essential learning for ctp candidates new york …c.ymcdn.com/sites/ rate of return and...

Essential Learning for CTP CandidatesNew York Cash Exchange: 2016 – Session #04

Copyright © 2016 – The Treasury Academy, Inc.All Rights Reserved – www.treasuryacademy.org 1

New York Cash Exchange: 2016Essential Learning for CTP CandidatesSession #4: Wed. Afternoon (6/01)

ETM4-Chapter 18:Financial Accounting and Reporting

ETM4-Chapter 19:Financial Planning and Analysis

ETM4-Chapter 20:Financial Decisions and Management

© 2016 - The Treasury Academy, Inc. - All Rights Reserved 1

Essentials of Treasury Management, 4th Ed. (ETM4) is published by the AFP which holds the copyright and all rights to the related materials.

As a prep course for the CTP exam, significant portions of these lectures are based on materials from the Essentials text.

Overview of Chapter 18 Topics

IntroductionAccounting Concepts and

StandardsFinancial Reporting

StatementsAccounting for

Derivatives, Hedges, and Foreign Exchange(FX) Translation

Accounting for G/NFP

2© 2016 - The Treasury Academy, Inc. - All Rights Reserved

Introduction to Financial Accounting and Reporting Financial

statements

summarize a

company’s

operating

results and

financial

position




Analyzing Financial Statements Provides Insights Into:

Management of liquidity positionEffective use and

financing of assetsBalance between debt

and equity financingControl of operating

and financing costsProfitability


Accounting Concepts and Standards

Global Accounting Standards IASB & IFRS

U.S. Accounting Standards GAAP & SEC Filings

Comparison IFRS is high level/less detailed

than GAAP GAAP converging towards

IFRS standards5© 2016 - The Treasury Academy, Inc. - All Rights Reserved

Group Exercise

Working in your groups,answer the following questions:Why do we need auditors?Is there a difference between internal

and external auditors?What was the impact of SOX on the

auditing profession?




Auditing & Financial Statement Reliability

Confidence in the integrity of financial reports is critical in an open, market-driven economyCertification of

accounting and auditing professionals is a key part of the process


The Audit Process

An independent audit helps to assure outside parties that the information provided in the financial statements is relevant, complete, accurate and presented fairly


Audit Opinions

Standard Unqualified Opinion

Unqualified with Explanatory

Paragraph or Modified Unqualified

Qualified

Adverse

Disclaimed




Impact of SOX on Audit Process

Role of the PCAOBcontrolsCEO and CFO

certification of financial statementsFines and criminal

penaltiesRequires independent

audit committees


Types of Financial Statements

Balance Sheet Assets Liabilities Shareholders’ Equity

Income StatementRevenues Expenses

Statement of Retained EarningsStatement of Cash Flows Sources and Uses of Funds


Sample Balance Sheet

“Snapshot”Assets:

Current assetsFixed assetsDepreciable fixed

assetsIntangible assets

Liabilities:Current liabilitiesLong-term liabilities

EquityAssets = Liabilities +

Shareholders’ Equity

© 2016 - The Treasury Academy, Inc. - All Rights Reserved 12Source: ETM3 - © AFP



Sample Income Statement

A record of revenues and expenses

Shows the net change in shareholders’ equity from operations over a specified period


Source: ETM3 - © AFP

Sample Statement of Cash FlowsShows sources and

uses of cash

Sections:

Operating

Investing

Financing

Cash from operations calculated by adding back non-cash charges (e.g., depreciation)

Cash, not earnings, repays debt

This example shows the indirect format


Accounting for Derivatives, Hedges and FX Translation

Derivative/Hedge AccountingWhat is instrument’s intended use?

FX Translation Accounting Functional Currency: currency of

the primary economic environment in which the entity operates

Translation of foreign statementsto reporting currency

GAAP VS IFRS




Overview of Chapter 19 Topics

IntroductionCost BehaviorDecision EvaluationDeveloping Operating

and Financial BudgetsFinancial Statement

AnalysisPerformance

MeasurementFinancial Analysis and

Rating Agencies


Who Uses Financial Analysis?

Suppliers

Trading Partners

Lenders

Rating Agencies

Investors


Cost Types and Behaviors





Basic Financial ConceptsTime Value of Money Future Value Present Value

Opportunity Cost What is the right rate to use?

Cost of Capital Concept of WACC

Cost Behavior Total, Fixed, Variable, Semi-variable Operating & Financial Leverage, Econ. of Scale

Capital Budgeting NPV, PI, IRR

n

2FV = PV × (1 + i)

= $100 × (1 + .10)= $100 × 1.21 = $121


Time Value of MoneyThe value of cash flow is determined by:

• Amount of the cash flows.• Appropriate interest rate.• At what future period the

cash flow is expected to occur.


Future Value

121$21.1100$

)10.1()10.1(100$

)10.1(100$

i)(1 PV ValueFuture2

n

What is the future value of $100 if it can be invested for two years, compounded annually, at a rate of 10% per year?

Where: FV = Future value PV = Present valuei = Periodic interest raten = Number of periods





Present Value

What is the present value of $2,382 to be received after three years, discounted at a rate of 6.00% annually?

Where:FV = Future valuei = Periodic interest raten = Number of periods

000,2$191.1

382,2$

)06.1)(06.1)(06.1(

382,2$

)06.01(

382,2$

i)(1

FV ValuePresent

3n



PV of a Stream of Payments


31 2 n1 2 3 n

CC C CPV ... ...

(1 i) (1 i) (1 i) (1 i)

1 2 3

$200 $400 $600PV

(1 .12) (1 .12) (1 .12)

$200 $400 $600

1.12 1.2544 1.4049

$178.57 $318.88 $427.08 $924.53

As an example, assume the following annual cash flows: $200 in year one, $400 in year two and $600 in year three. If the appropriate discount rate is 12%, then the PV of the stream would be:


Breakeven Analysis

Fixed CostsUnit B/E Point = Selling Price Per Unit Variable Cost Per Unit

$10,000= $10 $6

= 2,500 Units

Breakeven point: Level of activity for an operation at which costs exactly equal benefits





Capital BudgetingDeveloping strategic plans for a company’s

proposed large-dollar investments

For example, replacement of existing equipment, expansion of facilities, purchase of new equipment or introduction of a new product line

Form of Cost-Benefit analysis using models Payback period

Net present value

Profitability index

Internal rate of return


Group ExerciseWorking in your groups,

answer the following questions:What is the difference between

Payback Period, Net Present Value, Internal Rate of Return and Profitability Index?What are the key inputs needed to

use these evaluation approaches?


Net Present Value (NPV)Evaluates the present value

(PV) of all inflows and outflows of a project using the weighted average cost of capital as a discount rate

If the only cash outflow takes place in the present :

NPV = PV of Cash Inflows PV of Cash Outflows

31 2 n1 2 3 n

NPV = PV of Cash Inflows Cash Cost

CC C CNPV = + + + ... + Cost

(1+ i) (1+ i) (1+ i) (1+ i)




Net Present Value (NPV)

A 1 2 3 4 5

B 1 2 3 4 5

$300 $300 $400 $100 $100NPV = + + + + $1,000(1 + .10) (1 + .10) (1 + .10) (1 + .10) (1 + .10)

= $ 48.42

$1,000 $1,000$300 $300 $400NPV = + + + + (1 + .10) (1 + .10) (1 + .10) (1 + .10) (1 + .10)

$1,000

= $1,124.98

Year 1 Year 2 Year 3 Year 4 Year 5

Project A $300 $300 $400 $100 $100

Project B $300 $300 $400 $1,000 $1,000

Assume an initial outlay of $1,000 and a cost of capital of 10%



Profitability Index (PI)

Present Value of Cash InflowsProfitability Index = Present Value of Cash Outflows

Ratio of the PV gained to the cost required to obtain that value; shows value gained per dollar of investment

If the only cash outflow is in the present (period 0):

A

B

$951.57PI = = 0.952$1,000

$2,124.98PI = = 2.125$1,000


Internal Rate of Return (IRR)Discount rate (i) for NPV = 0

or

PV of Cash Inflows = PV of Cash Outflows

=

A 1 2 3 4 5

B 1 2

NPV = PV of Cash Inflow Cost = 0

$300 $300 $400 $100 $100NPV = + + + + $1,000 0(1 + i) (1 + i) (1 + i) (1 + i) (1 + i)

i = 7.7%

$300 $300 $400NPV = + + (1 + i) (1 + i) (1 + i

=

3 4 5

$1,000 $1,000+ + $1,000 0) (1 + i) (1 + i)

i = 38.1%




Capital Expenditure Analysis Summary

MethodProject

Acceptance Criterion

Project A Project B

Net Present Value (NPV)

NPV > 0 $–48.43 $1,124.98

Profitability Index (PI)

PI > 1 0.952 2.2125

Internal Rate of Return (IRR)

IRR > WACC* 7.7% 38.1%

* Weighted Average Cost of Capital (WACC) = 10% in the example © 2016 - The Treasury Academy, Inc. - All Rights Reserved 31


Risk AnalysisScenario analysis “What if” analyses establishing best and worst

cases (calculates NPV for each)

Sensitivity analysis Identifies and evaluates areas of greatest

vulnerabilities by varying one factor while holding others constant in an NPV calculation

Simulation Monte Carlo simulation

Risk Adjusted Discount Rate (RADR) Requires high-risk endeavors to earn a higher

rate of return in order to justify the investment


Financial Statement Analysis

Common-Size Statements and RatiosLiquidity or Working Capital RatiosEfficiency or Asset Management RatiosDebt Management RatiosPerformance RatiosIntegrated Ratio AnalysisService Industry RatiosStrengths and Limitations of Ratio

Analysis




Sample Common-Size Balance Sheet


Financial Statement AnalysisSuppliers determine whether

to make sales on credit.

Trading partners assess thefinancial ability of a counterpartyto meet contractual obligations.

Lenders determine whether to extend or maintain credit.

Rating agencies assess credit risk of issues.

Investors make decisions about purchasing and selling corporate debt and equity.


Key Financial Ratios

Liquidity or Working Capital Measures firm’s ability to meet its

payment obligations and cash management efficiency

Efficiency or Asset Management Measures how efficiently assets

are utilized

Debt Management Measures level of debt and

ability to service it

Performance Measures profitability in relation

to revenue and investment




Efficiency and Asset Management: Total Asset Turnover

RevenuesTotal Asset Turnover =

Total Assets

$15,000= = 0.968 Times

$15,500

Measures how many times the asset base is turned over with the flow of revenue


Efficiency and Asset Management: Fixed Asset Turnover

RevenueFixed Asset Turnover =

Net Property, Plant & Equip

$15,000= = 2.0 Times

$7,500

Focuses on how efficiently fixed assets, or plant and equipment, are used


Debt Management: Total Liabilities to Total Assets

Total LiabilitiesTotal Liabilities to Total Assets =

Total Assets

$7,300= = .471 or 47.1%

$15,500

Measures the percentage of all liabilities relative to total investments or total assets




Debt Management: Long-Term Debt to Capital

-

-

Long Term DebtL / T Debt to Capital =

Long Term Debt + Equity

$3,900= = .322 or 32.2%

$3,900 + $8,200

Measures the percentage of a company’s capitalization that is provided by long-term debt


Debt Management/Coverage: Times Interest Earned (TIE) Ratio

Operating ProfitTIE =

Interest Expense

EBIT =

Interest Expense

$1,600= = 5.33 Times

$300

Measures a firm’s ability to service debt through interest payments



Performance: Gross Profit Margin

Gross Profit $5,800Gross Profit Margin = =

Revenues $15,000

= .387 or 38.7%

Measures the percentage of revenues remaining after the cost of goods sold is deducted from revenue – it is also a typical common-size ratio measure




Performance: Operating & EBITDA Profit Margins

EBITOperating Profit Margin =

Revenues

$1,600= = 0.107 or 10.7%

$15,000

Measures the flow of commonly used operating income measures in relation to the flow of revenue

EBITDAEBITDA Margin =

Revenues

$1,800= = 0.120 or 12.0%

$15,000© 2016 - The Treasury Academy, Inc. - All Rights Reserved 43


Performance: Net Profit Margin

Net IncomeNet Profit Margin =

Revenues

$850=

$15,000

= .057 or 5.7%

Measures the flow of net income in relation to the flow of revenue


Performance: Return on Total Assets

Net IncomeReturn on Total Assets =

Total Assets

$850=

$15,500

= .055 or 5.5%

Measures net income in relation to the stock of assets





Performance: Return on Common Equity

Earnings Avail. to Common S / HsReturn on Common Equity =

Common Equity

Net Income Preferred Dividends=

Total Equity Preferred Stock

$850 0= = 0.104 or 10.4%

$8,200 0

Measures earnings available to common shareholders (net income less any preferred stock dividends) expressed as a percentage of common equity



Strength and Limitations of Ratio Analysis

Advantages:

Easily computed

Widely used

Information easily

obtained

Facilitate comparison

between companies

Disadvantages:

Express static (historical), not

dynamic, relationships

Summarize accounting information

and may not reflect economic value

Cannot reflect qualitative value

(business strategies, managerial

talent)

Use of different accounting methods

may reduce the validity of

comparisons between companies


Performance Measurement

Return on Investment (ROI)

Residual Income (RI)

Free Cash Flow (FCF)

Economic Value Added (EVA)




Performance Measurement Return on investment (ROI) ROI over a partial period may be misleading. ROI does not include charge for cost of capital. Positive NPV project can be rejected if it lowers overall ROI

Residual Income (RI) Assigns charge for invested capital. RI is a dollar amount, and any profitable project after

deducting cost of capital will increase RI.

Net Income Net IncomeROI = = Invested Capital Long-Term Debt + Equity

$850 $850= = = 0.0702 or 7.02%$3,900 + $8,200 $12,100

RI = Net Income Invested Capital Cost of Capital

= $850 $12,100 .10 = $850 $1,210 = $360


Performance Measurement: Free Cash Flow

Free Cash Flow (FCF) A type of RI analysis, but also includes adjustments

for noncash items, operating working capital investments and capital expenditures (CapEx) There are many different formulas used for FCF Considered a better representation of the value of

the firm to shareholders

FCF = Net Income + (D&A) Change in Op W/C CapEx

= $850 + $200 $500 $900 = $350


Economic Value Added (EVA)A measure of the incremental value that a

company’s investments add.What is the EVA for the following company? Long-term debt of $3,900

Equity of $8,200

Marginal tax rate of 34.615%

Weighted average cost of capital (WACC) of 10%

Operating income (EBIT) of $1,600

EVA = EBIT (1 Tax Rate) (WACC)(Long-term Debt + Equity)

= $1,600 (1 .34615) (.10)($3,900 + $8,200)

= $1,046 (.10)($12,100)

= $1,046 $1,210 = $164




Financial Analysis and Rating Agencies

Role of rating agencies in debt issuesRating fees are typically paid for by

the entity being ratedCredit ratings are also done internally

by banks and other lenders, as well as by trade creditors to a business


Overview of Chapter 20 Topics Introduction

Capital Structure of ACompany

Raising and Managing Long-Term Capital

Cost of Capital and Firm Value

Lease Financing and Management

Equity Financing and Management

Other Topics in Financial Decisions


Capital Structure of A Company

Optimal and Target Capital StructuresTrade-Offs Between Financing with

Long-Term Debt and Common StockCapital Structure TheoryBusiness and Financial RiskTarget Capital StructureOther Consideration in Capital

Structure DecisionCapital Structure in Not-For-Profit

Organizations




Cost of Capital


More on Raising CapitalAdvantages and disadvantages of

using both debt & equity (stock) financingAdvantages and disadvantages of

private placements vs. public issuesAdvantages and disadvantages of

listing stocksIssues related to lease financingDividend policy & stock

repurchases


Operating Risk and LeverageOperating risk is a function of the mix of

variable and fixed costs in a company’s operations

It is assessed by looking at the changes in a company’s EBIT for given change in sales


% Change in EBITDegree of Operating Leverage =

% Change in Sales

33%Degree of Operating Leverage = = 1.65 Times

20%

Using the information from the text Exhibit 14.1




Financial Risk and LeverageFinancial risk is a function of the

mix of capital sources used to finance the company

It is assessed by looking at the changes in a company’s net income for given change in EBIT


% Change in Net IncomeDegree of Fin. Leverage =

% Change in EBIT

Cost of Capital and Firm ValueCost of capital is the basic target number that

asset returns must exceed if the company is to create shareholder value

Capital Components and Costs Primary sources of “permanent” capital are long-term

debt (bonds) and equity (common stock and retained earnings)

The relevant costs ofthese sources are theirmarginal cost

Be sure to use onlyafter-tax values for the costs

Typically calculated as WACC Weighted Average Cost of Capital


Cost of DebtRelevant cost is after-tax YTM

After-tax kd = Before-tax kd(1 – T)

Calculation Example – AssumeYTM of 5% and marginal tax rate of 30%: After-tax kd = 5%(1 – .3) = 3.5%

In companies with complicated tax liabilities, the marginal tax rate may be difficult to estimate from standard financial statements

Though flotation costs of debt are usually low, they should be considered if they are significant




Cost of Common Equity

Two sources of common equity Retained earnings during the period

Issue new common stock

CAPM may be used to estimate the market’s required rate of return on equity

Flotation costs are usually not considered for retained earnings, but may be significant for new common stock issues


Common Equity Calculation Example

Assume a risk-free rate of 4.0%, a return on the stock market of 10.0% and a Beta of 1.2In this case the cost of equity is:


E RF M RFr r (r r )

= .04 + (.10 .04)(1.2) = .112 or 11.2%

Weighted Average Cost of Capital (WACC)

Assume 1/3 of total financing is from debt and 2/3 is from equity, and the costs of debt and equity are those found on previous slides:


D D E EWACC = W r (1 T) W r

D D E EWACC = W r (1 T) W r

[.333 0.05 (1 0.3)] (.667 0.112)

8.64%



Repatriation of Capital for MNCs

Multinational Company Dividends

Management Fees

Transfer Pricing

Intra-company Loans

Deemed Dividends

Restrictions on Dividends


Session Wrap-upSession 4: Financial Statements, Analysis & Decision

What did we learn in this session?

What topics do we need to learn more about?


New York Cash Exchange: 2016Essential Learning for CTP Candidates

End of This Session

We will reconvene tomorrow morning.

The topic will be:

More Key ConceptsReview of CTP Calculations


essential learning for ctp candidates new york …c.ymcdn.com/sites/ rate of return and...

Documents