Finance Master. Winter 2015/16. Jprof. Narly Dwarkasing University of Bonn, IFS

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1 Finance Master Winter 2015/16 Jprof. Narly Dwarkasing University of Bonn, IFS

2 Chapter 2 Outline 2.1 Firms Disclosure of Financial Information 2.2 The Balance Sheet 2.3 The Income Statement 2.4 The Statement of Cash Flows 2.5 Financial Statement Analysis 2.6 Financial Reporting in Practice

3 2.1 Firms Disclosure of Financial Information Types of Financial Statements Balance Sheet Income Statement Statement of Cash Flows Statement of Stockholders Equity

4 2.2 Balance Sheet The Balance Sheet Identity: Assets Liabilities Stockholders' Equity

5

6

7 2.2 Balance Sheet (cont'd) Net Working Capital Current Assets Current Liabilities

8 2.2 Balance Sheet (cont'd) Market Value Versus Book Value Market Value of Equity (Market Capitalization) Market Price per Share x Number of Shares Outstanding Cannot be negative Often differs substantially from book value

9 2.2 Balance Sheet (cont'd) Market Value Versus Book Value Market-to-Book Ratio aka Price-to-Book Ratio Market-to-Book Ratio Market Value of Equity Book Value of Equity Value Stocks Low M/B ratios Growth stocks High M/B ratios

10 2.2 Balance Sheet (cont'd) Enterprise Value aka Total Enterprise Value (TEV) Enterprise Value Market Value of Equity Debt Cash The cost to take over the business

11 2.3 Income Statement

12 2.3 Income Statement (cont d) Earnings per Share EPS Net Income Shares Outstanding Stock Options Convertible Bonds Dilution Diluted EPS

13 2.4 Statement of Cash Flows Net Income typically does NOT equal the amount of Cash the firm has earned. Non-Cash Expenses Depreciation and Amortization Uses of Cash not on the Income Statement Investment in Property, Plant, and Equipment

14 2.4 Statement of Cash Flows (cont d)

15 2.4 Statement of Cash Flows (cont d) Operating Activities Adjusts net income by all non-cash items related to operating activities and changes in net working capital Accounts Receivable deduct the increases Accounts Payable add the increases Inventories deduct the increases

16 2.4 Statement of Cash Flows (cont d) Investing Activities Capital Expenditures Buying or Selling Marketable Securities Financing Activities Payment of Dividends Retained Earnings = Net Income Dividends Changes in Borrowings

17 2.5 Financial Statement Analysis Profitability Ratios Gross Margin Gross Margin= Gross Profit Sales Operating Margin Operating Margin= Operating Income Sales

18 2.5 Financial Statement Analysis Evaluate a firm s performance and value: Profitability Ratios EBIT Margin EBIT EBIT Sales Net Profit Margin Net Profit Margin Net Income Total Sales

19 2.5 Financial Statement Analysis (cont d)

20 2.5 Financial Statement Analysis (cont d) Working Capital Ratios Accounts Receivable Days Accounts Receivable Accounts Receivable Days Average Daily Sales Accounts Payable Days Accounts Payable Days Inventory Days Inventory Days Accounts Payable Average Daily Cost of Sales Inventory Average Daily Cost of Sales

21 2.5 Financial Statement Analysis (cont d) Working Capital Ratios Accounts Receivable Turnover Annual Sales Accounts Receivable Turnover Accounts Receivable Accounts Payable Turnover Annual Cost of Sales Accounts Payable Turnover Accounts Payable Inventory Turnover Inventory Turnover Annual Cost of Sales Inventory

22 2.5 Financial Statement Analysis (cont d) Interest Coverage Ratios EBIT/Interest EBITDA/Interest EBITDA = EBIT + Depreciation and Amortization

23 2.5 Financial Statement Analysis (cont d) Leverage Ratios Debt-Equity Ratio Total Debt Debt-Equity Ratio Total Equity Debt-to-Capital Ratio Debt-to-Capital Ratio Total Debt Total Equity + Total Debt

24 2.5 Financial Statement Analysis (cont d) Valuation Ratios P/E Ratio P / E Ratio Market Capitalization Net Income Enterprise Value to EBIT Enterprise Value to Sales Share Price Earnings per Share Market Value of Equity + Debt - Cash Enterprise Value to EBIT= EBIT Market Value of Equity + Debt - Cash Enterprise Value tosales= Sales

25 2.5 Financial Statement Analysis (cont d) The DuPont Identity ROE Net Income Sales Sales TotalAssets TotalAssets Book Value of Equity Net Profit Margin Asset Turnover Equity Multiplier Overall profitability, efficiency and leverage

26 A summary of key financial ratio s

27 2.7 Financial Reporting in Practice Even with safeguards, reporting abuses still happen: Enron Sold assets with the promise to buy back at higher price, recorded transaction as revenue WorldCom Accounting manipulations Sarbanes-Oxley Act (SOX) Improve accuracy of information

28 The effect of Sarbanes Oxley Corporate Governance and Firm Value: The Impact of the 2002 Governance Rules Vidhi Chhaochharia and Yaniv Grinstein, The Journal of Finance, 2007

29 The effect of Sarbanes Oxley The announcement of SO had a significant positive effect on firm value For firms that are less compliant Look at a portfolio of share returns of firms during the period of the introduction of SO

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