Session XIA

1
Session XI-A

• Financial Statement Analysis

2
The 3 Ps

• Preparation
• Processing
• Presentation

3
Reasons for Analysis

• Investment decisions
• Credit decisions
• Performance
• Valuation (investment)
• Legal liability amount (credit perf.)
• Going concern decisions (credit perf.)
• Unreasonable returns (performance)

4
FSA Steps

• Identify the economic characteristics
• Identify the corporate strategies
• Understand the financial statements
• Assess the profitability and risk
• Value the particular firm

5
Tools for Economic Analysis

• Value Chain Analysis
• Porters Five Forces
• Economic Attributes Framework

6
Porters Five Forces

• Buyer Power
• Supplier Power
• Rivalry among Firms
• Threat of New Entrants
• Threat of Substitutes

7
Economic Attributes Framework

• Demand
• price sensitivity
• demand growth
• cyclical demand
• seasonal demand
• Supply
• number of suppliers
• barriers to entry
• Manufacturing
• capital intensity
• process complexity
• Marketing
• marketing channel--corporate or consumer
• demand pull or demand creation
• Financing
• Nature of assets
• Asset risk
• Source of cash flow--internal or external

8
Strategic Analysis Framework

• Nature of product or service
• Degree of Integration
• Degree of Geographical Diversification
• Degree of Industry Diversification

9
Sources of Information

• Annual Report
• Form 10-K
• Form 10-Q
• Form 8-K
• Prospectus
• Form 20-F (foreign entity 10-K)

10
Financial Statements

• Balance Sheet
• Income Statement
• Statement of Cash Flows
• Footnotes
• Auditors Report
• Management Discussion and Analysis

11
Tools of Profit and Risk Analysis

• Common Size Financial Statements
• Percentage Change Statements
• Comparative Analysis
• Critical Financial Ratios

12
Risks of Comparative Analysis

• Timing
• GAAP Application
• Degree of Conservatism
• Management Attitude
• Size
• Geographic Diversification

13
Sustainability Issues

• Discontinued operations
• Extraordinary gains and losses
• Changes in accounting principles
• Impairment of long-lived assets
• Restructuring charges
• Changes in estimates
• Peripheral gains and losses
• Mgmt. analysis including the MDA

14
Profitability Analysis

• Rate of Return on Assets--ROA
• Measures success in using assets to generate
  earnings (excluding financing)
• Disaggregated ROA
• ROA Profit Margin X Asset Turnover
• Line by line P L Analysis
• A/R, Inventory F/A turnover

15
ROA Summary

• Level 1 ROA as a whole
• Level 2 Disaggregate ROA
• Level 3a Margin analysis in detail
• Level 3b Disaggregate turnover
• Level 4 ROA, margin turnover by geographic
  segment

16
ROCE--Return on Common Shareholders Equity

• Return after O-I-F activities
• ROA and ROCE
• ROCE gt ROA when ROA exceeds the cost of creditor
  and pref. Shareholder capital

17
Disaggregated ROCE

• ROCE ROA X CEL X CSL
• Common Earnings Leverage op. Income available
  to common s/h
• Cap. Structure Leverage multiplier effect of
  other capital sources

18
Risk Analysis

• Types of risk
• International
• Domestic
• Industry
• Firm-specific
• Financial
• Solvency
• Liquidity

19
S/T Financial Risk

• Current ratio
• Quick ratio
• Working Capital Activity ratios
• A/R turnoverDSO
• Inventory turnoverDays in inventory
• A/P turnoverDIP
• Cash Conversion Cycle
• DSO DII - DIP.should be negative

20
Relationship to Statement of Cash Flows (O-I-F)

• S/T riskOworking capital
• L/T riskIplant capacity
• L/T riskFdebt service rqmts.

21
Session IS-B

• Planning
• Strategic and Financial

22
Integrated Planning
SP
P
MBOs
23
International Complexity

• Language
• Attitudes towards planning
• Economic and legal environment
• Political system
• Political stability
• Labor considerations

24
Risk Mgmt. Issues

• Threat identification and mitigation approaches
• High risk makes planning more important
• Some risk factors to consider
• Loss of resources directly involved
• Loss of time
• Loss of resources indirectly involved
• Risk mitigation
• Use of joint ventures or alliances
• Geographic dispersion
• Avoiding certain competitors

25
Risk Management(includes Economic and Political
Risk)

• Risk identification
• Risk assessment
• Risk assignment
• Risk quantification
• Risk consolidation
• Risk settlement
• Avoid
• Diversify
• Share
• Transfer
• Control
• Accept--Exploit

At SBU-local level
At corporate level
26
The Strategic Planning Pyramid
MISSION STATEMENT
CORPORATE VALUES
KEY ISSUES
IMPLEMENT
PLAN
STRATEGIES (WHAT)
TACTICS (HOW)
MBOs (WHO)
27
Strategic Planning Model
Mission Stmt
Situational Analysis
Corporate Values
1
2
3
Core Review Integration
1. Update Mission and Values 2. ID Key Issues 3.
ID Strategies using SWOT Analysis
Publish
28
Financial Management Evolution
DATA
Todays Corporate Focus is on Results!
INFORMATION
See Exhibit 8.1
ANALYSIS
IMPLEMENTATION
29
Control Systems

• Centralization versus decentralization
• Performance metrics
• Balanced scorecard
• International subsidiary specifics
• Criteria--Exhibit 8.2 (financial)
• Criteria--Exhibit 8.3 (non-financial)
• Goals and measures--Exhibit 8.4

30
Typical Measures

• Return on investment--ROI
• Residual income
• EVA
• Return on equity

Note the differences in the definitions of these
ratios
Other considerations are definitions for
investment, income, choice of currency and use of
price-level indices.
31
Making the Financial Plan Really Count

• Traditional Quantitative Effort
• Translates Strategies into Numbers
• Spending Gameplan
• Avoiding the B Word

32
Revenue Consideration

• Backlog
• Direct Customer Contact
• Strategic Plan
• Product Development and Timing
• Capacity
• Historic Trends
• Competitive Reaction

33
Remember the F.A.T. Factor

• Future in Direction
• Action in Orientation
• Trackable in Design

34
Planning Traps and Risks

• Operations Abandonment
• Poor Assumptions and Allocations
• Lack of Reality
• Analysis Paralysis
• No Contingencies

35
Paradigm Shift

• Moving from Results of Operations
• To Operating information for Results
• Applies to all Management Accounting information
• Make certain that every employee fully
  understands the metrics that drive an
  organization toward improvement

36
Strategic Cost Management

• Value chain and value processes
• Core competency
• Cost advantage
• Reengineering
• ABC and ABM
• Total Quality Management (TQM)
• Performance Based Measurement (PBM)
• Just-in-time Inventory
• Target Costing
• Local Management Outsourcing