chapter 9 analyzing historical performance presented by shan li
TRANSCRIPT
Chapter 9 Chapter 9 Analyzing Historical Analyzing Historical
PerformancePerformancePresented by Shan LiPresented by Shan Li
Organization of this chapterOrganization of this chapter
• Reorganizing the accounting statements to gain greater analytical insights and to calculate ROIC and economic profit
• Calculate free cash flow• Breaking down ROIC and Developing an
integrated perspective• Analyzing credit health and liquidity• Dealing with more advanced issues in analyzing
financial performance
Reorganizing The Accounting Reorganizing The Accounting StatementsStatements
• The purpose of reorganization of accounting statements is to calculate Invested Capital, NOPLAT,ROIC and Economic Profit.
• ROIC and Economic Profit reflect more of an economic than accounting view of the company.
For example: distinguish operating from non-operating assets.
Invested CapitalInvested Capital
• Need to reorganize the balance sheet.• It reflect how much of the capital has been
invested in operating activities and other non-operating activities.
• Operating invested capital: the amount invested in the operation of the business.OIC = operating working capital + net property, plant and equipment + net other assets
Invested Capital-9 itemsInvested Capital-9 items
• Operating current assets Comprise all current assets used in or
necessary for the operation of the business. OCA= cash balance + trade accounts
receivables + inventories. Specifically excluded are cash and
marketable securities greater than the operational needs of the business.
Invested Capital-9 itemsInvested Capital-9 items
• Non-interest-bearing current liabilitiesSuch as accounts payable and accrued expenseNet working capital=Operating current assets
– Non-interest-bearing current liabilities
• Net property, plant and equipmentIs the book value of the company’s fixed
assetsNPPE=Gross PPE – Accumulated depreciation
Invested Capital-9 itemsInvested Capital-9 items
• Other operating assets, net of other liabilitiesAny other assets or non-interest-bearing liabilities
related to the operation of business
• Non-operating assetsAny assets not included in operating invested capital
should be added when total investor funds.For example: Goodwill, Excess cash and securities,
Non-operating investments.
Invested Capital-9 itemsInvested Capital-9 items
• Equity Is the sum of all common equity accountsSuch as paid-in capital and retain earnings, preferred
shares, and minority interest in consolidated subsidiaries
• Quasi-equity itemsAccounts recorded as liabilities for accounting
purpose, but should be treated as equity to determine how much capital the shareholder have invested.
For example: deferred income taxes
Invested Capital-9 itemsInvested Capital-9 items
• Adjusted equityIs the sum of all equity accounts plus all quasi-
equity accounts
• Interest-bearing debtIncludes long-term debt, short-term debt,
current maturities of long-term debt, and capital lease
NOPLATNOPLAT
• NOPLAT-Net Operating Profit Less Adjusted Taxes
• Need to reorganize income statement
• Represents the after-tax operating profits of the company after adjusting the taxes to a cash basis
NOPLAT-4 itemsNOPLAT-4 items
• EBITAEBITA-Earning Before Interest, Taxes and
Amortization of goodwill Is the pretax operating income that a company would
earned if it had no debt and no goodwill amortization Includes all types of operating income, including
most revenues and expensesExcludes interest income and expense, gain or loss
from discontinued items, extraordinary income or loss, investment income from non-operating invests
NOPLAT-4 itemsNOPLAT-4 items
• Taxes on EBITARepresent the income
taxes that are attributable to EBITA
Are taxes the company would pay if it had no debt, cash above operating needs, or non-operating income or expenses
Total income tax provision from income statement 216
Tax shield on interest expense 33
Tax on interest income 0
Tax on non-operating income (18)
Taxes on EBITA 231
NOPLAT-4 itemsNOPLAT-4 items
• Change in deferred taxesDeferred taxes are the difference between the
provision for income taxes in the income statement and the actual taxes paid in cash.
Can be made by calculating the change in accumulated deferred income taxes on the company’s balance sheet
For example: accumulated deferred taxes in 1995 was 192, in 1996 was 224. Therefore, change in deferred taxes is 224-192=32.
NOPLAT-4 itemsNOPLAT-4 items
• Reconciliation to net income
To ensure that nothing is missing in the calculation of NOPLAT
To ensure a complete understanding of the company’s financial statements
Net income 282
Add: Increase in deferred taxes (1)
Add: Goodwill amortization 15
Adjusted net income 296
Add: Interest expense after-tax, net 27
Total income available to investors 323
After-tax non-operating income 0
NOPLAT 323
ROICROIC
• ROIC-Return On Invested Capital• ROIC= Net operating profit less adjusted taxes Invested capital• Invested capital is generally measured at the
beginning of the period or as an average of the beginning and end of the period.
• ROIC is a better analytical tool because it focuses on the true operating performance of the company.
Economic ProfitEconomic Profit
• It measures the dollars of economic value created by a company in a single year.
• Economic profit=Invested capital x (ROIC-WACC) or
• Economic profit=NOPLAT-Capital charge or• Economic profit=NOPLAT-(Invested capital x
WACC)• Economic profit combines spread and size of
company into dollar performance
Free Cash FlowFree Cash Flow
• Free cash flow is a company’s true operating cash flow.
• It is the total after-tax cash flow generated by the company that is available to all providers of the company’s capital, both creditors and shareholders.
• Free cash flow is before financing and therefore not affect by the company’s financial structure.
Free Cash FlowFree Cash Flow
• FCF=NOPALT-Net investment
=[NOPLAT + Depreciation]-[Net investment + Depreciation]
=Gross cash flow-Gross investment
Where net investment is the change in invested capital.
Free Cash Flow-14 itemsFree Cash Flow-14 items
• Depreciation Includes all the noncash charges deducted from
EBITA except goodwill amortization
• Gross cash flowRepresents the total cash flow thrown off by the
company’s operation It is the amount available to reinvest without relying
on additional capitalGCF=NOPLAT + Depreciation
Free Cash Flow-14 itemsFree Cash Flow-14 items
• Change in operating working capitalIs the amount the company invested in
operating working capital during the period.
• Capital expenditureInclude expenditures on new and replacement
property, and equipmentCapital expenditure=increase in net property,
plant and equipment + depreciation expenses
Free Cash Flow-14 itemsFree Cash Flow-14 items
• Increase in other assets, net of liabilitiesEquals the expenditure on all other operating assets
including deferred expense, and net of increases in non-current, non-interest-bearing liabilities
• Gross investment Is the sum of a company’s spending for new capital Includes working capital, capital expenditures, and
other assetsGI=change in working capital + capital expenditure +
change in other assets + foreign currency translation effect
Free Cash Flow-14 itemsFree Cash Flow-14 items
• Investment in goodwillEquals the expenditures to acquire other
companies in excess of the book value of their net assets
IIG=net changes in goodwill + amortization of goodwill
Free Cash Flow-14 itemsFree Cash Flow-14 items
• Non-operating cash flowRepresents the after-tax cash flow from items
not related to operationsIncludes cash flow from discontinued
operations, extraordinary gain or loss, and the cash flow from investments in unrelated subsidiaries
TV=PV of FCF + PV of After Tax Non-Operating CF and Marketable Securities
Free Cash Flow-14 itemsFree Cash Flow-14 items
• Change in excess marketable securities Excess marketable securities are the short-term
investments that the company holds above its target balance to support operation.
The change in excess marketable securities can be treated as non-operating cash flow or as financing cash flows.
Free Cash Flow-14 itemsFree Cash Flow-14 items
• Foreign Currency translation effectIs driven by the changes in translation rates
applies to both assets and debtTreat this gain or loss as non-operating cash
flow
• Total funds available to investor=FCF + all non-operating items
Free Cash Flow-14 itemsFree Cash Flow-14 items
• Change in DebtRepresents the net borrowing or repayment on
all the company’s interest-bearing debtIncludes short-term debt and capital lease
• After-tax interest expense=pretax interest expense x (1-marginal tax
rate)
Free Cash Flow-14 itemsFree Cash Flow-14 items
• DividendsIncludes all cash dividends on common and
preferred shares
• Share issues/repurchasesIncludes both preferred and common shares
and the effects of conversions of debt to equity
Breakdown ROICBreakdown ROIC
• ROIC = NOPLAT Invested Capital
• NOPLAT=EBITA x (1-Cash tax rate)
• ROIC= EBITA x (1-cash tax rate) Invested Capital
Breakdown ROICBreakdown ROIC
EBITA EBITA RevenuesInvested Capital = Revenues x Invested Capital
• Operating Margin (EBITA/Revenues) measures how effectively the company converts revenues into profits.
• Capital turnover ( Revenue/Invested capital) measures how effectively the company employs its invested capital.
Credit Health and LiquidityCredit Health and Liquidity
• Interest CoverageIs the amount of earnings available to pay
interest expenseIt provides a sense of how far operating profits
could fall before the company would have difficulty servicing its debt.
Measures the company’s financial cushionInterest Coverage= EBIT/Interest expense
Credit Health and LiquidityCredit Health and Liquidity
• Debt/Total Investor FundsMeasures the company’s reliance on debt
capitalExpressed both at book value (creditors often
use) and at market values
Credit Health and LiquidityCredit Health and Liquidity
• Investment RateIs the ratio of investment to available fundsNet basis : Net investment / NOPLAT Gross basis: Gross investment / Gross cash
flowInvestment rate > 1 : company is consuming
more funds than it is generating
Credit Health and LiquidityCredit Health and Liquidity
• Dividend Payout Ratio Is total common dividends divided by income
available to common shareholders= Common Dividends / Net Income available
to commonIf a company has investment rate >1 and a
high dividend payout ratio, it must be borrowing money to fund a negative free cash flow to pay interests and dividends.