Course Summary Flashcards
What three key factors have an impact on the financial performance of a business?
- industry
- Market
- quality
What are the two parts that have to be in balance regarding the enterprise value?
- nature of the business
- financing of the business
What determines the enterprise value and what matches the enterprise value?
- determines: financial performance
- matches: size of financial structure
What is meant by the “value break”?
- determined by enterprise value
- above the value break: investors have no remaining economic interest in the business
- below the value break: investors have retained the full value of their investment. they will make sure that the financial restructuring does not harm their position
What determines the financial structure?
- size
- mix (equity - debt)
Characteristics of Debt
- fixed returns (interest)
- no upside potential
- security against downside risk (limited by seniority/ security position)
- prefer stability over growth (take less risk; accept lower return)
Characteristics of Equity
- variable returns (dividends); dependent on performance of the business
- upside potential
- significant downside risk (no downside protection)
- (usually) full loss of investment
- usually prefer growth over stability (take higher risk; thus, demand higher return)
What is the leverage effect?
- Leverage is the use of various financial instruments or borrowed capital, such as margin, to increase the potential return of an investment
- Most companies use debt to finance operations. By doing so, a company increases its leverage because it can invest in business operations without increasing its equity
- A firm with significantly more debt than equity is considered to be highly leveraged
- Leverage helps both the investor and the firm to invest or operate. However, it comes with greater risk.
Possible variations of debt and equity
- debt with warrants
- convertible debt
- Mezzanine
- preferred equity
What does financial restructuring mean?
- adjusting the size and mix of the financial structure
What are the key drivers of the EV if a business is financed by debt/ financed by equity?
- financed by debt: earnings and CFs today; stable earnings and CFs; strong net asset base
- financed by equity: growth prospects (i.e. future earnings and CFs); volatility; weak asset base; earnings and CFs are not stable
Describe cash in- and outcomes as well as correlating timing differences.
Difference between cash and earnings:
- Cash from customers: accounts receivable: sales
- cash to suppliers: accounts payable: costs
- other timing differences: e.g. Tax, CAPEX vs. depreciation
Name the three basic financial statements.
- Profit and Loss statement
- Balance Sheet
- Cash Flow
What ratios are used by e.g. banks to identify a crisis?
- Interest cover: EBITDA/ interest cost
- Leverage: Net Debt/ EBITDA
- Cash Flow cover: Free cash flow/ debt service
What is each of the 3 credit KPI trying to measure?
- Leverage cover: how many years of EBITDA are required to repay debt?
- Interest cover: can interest costs be covered by earnings (“how healthy is the income statement?”)
- Cash Flow cover: Liquidity (Does the company have enough cash to service the debt?)
