CORPORATE FINANCE Laurence Booth • W. Sean Cleary INTRODUCTION TO Prepared by

Transcription

INTRODUCTION TO
CORPORATE FINANCE
Laurence Booth • W. Sean Cleary
Prepared by
Ken Hartviksen
CHAPTER 4
Financial Statement
Analysis and Forecasting
Lecture Agenda
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Learning objectives
Important terms
Consistent financial analysis
Leverage ratios
Efficiency ratios
Productivity ratios
Liquidity ratios
Valuation ratios
Financial forecasting
Formula forecasting
Summary and Conclusions
– Concept Review Questions
CHAPTER 4 – Financial Statement Analysis and
Forecasting
4-3
Learning Objectives
1.
2.
3.
4.
5.
6.
Why return on equity is one of the key financial ratios used for
assessing a firm’s performance, and how it can be used to
provide information about three areas of a firm’s operations
Why outsiders and insiders are concerned with a company’s
ratios related to leverage, efficiency, productivity, liquidity and
value
How to calculate, interpret, and evaluate the key ratios related
to leverage, efficiency, productivity, liquidity, and value
Why financial forecasts provide critical information for both
management and external parties
How to prepare financial forecasts by using the percentage of
sales approach
How external financing requirements are related to sales
growth, profitability, dividend payouts, and sustainable growth
rates.
Forecasting
4-4
Important Chapter Terms
• Acid test ratio
• Average collection period
• Average days sales in
inventory
• Break-even point
• Cash flow to debt ratio
• Current ratio
• Debt ratio
• Debt-equity ratio
• Degree of total leverage
• Dividend payout
• Dividend yield
•
•
•
•
•
•
•
•
•
•
EBITDA multiple
Efficiency ratios
Equity book value per share
External financing
requirements
Financial leverage
Fixed asset turnover
Forward P/E ratio
Gross profit margin
Inventory turnover
Invested capital
Forecasting
4-5
Important Chapter Terms …
•
•
•
•
•
•
•
•
•
•
•
Leverage ratio
Liquidity
Market-to-book ratio
Net operating income (NOI)
Net profit margin
Off-balance-sheet liabilities
Operating margin
Percentage of sales method
Price-earnings (P/E) ratio
Productivity ratios
Quick ratio
•
•
•
•
•
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•
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Receivables turnover
Retention (plowback) ratio
Return on assets (ROA)
Return on equity (ROE)
Spontaneous liabilities
Stock ratios
Sustainable growth rate
Times interest earned
Total enterprise value
Turnover ratio
Working capital
Working capital ratio
Forecasting
4-6
Consistent Financial Analysis
• Your text describes the importance
of consistent financial analysis
across companies, across
industries, across countries
• Morgan Stanley’s ModelWare is a
start on this.
• It is up to you, the analyst, to
understand the challenges to
comparability and you must attempt
to ascertain the financial health of
the organizations you study,
understanding the limitations
inherent in financial accounting
practice.
Forecasting
4-7
Intra-Company Comparisons
• GAAP provides considerable latitude for the company.
• Once a firm chooses an acceptable accounting treatment for:
– Revenue recognition
– Capitalization of expenses
– Inventory valuation, etc.
then the firm must use these same provisions year after year.
• Any change in accounting principles must be noted in the
financial statements and prior years restated to ensure there
is a common basis of comparison to the present.
• Therefore internal comparisons, year over year, are possible
and supported by GAAP.
Forecasting
4-8
Inter-Company Comparisons
• Making comparisons between companies, even
in the same industry are much more difficult
because:
– Widely divergence accounting treatment under GAAP
– Historical cost-based accounting can seriously affect
efficiency, leverage and profitability ratios.
Forecasting
4-9
Analysis of Financial Statements
• Study the absolute numbers, and the
comparative statements for the company to:
– Ascertain trends in the balance sheet, income
statement and statement of cash flows
– Ascertain areas of concern
– Ascertain areas of strength
• Complement your study of the absolute
numbers by using ratios again to:
– Ascertain trends
– Identify areas of concern
– Identify areas of strength
Forecasting
4 - 10
A Framework for Financial Analysis
Return on Equity (ROE) and DuPont System
• The DuPont System gives a framework for the
analysis of financial statements through the
decomposition of the Return on Equity ratio
ROE 
NI
SE
[4-1]
Net Income
Return on Equity 
Shareholde rs' Equity
(See Figure 4 -2 that illustrates the constituent parts of ROE )
Forecasting
4 - 11
Framework for Financial Analysis
Du Pont System
4 - 2 FIGURE
ROE
NI
ROA 
TA

GOOD OR BAD?
 TA 
 SE 
 NI 
 Sales 

LEVERAGE RATIOS
EFFICIENCY RATIOS
Sales
TA
PRODUCTIVITY
RATIOS
Forecasting
4 - 12
DuPont System and Decomposition of ROE
• As Figure 4 – 2 illustrates, ROE is a function of:
– Corporate use of leverage (use of debt)
– Efficiency ratios (ability of the firm to control costs in relationship to
sales)
– Productivity ratios (the degree to which the firm can generate sales in
relationship to assets employed)
ROE 
NI
SE
[4-1]
Net Income
Forecasting
4 - 13
Return on Equity (ROE) and DuPont System
• ROE is not a pure ratio because it involves dividing an income
statement item (flow) by a balance sheet (stock) item.
ROE 
NI
SE
[4-1]
Net Income
• Instead of using ending SE, many argue you should use
average SE (beginning SE plus ending SE divided by 2)
because SE changes over the year as income is earned and
retained earnings grow.
Forecasting
4 - 14
Return on Equity (ROE)
ROA
Leverage
NI  NI
Sales  TA
ROE 




SE  Sales TA  SE
[4- 7]
ROE when decomposed shows that it is a function of the
return earned on assets and of the leverage used by the firm.
Forecasting
4 - 15
Return on Total Assets
• ROA shows the ratio of income to assets that
have been used to produce them.
ROA 
NI
TA
Return on Assets 
Net Income
Total Assets
[4-2]
• ROA can be further decomposed as shown and
the following slide
Forecasting
4 - 16
Return on Assets (ROA)
• ROA is the product of the net profit margin and
the sales to total asset ratio:
NI
NI
Sales
ROA 


TA Sales
TA
[4- 6]
• The sales cancel and we are left with NI / TA
Forecasting
4 - 17
Leverage Ratio
• If ROA is multiplied by TA and divided by SE, the TA’s
cancel out and produces ROE.
• TA / SE is the leverage ratio
Leverage 
Leverage 
TA
SE
[4-3]
Total Assets
• It measures how many dollars of total assets are
supported by each dollar of Shareholders Equity.
Forecasting
4 - 18
DuPont System
• The DuPont system provides a good starting point for
any financial analysis
– It shows that financial strength comes from many sources
(profitability, asset utilization, leverage)
– It reinforces the concept that good financial analysis requires
looking at each ratio in the context of the other
– Whenever you are presented with financial statements it is
important that you look at a sample of ratios from each major
category to identify areas of strength and weakness
(Table 4 -1 illustrates E-Trade Canada’s ROE analysis of Rothmans)
Forecasting
4 - 19
Return on Equity (ROE) and the DuPont System
Table 4-1 E-Trade Canada's Rothman's Dupont ROE Analysis
Return on Equity
(1) Net Sales
(2) Pretax Income
(3) Net Income
(4) Total assets
(5) Shareholders' equity
Pretax margin % (2/1)
× Tax retent % (3/2)
=profit margin % (3/1)
× Asset Utilization % (1/4)
= ROA % (3/4)
× Leverage % (4/5)
=ROE % (3/5)
3/31/2006
652,271
274,829
99,464
449,075
113,860
42.13%
36.19%
15.25%
145.25%
22.15%
394.41%
87.36%
3/31/2005
636,771
261,345
92,997
528,528
193,708
41.04%
35.58%
14.60%
120.48%
17.60%
272.85%
48.01%
3/31/2004
620,104
252,683
90,277
496,757
168,497
40.75%
35.73%
14.56%
124.83%
18.17%
294.82%
53.58%
3/31/2003
575,469
240,197
86,678
429,965
130,537
41.74%
36.09%
15.06%
133.84%
20.16%
329.38%
66.40%
So urce: Data fro m E-Trade Canada
Forecasting
4 - 20
Interpreting Ratios
• A ratio is just one number over another number
– by itself, there is little ‘information’
• To judge whether a ratio is ‘good’ or ‘bad’
requires that it be compared to something else
such as:
– The company’s own ratios over time to ascertain
trends
– Other comparable companies or industry averages
(Table 4 -2 illustrates Rothmans DuPont ratios over time)
Forecasting
4 - 21
Interpreting Ratios
Table 4-2 Rothman's Dupont Ratios
Rothmans (March 31)
ROE
ROA
Net profit margin
Turnover
Leverage
2004
2005
2006
0.5358
0.1817
0.1456
1.2483
2.9482
0.4801
0.1760
0.1460
1.2048
2.7285
0.8736
0.2215
0.1525
1.4525
3.9441
Do you see trends here?
What factors are driving the
trend in ROE?
Forecasting
4 - 22
Interpreting Ratios
Table 4-3 Altria's Dupont Ratios
Altria (December 31)
ROE
ROA
Net profit margin
Turnover
Leverage
2003
2004
2005
0.3670
0.0957
0.1132
0.8455
3.8352
0.3066
0.0926
0.1051
0.8816
3.3095
0.2922
0.0967
0.1066
0.9065
3.0232
Do you see trends here?
What factors are driving the trend in ROE?
How do these results compare to Rothmans
on the previous slide?
Forecasting
4 - 23
Leverage
• Leverage = magnification
• Financial leverage occurs when a firm uses
sources of financing that carry a fixed cost
(such as long-term debt), and uses this to
generate greater returns than result in
magnified returns to shareholders.
• Leverage means magnification of either profits
or losses.
Forecasting
4 - 24
Leverage Ratios
• Include:
–
–
–
–
Debt ratio
Debt to equity ratio
Times interest earned ratio
Cash flow to debt ratio
Forecasting
4 - 25
Leverage Ratios
Debt Ratio
• Is a stock ratio indicating the proportion of total
assets financed by debt at a particular point in
time (the balance sheet date)
TL Total Liabilitie s
Debt ratio 

TA
Total Assets
Forecasting
[4- 8]
4 - 26
Leverage Ratios
Debt-Equity Ratio
• Is a stock ratio indicating the proportion that
total debt represents in relationship to the
shareholders equity (common stock and
retained earnings) at the balance sheet date.
D
Total Debt
Debt/Equit y ratio 

SE Shareholde rs' Equity
Forecasting
[4- 9]
4 - 27
Leverage Ratios
Times Interest Earned (TIE)
• Is an income statement (flow) ratio indicating
the number of times the firm’s pre-tax income
exceeds its fixed financial obligations to its
lenders (debt holders)
EBIT
I
Earnings Before Interest and Taxes
TIE 
Interest Expense
Times Interest Earned 
Forecasting
[4- 10]
4 - 28
Leverage Ratios
Cash Flow to Debt Ratio
• Measures how long it would take to payoff a
firm’s debt (D)
CFO
Cash flow to debt ratio 
D
Cash Flow from Operations
CF / D 
Total Debt
Forecasting
[4- 11]
4 - 29
Leverage Ratios
Cash Flow to Debt Ratio
Table 4-4 Leverage Ratios
Rothmans (March 31)
Leverage
Debt ratio
D/E ratio
TIE
Cash flow to debt
2004
2005
2006
2003
2004
2005
2.9482
0.6608
0.8902
46.7842
1.5037
2.7285
0.6335
0.7729
36.1270
1.0823
3.9441
0.7465
1.3152
42.7356
1.2235
3.8352
0.7393
0.9785
13.7035
0.4408
3.3095
0.6978
0.7482
12.9082
0.4739
3.0232
0.6692
0.6703
14.3405
0.4621
Which firm exhibits greater use of leverage?
Which exhibits greater capacity to take on and
service debt?
Forecasting
4 - 30
Efficiency Ratios
Efficiency ratios measure how efficiently a
dollar of sales is turned into profits.
• Gives insight to the firm’s cost structure
• Whether problems exist with variable costs or fixed costs
(overhead) or both
Forecasting
4 - 31
Efficiency Ratios
• Include:
–
–
–
–
Degree of total leverage
Break-even point
Gross profit margin
Operating margin
Forecasting
4 - 32
Efficiency Ratios
Interpreting Ratios
Table 4-5 Profit Margin and Sales Variability
Sales
Contribution margin (40%)
Fixed cost
Interest
Tax
Net income
120
48
31
5
6
6
132
53
51
5
8.5
8.5
108
43
31
5
3.5
3.5
Net profit margin
5.0%
6.4%
3.2%
The focus of efficiency ratios is with the income statement.
This example demonstrates the leverage effect of using fixed
costs in lieu of variable costs in the cost structure.
Sales varied by +/- of 10% yet profits varied by +/- 40%.
Forecasting
4 - 33
Efficiency Ratios
Degree of Total Leverage Ratio
• An income statement ratio that measures the
exposure of profits to changes in sales.
• The greater the DTL, the greater leverage
effect.
CM
EBT
Contributi on Margin
DTL 
Earnings Before Taxes
Degree of Total Leverage 
Forecasting
[4- 12]
4 - 34
Efficiency Ratios
Break Even Point
• Estimates the volume of units that must be produced and
sold in order for the firm to cover all costs both fixed and
variable.
FC
Break Even Point 
CM
Fixed Costs
BEP 
Contributi on Margin
[4- 13]
• The break even point tends to increase as the use of
fixed costs increases.
Forecasting
4 - 35
Efficiency Ratios
Gross Profit Margin
• Demonstrates the percentage of sales that are available
to cover fixed (period) costs and financing expenses
after variable costs have been paid.
S  CGS
S
Sales - Cost of Goods Sold
GPM 
Sales
Gross Profit Margin 
[4- 14]
• A declining gross profit margin raises concerns about
the firm’s ability to control variable costs such as direct
materials and direct labour.
Forecasting
4 - 36
Efficiency Ratios
Operating Margin
• Operating margin measures the cumulative
effect of both variable and period costs on the
ability of the firm to turn sales into operating
profits to cover, interest, taxes, depreciation
and amortization (EBITDA).
NOI
Sales
Net Operating Income
OM 
Sales
Operating Margin 
Forecasting
[4- 15]
4 - 37
Efficiency Ratios
Interpreting Ratios
Table 4-6 Efficiency Ratios
Rothmans (March 31)
Net profit margin
Gross profit margin
Operating margin
2004
2005
2006
2003
2004
2005
0.1456
0.4261
0.4102
0.1460
0.4305
0.4155
0.1525
0.4426
0.4263
0.1132
0.3519
0.1938
0.1051
0.3348
0.1867
0.1066
0.3286
0.1696
Which firm is able to produce a greater percentage of sales as
profits?
Which firm is able to produce strong and consistent
profitability?
Forecasting
4 - 38
Productivity Ratios
• Measure the ability of the firm to generate sales
from the assets that it employs.
• Excessive investment in assets with little or no
increase in sales reduces the rate of return on
both assets and equity (ROA) and (ROE)
Forecasting
4 - 39
Productivity Ratios
• Include:
–
–
–
–
–
Receivables turnover
Average collection period (ACP)
Inventory turnover
Average days sales in inventory (ADSI)
Fixed asset turnover
Forecasting
4 - 40
Productivity Ratios
Receivables Turnover
• Measures the sales generated by every dollar of
receivables.
Receivable s turnover 
RT 
S
AR
[4- 16]
Sales
Accounts Receivable
Forecasting
4 - 41
Productivity Ratios
Average Collection Period
• Estimates the number of days it takes a firm to collect on
its accounts receivable.
Average Collection Period 
ACP 
AR
365

ADS Receivable s Turnover
[4- 17]
AR
Receivable s turnover
• If ACP is 40 days, and the firm’s credit policy is net 30,
clearly, customers are not paying in keeping with the
firm’s policy, and there may be concerns about the
quality of the firm’s customers, and what might happen if
economic conditions deteriorate.
Forecasting
4 - 42
Productivity Ratios
Inventory Turnover
• Estimates the number of times, ending inventory was
‘turned over’ (sold) in the year.
CGS
Inventory Turnover 
INV
[4- 18]
• A ratio that involves both ‘stock’ and ‘flow’ values
• Is strongly a function of ending inventory
value…managers often try to improve this ratio as they
approach year end through inventory reduction
strategies (cash and carry sales/inventory clearance,
etc.)
Forecasting
4 - 43
Productivity Ratios
Inventory Turnover
• When Cost of Goods Sold is not available, it may be
necessary to estimate inventory turnover using sales.
Sales
Inventory Turnover 
INV
[4- 19]
• Use of the sales figure is less valid than Cost of Goods
Sold because Cost of Goods Sold is based on
inventoried cost, but Sales includes a profit margin on
top of inventoried cost.
Forecasting
4 - 44
Productivity Ratios
Average Days Sales in Inventory (ADSI)
• Estimates the number of days of sales tied up in
inventory (based on ending inventory values)
Average days sales in inventory (ADSI) 

INV
ADS
[4- 20]
365
Inventory turnover
Forecasting
4 - 45
Productivity Ratios
Fixed Asset Turnover
• Estimates the number of dollars of sales
produced by each dollar of net fixed assets.
Fixed Asset Turnover 

S
NFA
[4- 21]
Sales
Net Fixed Assets
Forecasting
4 - 46
Productivity Ratios
Interpreting Ratios
Table 4-7 Productivity Ratios
Rothmans (March 31)
2004
2005
2006
2003
Turnover
1.2483
1.2048
1.4525
0.8455
Receivables turnover 19.3825 19.8254 55.3006
NA
ACP
18.8314 18.4108 6.6003
NA
Inventory turnover
3.1170
3.0349
3.1597
8.5241
(using sales)
ADSI
117.0988 120.2692 115.5165 42.8197
Fixed asset turnover 11.0158 9.2087
8.5490
5.0613
2004
2005
0.8816
15.5735
23.4372
0.9065
18.2529
19.9968
8.9244
40.8991
5.4959
9.2455
39.4788
5.8673
Which firm has been improving its efficiency ratios to a
greater degree?
Forecasting
4 - 47
Liquidity Ratios
• Measure the ability of the firm to meet its
maturing financial obligations through liquid
(cash and near cash) resources
• Include:
– Working capital ratio
– Current ratio
– Quick (acid-test) ratio
Forecasting
4 - 48
Liquidity Ratios
Working Capital Ratio
• Measures the percentage of total assets that is
invested in current assets.
• Helps to analyze capital intensity as well as
corporate liquidity.
CA
Working Capital Ratio 
TA
Current Assets

Total Assets
Forecasting
[4- 22]
4 - 49
Liquidity Ratios
Current Ratio
• Measures the number of dollars of current
assets for each dollar of current liabilities.
• Helps to estimate the capacity of the firm to
meet its maturing financial obligations.
CA
CL
Current Assets

Current Liabilitie s
Current Ratio 
Forecasting
[4- 23]
4 - 50
Liquidity Ratios
Quick Ratio
• Recognizing that inventories may be less liquid than
other current assets, and in some cases, when liquidated
quickly result in cash flows that are less than book value,
the quick ratio gives a clearer indication of the firm’s
ability to meet its maturing financial obligations out of
current, liquid assets.
C  MS  AR
CL
Current Assets  Inventories

Current Liabilitie s
Quick Ratio 
Forecasting
[4- 24]
4 - 51
Liquidity Ratios
Interpreting Ratios
Table 4-8 Liquidity Ratios
Rothmans (March 31)
Current ratio
Quick ratio
Working capital ratio
2004
2005
2006
2003
2004
2005
2.8868
1.4981
0.8414
2.9310
1.5092
0.8235
2.4756
1.0037
0.7800
NA
NA
NA
1.0987
0.4877
0.2548
0.9856
0.4442
0.2388
Which firm has greater liquidity and capacity to meet its
financial obligations?
Forecasting
4 - 52
Estimating Net Realizable Values
Interpreting Ratios
• When firm’s are financially-strained and no longer a
‘going concern,’ book (accounting) become less valid
• Net liquidation values can be estimated by discounting
asset values based on their degree of liquidity
– Liquid assets are valued close to or the same as book value
– Illiquid assets are discounted from book value based on the
degree of illiquidity
– Liabilities are stated in nominal terms because it takes those
dollars to satisfy debt obligations
– Preferred stock value is based on residual values (if there is any
estimated residual value)
(Table 4 – 9 is an example of E-Trade Canada’s Risk Ratings for Rothmans)
Forecasting
4 - 53
Estimating Net Liquidation Value
Interpreting Ratios
Table 4-9 E-Trade Canada's Risk Ratings
Growth Rates
Net ROA %
Long-term debt growth (YTY %)
Asset growth (YTY %)
Components of Net Liquidated Value
Cash @ 100%
Marketable securities @ 98%
Receivables @ 90%
Other current assets @ 80%
Inventory @ 50%
Net plant @ 25%
Total Liquid Assets
Current liabilities (100%)
Long-term debt (100%)
Other liabilities (100%)
Net of Liabilities = net liquidation value
Average shares
Net Liquidation Value per Share
2006
2005
2004
2003
22.15%
3.00%
-15.03%
17.60%
-0.19%
6.40%
18.17%
0.00%
15.53%
20.16%
N/A
N/A
130,231
N/A
10,616
1,468
103,217
19,075
264,607
141,496
149,751
10,761
-37,401
67,745
($0.55)
191,995
N/A
28,907
1,058
104,910
17,287
344,157
148,498
149,708
0
45,951
67,492
$0.68
184,907
N/A
28,794
1,698
99,471
14,073
328,943
144,786
150,000
0
34,157
33,610
$1.02
113,270
N/A
75,373
2,027
76,767
13,654
281,091
110,964
150,000
0
20,127
33,299
$0.60
So urce: Data fro m E-Trade Canada.
Forecasting
4 - 54
Valuation Ratios
• Used to assess how the market is valuing the
firm (share price) in relationship to assets and
current earnings, profits and dividends
• Include:
–
–
–
–
–
–
–
Equity book value per share (BVPS)
Dividend yield
Dividend payout
Price-earnings (P/E) ratio
Forward (P/E) ratio
Market-to-book (M/B) ratio
EBITDA multiple
Forecasting
4 - 55
Valuation Ratios
Interpreting Ratios – Book Value per Share
• Expresses shareholders’ equity on a per share
basis.
Book Value Per Share 
Number of Shares
Forecasting
[4- 25]
4 - 56
Valuation Ratios
Interpreting Ratios – Dividend Yield
• Expresses dividend payout as a percentage of
the current share price.
Dividend Per Share DPS
Dividend Yield 

Price per Share
P
[4- 26]
• Can be compared to other investment
instruments such bonds (current yield) or with
other dividend-paying companies.
Forecasting
4 - 57
Valuation Ratios
Interpreting Ratios – Dividend Payout Ratio
• Expresses dividends as a percentage of
earnings on a per share basis.
Dividend Per Share DPS
Dividend Payout 

Earnings per Share EPS
Forecasting
[4- 27]
4 - 58
Valuation Ratios
Interpreting Ratios – Trailing P/E Ratio
• Earnings multiple based on the most recent earnings.
• Often used in estimating the value of a stock.
Price - earnings ratio 
Share Price
P

Earnings per Share EPS
[4- 28]
• A stock trading at a P/E multiple of 10 will take ten years
at current earnings to recover the price of the stock.
• A stock trading at a P/E multiple of 100 will take 100
years at current annual earnings to recover the price of
the stock.
Forecasting
4 - 59
Valuation Ratios
Interpreting Ratios – Forward P/E Ratio
• Earnings multiple based on forecast earnings per share.
• Often used in estimating the value of a stock especially
with companies with rapid growth in earnings per share.
Forward Price - earnings ratio 
Share Price
P

Estimated Earnings per Share EEPS
[4- 29]
• Low P/E shares are regarded as value stocks
• High P/E shares are regarded as growth stocks
Forecasting
4 - 60
Valuation Ratios
Interpreting Ratios – Market to Book Ratio
• Estimates the dollars of Share Price per dollar of book
value per share.
Market - to - book ratio 
Share Price
P

Book Value per Share BVPS
[4- 30]
• Given historical cost accounting as the basis for book
value per share, the degree to which market value per
share exceeds BVPS indicates the value that has been
added to the company by management.
Forecasting
4 - 61
Valuation Ratios
Interpreting Ratios – EBITDA Multiple
• Total enterprise value is an estimate of the total market
value of the firm (market value of equity plus market
value of debt)
• EBITDA multiple expresses total enterprise value for
each dollar of operating income (EBITDA)
Total Enterprise Value
Earnings before interest, taxes, depreciati on and amortizati on
TEV

EBITDA
EBITDA multiple 
Forecasting
4 - 62
Valuation Ratios
Interpreting Ratios
Table 4-10 Value Ratios
Rothmans (March 31)
Dividend yield
Dividend payout
P/E
M/B
EBITDA multiple
Dividend yield (excl.
special dividend)
Dividend payout (excl.
special dividend)
2004
2005
2006
2003
2004
2005
0.0474
0.6063
12.7799
6.8451
4.8535
0.0438
0.7664
17.5109
8.3685
6.3545
0.1333
1.8621
13.9655
12.0682
5.2095
0.0485
0.5841
12.0398
4.4208
7.8436
0.0462
0.6184
13.3991
4.0979
8.8194
0.0410
0.6132
14.9739
4.6319
9.7774
N/A
N/A
0.0593
N/A
N/A
N/A
N/A
N/A
0.8276
N/A
N/A
N/A
Can you draw any conclusions for the comparative valuation
ratio data summarized in this table?
Forecasting
4 - 63
Financial Forecasting
Purpose
Financial managers must produce forecasts
for the financial results of corporate plans
to:
– Determine whether the corporate plans will require
additional external financing
– Determine whether the corporate plans will produce
surplus cash resources that could be distributed to
shareholders as dividends
– Assess the financial forecasts to determine the financial
feasibility of corporate plans – if poor financial results are
forecast, this gives management the opportunity to
reexamine and amend corporate plans to produce better
results before resources and people are committed.
Forecasting
4 - 64
The basis for all financial forecasts is the sales forecast.
The most recent balance sheet values are the starting
point.
Pro forma (forecast) balance sheets are projected
assuming some relationship with projected sales
(constant percentage of sales)
Current liabilities are usually assumed to rise and fall in a
constant percentage with sales – we call them
‘spontaneous liabilities’ because they change without
negotiation with creditors.
Forecasting
4 - 65
The Percentage of Sales Method
The percentage of sales method involves
the following steps:
1. Determine which financial policy variables you are
interested in
2. Set all the non-financial policy variables as a
percentage of sales
3. Extrapolate the balance sheet based on a percentage
of sales
4. Estimate future retained earnings
5. Modify and re-iterate until the forecast makes sense.
This process most often results in a balance sheet that does
not balance – a ‘plug’ (balancing) amount is the external
funds required (or surplus funds forecast)
Forecasting
4 - 66
The historical balance sheet.
If sales
increase,
assets
used to
produce
those
sales
must
grow.
Spontaneous
liabilities
Table 4-11 Balance Sheet
Cash
Securities
Receivables
Inventory
Current assets
Net fixed assets
5
10
10
25
50
100
Total assets
150
Accruals
Payables
Bank debt
5
5
20
Current liabilities
Long-term debt
Common equity
30
40
80
Total Liabilities
Forecasting
Policy
variables
requiring
decision.
150
4 - 67
Table 4-12 Initial Forecast
Sales
120
%
100.0%
132
145
160
Cash
Securities
Receivables
Inventory
Net fixed assets
Total assets
5
10
10
25
100
150
4.2%
8.3%
8.3%
20.8%
83.3%
125.0%
5.5
11.0
11.0
27.5
110.0
165.0
6.0
12.1
12.1
30.2
120.8
181.3
6.7
13.3
13.3
33.3
133.3
200.0
Accruals
Payables
Short-term debt
Long-term debt
Equity
Total liabilities and equity
Cumulative (EFR)
5
5
20
40
80
150
4.2%
4.2%
16.7%
33.3%
66.7%
125.0%
5.5
5.5
20.0
40.0
80.0
151.0
14.0
6.0
6.0
20.0
40.0
80.0
152.1
29.2
6.7
6.7
20.0
40.0
80.0
153.3
46.7
Forecasting
Sales
Naïve
projections
increases
the
inand
balance
base
case
sheet
of $120
percentages
accounts
Accounts
First
passin
of sales
same
requiring
funding
proportion
decision
Balance
shortfall
to
are
Sheet
projected.
projected
assumed
Values to
sales
remain
calculated
constant
as a on
first pass.
percentage
of sales.
4 - 68
Percentage of Sale Method
Improving the Pro Forma Balance Sheet
• The prior pro form balance sheet was
developed using very naïve assumptions:
– Policy variables held constant
– Asset growth in all accounts held at the same
percentage of sales
– Spontaneous liabilities increased at a constant
percentage of sales.
• One improvement is to realize that the firm’s
equity will grow by the amount of retained
earnings.
(See the following income statement)
Forecasting
4 - 69
Table 4-13 Income Statement
Sales
Gross operating profit
Fixed costs
EBIT
Interest
Taxes @ 50%
Net Income
Dividends
120
48
31
17
5
6
6
3
Forecasting
Retained
earnings = net
income less
dividends.
Assuming the
firm holds this
percentage
constant we can
project increases
in equity on the
balance sheet as
50% of the 5%
profit margin or
2.5% of sales.
4 - 70
Table 4-14 First Revision of Forecast
Sales
120
%
100.0%
132
145
160
Cash
Securities
Receivables
Inventory
Net fixed assets
Total assets
5
10
10
25
100
150
4.2%
8.3%
8.3%
20.8%
83.3%
125.0%
5.5
11.0
11.0
27.5
110.0
165.0
6.0
12.1
12.1
30.2
120.8
181.3
6.7
13.3
13.3
33.3
133.3
200.0
Accruals
Payables
Short-term debt
Long-term debt
Equity
Cumulative (EFR)
5
5
20
40
80
150
4.2%
4.2%
16.7%
33.3%
66.7%
125.0%
5.5
5.5
20.0
40.0
83.3
154.3
10.7
6.0
6.0
20.0
40.0
86.9
159.0
22.3
6.7
6.7
20.0
40.0
90.9
164.2
35.8
Forecasting
Equity
Notice
how
accounts
the
increased
retained
by
earnings
projected
has
retained
reduced
earnings
the
that
projected
increase
Externalin
proportion
Funds
to sales.
Required.
4 - 71
Second Revision the Pro Forma Balance Sheet
• Further improvements to the pro forma balance sheet
include:
– Recognizing that cash balances may not have to rise as a
constant percentage of sales
• Cash balances are required for a variety of reasons
– To support transaction
– As a safety cushion against unforeseen cash needs
– As a speculative balance to take advantage of unforeseen opportunities
• Even at low levels of sales, cash balances are required
• As sales increase, additional cash on hand may be required, but at
a decreasing percentage of sales.
– The following slide illustrates the difference between a simple
percentage of sales forecast, and perhaps a more realistic
forecast that includes a base amount (constant) and a
decreasing percentage of sales
Forecasting
4 - 72
Percentage of Sales Method
44-3
- 3FIGURE
FIGURE
Cash Forecast
14.0
Simple %
Cash
12.0
Linear with
constant
10.0
8.0
6.0
4.0
2.0
0.0
0
20
40
60
80 100 120 140 160 180 200 220 240 260 280 300
Sales
Forecasting
4 - 73
• Further improvements to the pro forma balance sheet include
reexamining asset growth assumptions:
– Refinement of the cash forecast (as per the previous two slides
– Realization that EFR can be offset by marketable securities that can easily be
liquidated to finance growth needs.
– Reexamine our assumptions about growth in Accounts Receivable and whether
we want to change our credit policies in the context of the forecast macro
economic and competitive environment
– Reexamine our inventory management policies taking into account the
macroeconomic and competitive environment
– Realization that increases in net fixed assets is ‘lumpy’ and not continuously
incremental (if we have excess production capacity, we may not need to invest
any further in fixed assets until we are forecast to exceed that capacity)
• Further improvements to the pro forma balance sheet
include reexamining assumptions regarding the growth
in spontaneous liabilities
(See the effects of these changes on the pro forma balance sheet on the following
slide)
Forecasting
4 - 74
Table 4-15 Second Revision of Forecast
Sales
120
%
100.0%
132
145
160
Cash
Securities
Receivables
Inventory
Net fixed assets
Total assets
5
10
10
25
100
150
4.2%
8.3%
8.3%
20.8%
83.3%
125.0%
5.0
0.0
11.0
27.5
100.0
143.5
5.0
0.0
12.1
30.2
90.0
137.3
5.0
0.0
13.3
33.3
80.0
131.7
Accruals
Payables
Short-term debt
Long-term debt
Equity
Cumulative (EFR)
5
5
20
40
80
150
4.2%
4.2%
16.7%
33.3%
66.7%
125.0%
5.5
5.5
20.0
40.0
83.3
154.3
-10.8
6.0
6.0
20.0
40.0
86.9
159.0
-21.7
6.7
6.7
20.0
40.0
90.9
164.2
-32.6
Forecasting
Assuming
cash remains
constant, we
liquidate
marketable
securities and
we retain 50%
of our profits
dramatically
affects the
forecast.
We now have
surplus
resources!
4 - 75
Final Revisions to the Pro Forma Income Statement
•
Given our assumptions about capacity, and there being no need
for further expansion in plant and equipment to support
anticipated sales growth, we can reexamine our assumptions
about the cost structure of the firm.
Variable Costs
• Variable costs (direct materials and direct labour) will likely grow in proportion to
sales.
Fixed Costs
• Fixed costs, however should remain fixed.
• By modifying the income statement for this change in assumptions, we see the net
result of this is an increase in forecast net income.
Dividends
• Most firms do not follow a constant payout ratio, but hold dividends constant over
multiple years.
• Assume that we hold dividends at $3 for the next three years.
(See the effects of these changes on the final pro forma income statement on the following slide)
Forecasting
4 - 76
Table 4-16 Profit Margin and Sales
Sales
Gross operating profit
Fixed costs
EBIT
Interest
Taxes @ 50%
Net Income
Net profit margin
Dividends
Additions to Retained earnings
$120
48
31
17
5
6
6.0
5.0%
$132
53
31
22
5.0
8.5
8.5
6.4%
$145
58
31
27
5.0
11.0
11.0
7.6%
$3.0
$3.0
$3.0
$5.5
$3.0
$8.0
Forecasting
$160
64
31
33
5.0
14.0
14.0
8.8%
$3.0
$11.0
4 - 77
Final Revisions to the Pro Forma Balance Sheet
• Given our modified income statement and
assumptions regarding net profit and cash
dividends we can prepare a final revised balance
sheet
• This balance sheet now shows that we forecast
significant surplus cash resources and must make
some decisions about how we will manage them:
– Investment temporarily in marketable securities in anticipation of further
investment opportunities in growing the firm?
– Distribute them in the form of cash dividends?
(See the effects of these changes on the final pro forma balance sheet on the
following slide)
Forecasting
4 - 78
Table 4-17 Final Revision of Forecast
Sales
120
%
100.0%
132
145
160
Cash
Securities
Receivables
Inventory
Net fixed assets
Total assets
5
10
10
25
100
150
4.2%
8.3%
8.3%
20.8%
83.3%
125.0%
5.0
0.0
11.0
27.5
100.0
143.5
5.0
0.0
12.1
30.2
90.0
137.3
5.0
0.0
13.3
33.3
80.0
131.7
Accruals
Payables
Short-term debt
Long-term debt
Equity
Cumulative (EFR)
5
5
20
40
80
150
4.2%
4.2%
16.7%
33.3%
66.7%
125.0%
5.5
5.5
20.0
40.0
85.5
156.5
-13.0
6.0
6.0
20.0
40.0
93.5
165.6
-28.3
6.7
6.7
20.0
40.0
104.5
177.8
-46.2
Forecasting
4 - 79
Formula Forecasting
The Simple Percentage of Sales Forecasting Method
We can express the foregoing percentage of sales method
forecasting using equations rather than spreadsheets.
When we subtract spontaneous liabilities from total assets we get
the firm’s invested capital or net assets as a percentage of
sales.
We will denote this by ‘a’
‘a’ is the treasurer’s financial policy variable because it is the total
invested capital requirement of the firm as a percentage of sales.
Forecasting
4 - 80
Formula Forecasting
The Per
External Funds Required can now be expressed as a formula of
relationships:
EFR  a  S  g  b  PM  (1  g )  S
[4- 32]
Where:
‘a’ g
S
S×g
a×S×g
PM
b
1–b
treasurer’s financial policy variable
- sales growth rate
- current sales
- next period’s sales growth
- incremental capital required
- profit margin on sales
- payout ratio
- retention or plowback ratio
Forecasting
4 - 81
Formula Forecasting
The Per
External Funds Required can also be expressed as a linear
function of the sales growth rate (g) and this can be seen more
easily by dividing both sides of Equation 4 – 32 by the current
sales level and rearranging:
EFR
 b  PM  (a  b  PM ) g
S
[4- 33]
This line can be graphed to show the relationship between the
sales growth rate and External Funds Required.
(See Figure 4 -4 found on the following slide)
Forecasting
4 - 82
External Financing Requirements
44-3
- 4FIGURE
FIGURE
0.15
Sustainable growth rate ( g*)
0.05
0.18
0.16
0.14
0.12
0.1
0.08
0.06
0.04
0.02
0
-.002
-.004
-0.06
-0.05
-0.08
0.0
-0.1
EFR / S
0.1
-0.1
-0.15
Sales Growth Rate
-0.2
Forecasting
4 - 83
Formula Forecasting
The Sustainable Growth Rate (g*)
The sustainable growth rate is the sales growth rate at which the
firm neither generates nor needs external financing – that is, it
can sustain its own rate of growth through reinvestment of
profits earned.
The sustainable growth rate (g*) is the point in Figure 4 – 4 at
which the line crosses the horizontal axis.
Using equation 4 – 33 we can rearrange and solve for g*:
g*
b  PM
(a  b  PM )
[4- 34]
Forecasting
4 - 84
Summary and Conclusions
In this chapter you have learned:
– The importance of understanding the sources of a firm’s
profitability or where the challenges to profitability exist.
– How to calculate and interpret operating, profitability,
liquidity, leverage and efficiency ratios
– How to prepare financial forecasts and understand the
assumptions underlying the percentage of sales method
of financial forecasting.
Forecasting
4 - 85
Copyright
Copyright © 2007 John Wiley & Sons Canada, Ltd. All rights reserved.
Reproduction or translation of this work beyond that permitted by
Access Copyright (the Canadian copyright licensing agency) is
unlawful. Requests for further information should be addressed to the
Permissions Department, John Wiley & Sons Canada, Ltd. The
purchaser may make back-up copies for his or her own use only and
not for distribution or resale. The author and the publisher assume no
responsibility for errors, omissions, or damages caused by the use of
these files or programs or from the use of the information contained
herein.
Forecasting
4 - 86

CORPORATE FINANCE Laurence Booth • W. Sean Cleary INTRODUCTION TO Prepared by

Transcription

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