Evaluating a Firm

1
Chapter 2

• Evaluating a Firms Financial Condition

Shapiro and Balbirer Modern Corporate Finance
A Multidisciplinary Approach to Value
Creation Graphics by Peeradej Supmonchai
2
Learning Objectives

• Identify the basic elements of a companys
  balance sheet, income statement, and statement of
  cash flows.
• Explain why a firms financial statements based
  on historical cost may not reflect either
  economic value nor economic profits.
• Describe the differences between a firms
  accounting income and its cash flows.
• Use financial ratio analysis to evaluate a firms
  financial position.
• Indicate how non-financial measures of operating
  effectiveness can be valuable in assessing a
  firms ability to remain competitive.
• Explain how segmented financial statements can be
  used to evaluate the performance of diversified
  firms.
• Describe the differences between the financial
  statements of U.S.- and foreign-based companies.

3
The Basic Financial Statements

• Organizes the firms financial transactions for
  the year.
• The Firms Financial Statements
• Balance Sheet
• Income Statement
• Statement of Cash Flows

4
The Balance Sheet

• Tabulates a companys assets and liabilities at a
  specific point in time.
• Assets represent what a firm owns current assets
  are assets that will convert into cash within a
  year.
• Liabilities represent what a company owes
  current liabilities are debts due within a year.
• Net Working Capital Current Assets - Current
  Liabilities
• Shareholders Equity Total Assets - Total
  Liabilities

5
Anheuser-Busch Company Balance Sheet

• December 31 1997
  1996
• ASSETS
• Current Assets
• Cash and Marketable Securities
  147.3 93.6
  
• Accounts Receivable
  713.4 632.7
  
• Inventories
  550.2 531.1
  
• Other Current Assets 173.0
  208.4
  
• Total Current Assets
  1,583.9 1,465.8
  
• Investments and Other Assets
  2,392.6 1,789.6
  
• Net Plant and Equipment
  7,750.6 7,208.2
  
• Total Assets
  11,727.1 10,463.6

6
Anheuser-Busch Company Balance Sheet

• LIABILITIES AND SHAREHOLDER EQUITY
  1997 1996
• Current Liabilities
  
• Accounts Payable
  791.6 726.8
  
• Accrued Salaries, Wages, and Benefits
  224.3 227.6
  
• Accrued Taxes 183.9
  233.0
• Other Current Liabilities
  300.7 234.5
  
• Total Current Liabilities
  1,500.7 1,430.9
  
• Post-retirement Benefits
  525.4 526.6
  
• Long-Term Debt
  4,365.6 3,270.9
  
• Deferred Income Taxes
  1,293.6 1,208.1
  
• Shareholders Equity
  4,041.8 4,029.1
  
• Total Liabilities and Equity
  11,727.1 10,463.6

7
Current Assets

• Cash and Marketable Securities
• Accounts Receivable
• Inventory
• Other Current Assets

8
Fixed and Other Assets

• Goodwill
• Investments in Other Firms
• Land
• Plant and Equipment

9
Current Liabilities

• Accounts Payable
• Accrued Salary, Wages, and Benefits
• Accrued Taxes
• Other Current Liabilities

10
Long-Term Liabilities

• Post-retirement Benefits
• Long-term Debt
• Deferred Income Taxes

11
Shareholders Equity

• Preferred Stock
• Common Stock at Par
• Additional Paid-in Capital
• Retained Earnings

12
Accounting Versus Economic Values

• Asset and liability accounts do not represent
  current values.
• Intangible assets excluded from the balance
  sheet.
• Important liabilities may be under-stated or
  omitted.

13
Income Statement

• Records sales, expenses, taxes, and net income
  over a specific period of time.
• Prepared in accordance with the matching
  principle.
• A companys accounting income and cash flow are
  two different things.

14
Anheuser-Busch Company Income Statement

• Year Ended December 31 1997
  1996
• Net Sales 11,066.2
  10,883.7
• Cost of Goods Sold 7,096.9
  6,964.6
• Gross Profit
  3,969.3 3,919.1
• Marketing, and Admin. Expenses
  1,916.3 1,890.0
• Gain of Sale of St.Louis Cardinals
  - 54.7
  
• Operating Income 2,053.0
  2,083.8
• Interest Expense less Interest Income
  220.5 190.9
  
• Income Before Taxes 1,832.5
  1,892.9
• Provision for Taxes
  703.6 736.8
• Equity Income 50.3
  -
• Income From Continuing Operations
  1,179.2 1,156.1
  
• Effect of Accounting Change
  (10.0) -
• Income (Loss) From Discontd Oper. -
  33.8
• NET INCOME 1,169.2 1,189.9
  

15
Accounting versus Economic Income

• Depreciation expense may not measure the
  consumption of long-lived assets.
• Treating RD as an expense, distorts the nature
  of this investment.
• Inflation distorts the measuring of income and
  the valuation of assets.

16
Statement of Cash Flows

• Attempts to reconcile differences between accrual
  accounting and cash flows.
• Reports how much cash is generated during a
  period.
• Indicates where the cash comes from and what the
  firm did with that cash.

17
Cash Flows from Operating ActivitiesAnheuser-Bus
ch Companies

• CASH FROM OPERATING ACTIVITIES 1997 1996
• Net Income 1,169.2 1,189.9
  
• Adjustments
• Depreciation and Amortization
  683.7 611.5
  
• Decrease (Increase) in Working Capital
  5.4 233.7
• Other Adjustments
  (41.7) (14.2)
  
• Total Cash Flow From Operations
  1,816.6 2,020.9

18
Cash Flows From Investing ActivitiesAnheuser-Bus
ch Companies

• CASH FLOW FROM INVESTING ACTIVITIES 1997
  1996
• Capital Expenditures (1,199.6)
  (1,084.6)
• Proceeds From Sale of St. Louis Cardinals
  - 116.6
  
• Acquisitions (683.3) (135.7)
  
• Cash Used by Investing Activities
  (1,882.6) (1,103.7)

19
Cash Flows From Financing ActivitiesAnheuser-Bus
ch Companies

• CASH FROM FINANCING ACTIVITIES 1997
  1996
• Increase in Long-Term Debt
  1,104.3 198.5
  
• Dividends Paid to Shareholders
  (492.6) (458.9)
  
• Stock Repurchases (587.1)
  (770.2)
• Shares Issued Under Employee Stock Plans
  95.1 113.4
  
• Cash Used in Financing Activities
  119.7 (917.2)

20
Financial Ratio Analysis

• Trend Analysis
• Cross-Sectional Analysis

21
Ratio Categories

• Liquidity Ratios
• Activity Ratios
• Leverage Ratios
• Profitability Ratios

22
Liquidity Ratios

• Current Ratio Current Assets Current
  Liability
• Quick Ratio Current Assets - Inventory Curren
  t Liability

23
Current RatioSpectrum Manufacturing

• 1999
  1998 1997
• Total Current Assets 8,756
  9,138 5,519
• Total Current Liabilities 4,770
  4,307 1,916
• Current Ratio 1.84
  2.12 2.88
• Industry
  Average 2.16

24
Quick or Acid-Test RatioSpectrum Manufacturing

• 
  1999 1998 1997
• Total Current Assets less Inventory 4,824
  5,049 3,494
• Total Current Liabilities
  4,770 4,307 1,916
• Quick Ratio 1.01
  1.17 1.82
• 
  Industry Average 1.52

25
Activity Ratios

• Accounts Receivable Turnover
• Average Collection Period
• Aging of Accounts Receivable
• Inventory Turnover
• Total Asset Turnover

26
Accounts Receivable Turnover

• Accounts Net Credit Sales
• Receivable ¾¾¾¾¾¾¾¾
• Turnover Account Receivable

27
Accounts Receivable TurnoverSpectrum
Manufacturing

• 1999 1998
  1997
• Net Credit Sales 21,015
  27,450 21,900
• Accounts Receivable 4,545
  4,403 3,105
• Receivables Turnover 4.62X
  6.23X 6.95X
• Industry
  Average 6.79X

28
Average Collection Period
Average 365 Collection
¾¾¾¾¾¾¾¾¾¾¾¾¾¾ Period Account
Receivable Turnover
29
Average Collection PeriodSpectrum Manufacturing

• 
  1999 1998 1997
• Accounts Receivable 4,545
  4,403 3,105
• Credit Sales
  21,015 27,450 21,900
• Average Collection Period (Days) 78.9
  58.5 52.5
• Industry
  Average 53.8

30
Aging of Accounts ReceivableSpectrum
Manufacturing

• 1999 1998
  
• Amount Percentage Amount
  Percentage
• Outstanding of
  Total Outstanding of Total
• Receivables
• 0-30 Days Old 2,545 56
  2,994 68
• 31-60 Days Old 1,053 23
  793 18
• 61-90 Days Old 445 12
  352 8
• Over 91 Days 402 9
  264 6
• 4,545
  100 4,403 100

31
Inventory Turnover
Cost of Goods Sold Inventory Turnover
¾¾¾¾¾¾¾¾¾¾ Inventory
32
Inventory TurnoverSpectrum Manufacturing

• 1999 1998 1997
• Cost of Goods Sold 15,120
  20,925 16,575
• Inventory 3,932
  4,089 2,025
• Inventory Turnover 3.8X
  5.1X 8.2X
• 
  Industry Average 6.3X

33
Total Asset Turnover
Total Net Sales Asset
¾¾¾¾¾¾¾ Turnover Total Assets
34
Total Asset TurnoverSpectrum Manufacturing

• 1999 1998 1997
• Net Sales 21,015
  27,450 21,900
• Total Assets 13,396
  12,117 7,794
• Total Asset Turnover 1.6X
  2.3X 2.8X
• 
  Industry Average 2.6X

35
Financial Leverage Ratios

• Debt Ratio
• Debt-Equity Ratio
• Times Interest Earned
• Cash Flow Coverage

36
Debt Ratio Debt-Equity Ratio
Total Liabilities Debt
Ratio ¾¾¾¾¾¾¾¾
Total Assets Total Liabilities
Debt-Equity Ratio ¾¾¾¾¾¾¾¾
Total Equity
37
Debt Ratio Debt-Equity RatioSpectrum
Manufacturing

• 
  1999 1998 1997
• Total Liabilities 8,456
  7,609 3,695
• Total Assets 13,396
  12,117 7,794
• Stockholders Equity 4,940
  4,508 4,099
• Debt Ratio 0.63
  0.63 0.47
• Debt-Equity Ratio 1.71
  1.69 0.90
• Industry Average (Debt
  Ratio) 0.55
• Industry Average (Debt-Equity
  Ratio) 1.22

38
Times Interest Earned
Times Net Operating Income (EBIT)
Interest ¾¾¾¾¾¾¾¾¾¾¾¾¾¾ Earned
Interest Expense
39
Times Interest EarnedSpectrum Manufacturing

• 
  1999 1998 1997
• Net Operating Income (EBIT) 1,265
  1,775 1,915
• Interest Expense 389
  363 142
• Times Interest Earned 3.3X
  4.9X 13.5X
• 
  Industry Average 5.4X

40
Cash Flow Coverage

• EBIT Lease / Rental Payments
  Depreciation
• Cash Flow Coverage ¾¾¾¾¾¾¾¾¾¾¾¾¾¾¾¾¾¾¾¾¾¾
  ¾¾¾¾¾¾¾¾¾
• Interest Lease / Rental Payments
  Principal Repayment / (1-T)
• 
  1,265 470
• Cash Flow Coverage ¾¾¾¾¾¾¾¾¾
  1.14 times
• 
  389 680 0.60

41
Profitability Ratios

• Gross Profit Margin
• Operating Profit Margin
• Net Profit Margin
• Return on Assets(ROA)
• Return on Equity(ROE)

42
Gross, Operating, and Net Profit Margins
Gross Profits Gross
Profits Margin ¾¾¾¾¾¾¾¾
Total Assets
EBIT Operating Profit Margin ¾¾¾
Sales
Net Income Net Profit Margin
¾¾¾¾¾¾ Sales
43
Gross, Operating, and Net Profit
MarginsSpectrum Manufacturing

• 
  1999 1998 1997
• Gross Profits 5,895
  6,225 5,325
• Net Operating Income (EBIT) 1,265
  1,775 1,915
• Net Income
  552 835 944
• Net Sales
  21,025 27,450 21,900
• Gross Profit Margins 28.0
  22.7 24.3
• Operating Profit Margins 6.0
  6.5 8.7
• Net Profit Margins 2.6
  3.0 4.3
• Industry Average (Gross Profit Margin)
  23.1
• Industry Average (Operating Profit
  Margin) 7.3
• Industry Average (Net Profit Margin)
  3.4

44
Return on Assets and Return on Equity
Net Income Return on Assets
¾¾¾¾¾¾¾¾ Total Assets
Net Income Return on Equity
¾¾¾¾¾¾¾¾¾¾ Shareholders Equity
45
Return on Assets and Return on EquitySpectrum
Manufacturing

• 1999 1998 1997
• Net Income 552
  835 944
• Total Assets 13,396
  12,117 7,794
• Shareholders Equity 4,940
  4,508 4,099
• Return on Assets 4.1
  6.9 12.1
• Return on Equity 11.2
  18.5 23.0
• Industry Average (Return on Assets)
  7.3
• Industry Average (Return on Equity)
  16.7

46
Du Pont Analysis
Net Income Sales
Assets Return on equity ¾¾¾¾¾¾
¾¾¾¾ ¾¾¾¾¾¾¾¾¾
Sales Asset Shareholders Equity
47
Du Pont AnalysisSpectrum Manufacturing

• 1997-1999
• Year Net Profit x Total Asset x
  Equity ROE ()
• Margin () Turnover Multiplier
• 1997 4.3
  2.8 1.9
  22.9
• 1998 3.0
  2.3 2.7
  18.6
• 1999 2.6
  1.6 2.7
  11.2

48
Non-Financial Measures of Operating Effectiveness

• Innovation
• Customer Service
• Product Quality
• Reputation
• Good Employee Relations

49
Segmented Financial Statements

• Reports revenues, operating profits, and
  identifiable assets for each line of business
• Allows managers and shareholders to identify
  cross-subsidization

50
Segmented Financial Results for Anheuser-Busch