CF& CA LN Flashcards
Corporate Analysis
Step One: Understand The Big Picture 1
--Type of company? S&P has 10 sectors (Materials, Energy, etc.) --Industry Characteristics Cyclical nature (Defensive or Cyclical) Current trends in growth, competition and profitability --Company’s growth stage New venture, high growth, mature --Business Risks --State of the Economy
Corporate Analysis
Step One: Understand The Big Picture 2
–Perspective (debt or equity)
–What is your gut feeling about the company?
Do you like the company’s products and services?
Do you feel management has the right strategy?
Do you think the company is a long-term winner?
Corporate Analysis
Step One: Understand The Big Picture 3
--Competitive Position: Marketing/Sales Technology Efficiency Management Barriers to Entry
Step 2: Financial AnalysisWhat to look for?
Balance Sheet
Income Statement
Cash Flow Statement
Balance Sheet Focus 1
--Capital Structure and Financial Leverage
Objective: Minimize WACC and Maintain financial flexibility
Ratios:
Debt / Equity
Debt / (Debt +Equity)
Debt / EBITDA
--Liquidity
Objective: Balance liquidity risk and profitability
Ratios:
Current Ratio
Short-term Debt / Free Cash Flow
Cash on Balance Sheet
Cash burn or build rateBalance Sheet Focus 2
–Asset and Liability Composition
Asset Liability Management (ALM)
Mark-to-Market: What is the true market value of assets, liabilities and equity? Volatility of valuations?
Credit, Currency, and Interest rate risks?
--Off-B/S risks Derivative products Litigation or Pending Lawsuits Unfunded Pension Liabilities Subsidiaries
Example: Ruby Tuesday Inc. 10-k
See lecture note PPT
1st thing to look at is how leverage is the company +
2nd liqicty: CA-CL -
3rd Cash position
4th FCF
Goodwill impirment
If I see lot of Goodwill, I am concert. (usually auditor value if the good will worth as such.)
Income Statement and Profitability
–Profitability Drivers
Revenue
Units sold (Volume)
Pricing Power
Cost
Variable cost of producing product or service (COGS)
Other overhead costs including: administrative, marketing, distribution, depreciation, etc.
--Income statement Sales - COGS =Gross Profit - Administrative expenses Operating Profit (or Operating Income) -Interest -Taxes =Net Income
Note: Operating Profit is sometimes
referred to as EBIT
Income Statement Focus 1
Sales Growth Profit Margins Trends – expanding or contracting Ratios: Gross = (Sales – COGS) / Sales Operating = EBIT / Sales Net = Net Income / Sales
Earnings Growth and key Drivers to Growth
Income Statement Focus 2
–Quality of earnings
Stability and Sustainability
Level from core operations
–Returns
Return on Assets = Net Income/Total Assets
Return on capital = EBIT/Average Capital
Return on equity = Net Income/Common Equity
–EPS
NI available to common shareholders/# of shares
Growth in EPS is key
Profitability Model 1
Return on Assets (ROA)
Case 1: High Profit Margins & Low Asset Turnovers Examples: products & services based on technological innovations
Case 2: Low Profit Margins & High Asset Turnovers Examples: commodity-type products & services
Profitability Model 2
Return on Equity (ROE)
ROE=Asset Turnover * Net Profit Margin * Equity Multiplier ROE =NI/CE =NS /TA * NI/NS * TA/CE Assets ->Sales -> Profit->Earning ROE Drivers Are Assets generating Sales (Turnover)? Are Sales generating Profits (Margins)? Are Profits Levered (Capital Structure)?
Example: Ruby Tuesday Inc. Income Statement
We look at trands and conps:
1) sales goes down
2)bottom goes down more
=> MG is not good
What course it?
It may be one time restructure eg. closure and impairments and good will. it has negative impact.
Bright side: 2010 may have bigger on bottom line since goodwill was impairment and it may be one time only and the economic may gets better…
Statement of Cash Flows 1
–Changes the picture from accrual to cash
Key step in financial analysis
–Shows Cash Flows divided into 3 categories:
Cash flow from operations
Cash flow from investments
Cash flow from financing activities
Statement of Cash Flows 2
Cash flows from operations
Net Income adjusted for non-cash items
+/- changes in working capital (e.g. money spent on inventories)
Cash flows from investing activities
(-) Purchase plant & equipment (Capital Expenditures or Capex)
(+) Sell fixed assets
Buy (cash out) or sell (cash in) short term investments
Cash flows from financing activities
Cash inflow if we borrow money (bonds and loans) or issue stock
Cash outflow if we pay off debt, buyback stocks or pay dividends
Cash position
Shows the change in the company’s beginning and ending cash position based on the cash flows from the 3 categories above
Cash Flow Measures
- -Cash flow has many Definitions depending on at what level in your company’s operations/business cash flow is measured. Three key measures include:
- -Funds from Operations (FFO) = Net Income adjusted for non-cash items such as depreciation and impairments. FFO is your CF prior to investments in working capital and fixed assets (Capex)
- -(Net) Cash from Operating Activities (CF Ops) = FFO +/- changes to working capital requirements. CF Ops is a firm’s CF prior to investments in new plant and equipment (Capex) and it appears at the bottom of the first section of the CF Statement.
- -Free Cash Flow (FCF) = CF Ops - investments in new plant and equipment (Capex). Also referred to as Levered FCF or FCF to Equity.
Example Ruby Tuesday Statement of CF
A few things to increase CF:
1) can I make my WC more efficient? eg. shirking inventory, A/R shorter
2) Look at the leverage of the
Well, I need fund. should I raise debt, should I raise equity, how much and when
3) cut back Capex, selling asset, burn cash balance. (hope we don’t need to do 3)
Cash Flow Issues 1
Cash flow is the key number in corporate analysis
Is company building or burning CF and at what level?
FFO
CF from Ops
FCF
What are the key drivers of company’s CFs?
Sales growth
Profitability (Margins)
Working Capital
Capex requirements
Look forward anticipating CF and funding requirements over next 5 years
Analyze CF relative to business’ growth stage
Cash Flow Issues 2
–How does or will company finance negative FCF
More efficient use of working capital – internal funding
New debt or equity issues
Amounts
Timing
Sell Assets
Reduce Capex
Burn Cash balances
–What does company do with positive FCF:
Pay dividends or Repurchase Stock
Repay debt
Build Cash balances and invest in marketable securities
Increase Capex or M&A
Cash Flow Management
Liquidity: The Cash Conversion Cycle
Cash Conversion Cycle = Days Sales outstanding + Days of sales in inventory - Days of payables outstanding
Improve Free Cash Flow, Increase Asset Turnover and Reduce funding requirements by Shortening your Cash Conversion Cycle!
Cash Flow Issues 3
--Financial Policies and Strategies for managing CF Cash Conversion Cycle (CCC) Capex Dividends Capital Raising (Debt or Equity) Cash Position
–Key business decisions based on FCF
What projects to invest in (capital allocation)?
What is the optimal method of financing a company (capital structure)?
When and how much financing will be necessary?
Working capital management
Importance of Cash Flows
FCF drives: Equity Valuations Ability to raise debt and equity capital Growth Dividends and other returns to owners
Bottom Line: Does business’ long-term after-tax free cash flow provide a good risk-adjusted return to investors?
Connectivity of Financials
Income Statement->Balance SheetCash Flow Statement
Income Statement ->Cash Flow Statement
Financial Model for venture business is a good skill to have in a long run. very helpful
Financial Ratio Analysis 1
–Perspective
Equity
Debt
–To make ratios meaningful we need:
Trends across time
Comparisons with other firms’ and industry average
Financial Ratio Analysis 2
Ratios can help us:
- Identify deficiencies and take corrective actions.
- Evaluate performance (employees, divisions, etc.)
- Prepare financial projections
- Measure credit risk (making loans and buying bonds)
- Make equity investments
Credit Analysis and Financial Ratios
–Analyze a company’s financial ratios to determine credit risk and appropriate spread. We are analyzing from debt (not equity) perspective
--From a Debt perspective the focus is on Cash flow Leverage and capital structure Profitability Liquidity
S&P Credit Analysis
Total Debt / (Total Debt + Equity) : leverage: more debt has more financial risk since it has more debt. we don’t how which one has more one has more operateing and industry risk by looking at this.
FCF / Total Debt and FFO / Total Debt
EBIT / Average Capital
Cash Position and FCF relative to Short-term Debt
Note: For Total Debt S&P focuses on interest bearing debt not all liabilities
Case Study: An S&P Credit Analysis
We need to know how to valuate a company
Other Credit Considerations
Industry volatility
Current economic cycle
Availability of collateral (real estate, inventories)
Debt terms and conditions (Sub/Senior, Maturity, Covenants, etc)
P/E ratio, stock price trend, EPS growth
Hedging Activities: Forex, credit, interest rate risk
Dividend policy and Stock buybacks
Issues when rating Asian Corporate Debt
Main bank and group support
Industrial Policy / Exports
Equity ownership structure
Compare and Contrast Asian versus U.S. Corporate Finance
Ownership Capital Investment in P&E vs Outsourcing Operating Leverage M&A / Goodwill and Intangibles Conglomerates and Spinoff Opportunities Profitability Cash flow (CF from Ops and FCF) Trade Account: A/R and A/P WACC and Profitability Stock repurchases and Dividend Policy Interest Rates and Required Rates of Return
Asian Company FinancesWhat to watch for?
Equity exposures particularly with financials Relatively high level of short-term debt Relatively high Operating Leverage Foreign exchange risk Subsidiary risk and performance ALM
