Financial Analysis of Operations

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Financial Analysis of Operations
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Operating/Nonoperating vs. Core/Transitory
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Level I-Based DecompositionExample ROE, RNOA
Leverage
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Financial Leverage and Risk

• Given that increases in financial leverage
  increase ROE, why are all companies not 100 debt
  financed?
• The answer is because debt is risky. This
  increased risk increases the expected return that
  investors require to provide capital to the firm.
  
• Higher financial leverage also results in a
  higher interest rate on the companys debt.

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Leverage and Income Variability
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Level II Analysis of Operating Margin and
Operating Turnover
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Margin vs. Turnover
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Level 3 Analysis Disaggregation of Operating
Margin and Operating Turnover
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• The problem
• How do we distinguish between operating and
  non-operating accruals on the balance sheet and
  income statement?

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Analysis of Balance Sheet and Income Statement
the Steps

• Reformulate to distinguish between operating and
  financing activities
• Carry out common size and trend analysis
• Calculate balance sheet and income statement
  ratios

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The Standard Balance Sheet
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The Reformulated Balance Sheet
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Issues in Reformulating Balance Sheets

• Cash working cash and excess cash
• Short term notes receivable trade receivables?
• Finance receivables an operating asset
• Debt investments financial assets
• Short-term equity investments excess cash?
• Short-term notes payable trade notes?
• Leases
• Deferred tax assets and liabilities operating
• Deferred revenues and accrued expenses
• Minority interest not a financial obligation
• For financial firms, many financial items are
  operating assets and liabilities

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The Standard Income Statement
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The Reformulated Income Statement
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The Allocation of Taxes

• In the income statement only one tax number is
  reported It must be allocated to the operating
  and financial components to put both on an
  after-tax basis
• First, calculate the tax benefit (tax shield)
  provided by deducting interest expense
• where t is the marginal (not effective) tax rate
• From the operating income deduct both the total
  tax and the tax shield, to capture what the
  operating income would have been if there had
  been no financing activities
• To the net financial expense add the tax shield,
  because its net effect is attributable to the
  financing activities