios 11

12 Handout Problem Set 1: Financial Ratios 12

13 4. Ratios for profitability analysis: return on sales Gross (profit) margin Gross Margin Gross Profit Relationship between sales and manufacturing costs Operating margin Operating Margin OperatingIncome Profitability from operations Margin before Interest & Tax MarginBeforeInterest and Tax EBIT Independent of finance and tax position Profit margin Net income Profit Margin Net of all expenses Handout Problem Set 1: Financial Ratios 13

14 4. Ratios for profitability analysis: return on investment Return on Assets ROA EBIT Average Total Assets Net Income After - Tax Interest Cost ROA Average Total Assets Pretax After-tax (takes into account the tax shield of debt) Return on Total Capital ROTC EBIT Average (Total Debt Stockholder's Equity) Pretax (after-tax calculation is similar to the above one) Return on Equity ROE ROE Pretax Income Average Stockholder's Equity NetIncome Average Stockholder's Equity Pretax After-tax Handout Problem Set 1: Financial Ratios 14

15 4. Question 1: Calculate the following profitability ratios for Pfizer Pfizer Gross margin (%) Operating margin (%) Profit margin (%) ROA pre-interest and pretax (%) ROTC pre-interest and pretax (%) ROE after tax (%) Handout Problem Set 1: Financial Ratios 15

16 Ratios: an integrated analysis Financial analysis requires a review of three interrelationships among ratios: Economic relationships: Example: Higher sales are generally associated with higher investment in working capital components such as receivables and inventory. Ratios comprising these elements should be correlated Overlap of components: Identical terms in the numerator or denominator of different ratios A term in one ratio being a subset or component of another ratio Aggregations like the total assets turnover as aggregation of inventory, accounts receivable, and fixed asset turnover Ratios as composites of other ratios, e.g., ROA = profitability x turnover Implications of these interrelationships: Disaggregation of a ratio into its components allows us to gain insights into factors affecting a firm s performance Ratio differences can highlight the economic characteristics and strategies of The same firm over time Firms in the same industry Firms in different industries Firms in different countries Handout Problem Set 1: Financial Ratios 16

17 Analysis of firm performance Disaggregation of ROA ROA Total Asset Turnover Return on Assets OperatingIncome A firm s overall profitability is the product of an activity ratio and a profitability ratio Relationship between ROE and ROA ROE ROA Debt ROA - Cost of Debt Equity Benefits from financial leverage Disaggregation of ROE ROE Profitability Activity Solvency Income Net Income EBT EBT EBIT Assets EBIT Assets Equity Net Income Standard dupont analysis Extended dupont analysis Handout Problem Set 1: Financial Ratios 17

18 Appendix: The income statement some definitions revenue is income from sales (gross revenue) minus cost associated with things like returned or undeliverable merchandise (synonyms: sales, net sales, revenue, net revenue). cost are expenses directly related to creating the goods or services being sold (like the cost of raw materials, salaries of persons turning raw materials into sellable goods, depreciation of equipment); not included are expenses like R&D, marketing, and interest payments on debt. Synonyms: cost of sales, cost of goods sold (CoGS). Gross profit (synonym: sales profit) = sales revenue sales cost Operating expenses are expenses associated with running a business but not (necessarily) considered directly applicable to the current line of goods and services being sold. These include and Marketing, R & D, and General and Administrative costs (including the salaries of people working in these areas). Operating income = gross profit operating expenses. Operating income is the pre-tax, preinterest profit from the company's operations. Synonymous to EBIT, if the firm has no nonoperating income. Recurring income refers to a company s income by recurring activities and excludes the impact of transitory or random components which should not be regarded as components of permanent or sustainable income (unusual or infrequent items). Earnings (synonym: net income or profit) = total income minus total expenses. "Net income" is used for after-tax profit before paying dividends; this is the number that's carried to the top of the cash flow statement. Handout Problem Set 1: Financial Ratios 18