Part 3

Analysis of Financial Statements. The cash flow

CORPORATE FINANCE (PSBV026NABB)

Nóra Felföldi-Szűcs, PhD

Department of Finance, Corvinus
University of Budapest
2021 FALL

Corporate Finance, CUB - Nóra, Felföldi-Szűcs, PhD

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 11/15/21

This Course – the structure

Foundations of Corporate Finance
1. Time 2. Risk 3. Analysis

Utility ! Financial Statements

The nature of risk ! Ratios
Correlation & diversification
Portfolio return and standard
deviations
Portfolio Theory
Systematic and issuer-
specific risk
Capital Asset Pricing Model
& Beta
! Capital Structures

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 Cashflow Valuation
An asset can be valued as the sum of discounted future cash flows it generates
Valuation (NPV) Decision-making
• Projects • Optimal financial structure of the firm
• Enterprises (company / • Application for external financing
Business) • Liquidity management

Steps of valuation: 1) Determine cash flows, 2) Add them up

2020. 09. 07. Corporate Finance, CUB - Nora, Felfoldi-Szucs, PhD

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 Uses of Cashflow Valuation in Enterprises
Valuation (NPV)
• Projects
• Enterprises (company / Business)

Decision-making
• Optimal financial structure of the firm
• Application for external financing
• Liquidity management

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Financial Statements of Firms

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 Income statement
for an operating company
The income statement measures performance over a period of time.

" it comprises FLOWS of Revenues and Costs Sales Revenue

- Operating Costs

Profit Before Interest

(PBIT)
- Interest Cost
Profit Before Tax (PBT)
- Income Tax

Profit After Tax (PAT)

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 Income statement
It is the result of applying a set of accounting rules based on the ACCRUALS convention, which
effectively smooth cashflows e.g.

• Accounting Standards
• Local Accounting Regulations or Principles e.g. Corporate Accounting Law, US GAAP (Generally Accepted Accounting
Principles), Public Sector Accounting Principles; or
• International Financial Reporting Standards (IFRS) or International Public Sector Accounting Standards (IPSAS)

• Local Tax Regulations

Its Profit Before Tax is used to calculate income tax (directly or indirectly)

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 Income Statement
for an operating company
ACCRUALS convention
Sales Revenue Sales Income
- Operating Costs - Operating Expense
[Earnings before Interest [EBITDA]
Depreciation & Amortization]

- Operating Costs - Depreciation Expense

Profit Before Interest Operating Profit
(PBIT)
- Interest Cost - Interest Expense
Profit Before Tax (PBT) Pre Tax Profit
- Income Tax - Tax Expense

Profit After Tax (PAT) Net Profit or Earnings

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Income statement – a simple illustration
Income statement for year 2019 (items in
million of dollars)
+ Revenues
- Cost of goods sold
- Administrative expenses
- Depreciation expenses
- Other expenses
EBIT (Earnings before interest and taxes)
- Interest expenses
EBT (Earnings before taxes)
- Income taxes
Net income

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 Income Statement of MOL
Group.

https://molgroup.info/storage/documents/publications/annual_r
eports/2019/mol_group_annual_report_2019_eng.pdf
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Income statement and Balance sheet
– how they are linked

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 Operating Cashflows
for an operating company
But we are interested in flows using the CASH convention like Receipts and Payments!

CASH convention
Sales Revenue Sales Receipts
- Operating Costs - Operating Payments

Profit Before Interest Operating Cashflow

(PBIT)
- Interest Cost - Interest Payments
Profit Before Tax (PBT) Pre Tax Cashflow
- Income Tax - Tax Payments

Profit After Tax (PAT) After-Tax Cashflow

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 Profit versus Operating Cashflow
The income statement is based on accounting principles such as revenue recognition, and accruals.
• Revenue recognition: to record revenue when it is earned instead of when it is collected.
• Matching: to match expenses with the related revenues.
• Accruals: to record liabilities when they were incurred instead of when they are paid

Accounting principles vs. cash basis – this makes the difference between income statement and cash
flow statement.

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 Profit versus Operating Cashflow
• Revenues and expenses versus cash in- and out-flows:
• The income statement uses the accrual method of accounting, which means that revenues and expenses are "recognized"
as they are incurred rather than when the cash is received or paid out.
• See for example: Due date for suppliers (accounts payable) and customers (accounts receivable)

• Investment versus Depreciation and Amortization:

• The income statement spreads the expense of capital expenditures over time in form of annual depreciation instead of
recognizing it as an expense when the capital goods purchased are paid for.

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 Revenue, Costs and Profit (simplified)
Accounting and cashflow data are connected via the Balance Sheet
Accruals convention Δ Balance Sheet Cash convention

Sales Revenue Sales Income Δ Receivables Sales Receipts *

- Operating Costs - Operating Expense Δ Payables - Operating Payments

Δ Inventory *
[Earnings before Interest Depreciation [EBITDA]
& Amortization]

- Operating Costs - Depreciation - Depreciation Expense

Expense
Profit Before Interest Operating Profit [DA & Δ Short Term Operating Operating Cashflow
Working Capital]
(PBIT)
- Interest Cost - Interest Expense Δ Accrued Interest - Interest Payments

Profit Before Tax (PBT) Pre Tax Profit Pre Tax Cashflow

- Income Tax - Tax Expense Δ Accrued / Deferred - Tax Payments

Tax
Profit After Tax (PAT) Net Profit or Earnings DA & Δ Short Term After-Tax Cashflow
Working
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* Operating Receipts and Payments include recoverable taxes (VAT) and reimbursable disbursements, which obviously net off
 Operating Cashflow computation
So we can (re-)convert accounting data (back) to cashflow data

Income Statement Δ Balance Sheet Operating Cashflows

Sales Income 1. Δ Receivables
Direct Sales Receipts
Operating Expense Δ Payables
Method - Cash Operating
Expenditure
Operating Profit [DA & Δ Short Term Operating Operating Cashflow
Working Capital]

Interest Expense Δ Accrued Interest + Interest Payments

2. Indirect Method
Tax Expense Δ Accrued / Deferred + Tax Payments
Tax
Net Profit or Earnings + DA - Δ Short Term After-Tax Cashflow
Working Capital

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 Balance sheet
Financial statement showing a firm’s accounting value on a particular date

The two side – the same value but structured differently:

A=E+D

• Assets (A) – what a firm owns, how a firm uses its wealth

• Liabilities (D) and Equity (E) – where the wealth comes from – how the firm finances its activity

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 Balance sheet is a snapshot
– at a particular date
Would you risk arriving one hour early to a party?

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The two side – the same value
to light/from
to light/from grandma
grandma

to heat/bought with the

to
flatheat/bought with the
flat
to keep books on it/from
my first salary

to make the couch more

comfortable/DIY

to sit on it/financed by
credit

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 Balance sheet
Financial statement showing a firm’s SOLVENCY on a particular date. stock

Liabilities and
Assets
shareholders equity

Current liabilities

Long-term debt

Shareholders
Equity

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 Balance sheet
Financial statement showing the structure of a firm’s ECONOMIC RESOURCES on a particular date.
Liabilities and
Assets
shareholders equity
Net (or Short Current Assets Current liabilities
Term)
Inventory
Working
Accounts Receivable Accounts payable
Capital (NWC)
Cash & marketable securities Short-term debt

Fixed Assets
Tangible assets: plant,
equipment…
Invested
Capital
Intangible assets
Long term investments
Long-term debt
Funding Bonds, Bank loans…
= Capital Shareholders Equity
Employed
Common stock
Addition to retained earnings
Retained earnings
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 Net (or Short Term) Working Capital (NWC)
Current assets
• Inventory,
• Accounts receivable,
• Cash,
• Marketable securities
Current liabilities
• Accounts payable,
• other Non-Financial short term liabilities serving the operations (i.e. not resulting in interest payment
obligation)
Short Term working capital = Current Assets – Current Liabilities
A measure of liquidity, NWC > 0

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 Net (or Short Term) Working Capital (NWC)
Short Term Working Capital = Current Assets – Current Liabilities
Practically:
• STWC=Inventory+Accounts receivable+Cash – Accounts payable

If STWC is used for CF calculation:

• Short Term working capital = Current Assets(excluded cash) – Current
Liabilities
• STWC=Inventory+Accounts receivable – Accounts payable

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 Invested Capital: Fixed Assets
Tangible assets: Property, plants and equipment,
Intangible assets: patent, brand, trademark, goodwill, software etc.
Long-term investments

Useful lifetime more than 1 year: purchased once but used in business operation for a longer period
and provide long-term financial gains
They can be depreciated
They are generally illiquid

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 Fixed Assets – Depreciation and Investment
• Investment: purchase of a fixed asset in t=0 at a price of C0

• Cash-out-flow at t=0 but not an expense immediately

• Book value of the fixed asset will be C0

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 Fixed Assets – Depreciation and Investment
• Depreciation: this method of accounting allocates the cost of the fixed assets over their useful
lifetime.

• Depreciation spreads out the cost of investment (paid at the time when the purchase of the asset
took place) over the useful lifetime of asset in form of the expense „Depreciation and Amortization”

• D&A shows how much of an asset's value has been used up.

• D&A matches the earned revenue from an asset with the portion of its original investment cost each
year of the asset’s lifetime.

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 Fixed Assets – Depreciation and Investment
Types of depreciation:
•Straight-Line, accelerated depreciation, reducing balance
• How it works:

• Book value: BV0=C0

• One period later the book value will decrease by the annual D&A: BV1=C0-D&A1
CAPEX (Capital expenditure) ~ what the firm invested in fixed assets in the given
period
• CAPEX1= - (BV1- BV0 + D&A1)

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Balance Sheet of MOL
Group.

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Balance Sheet of MOL Group.

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Balance Sheet of MOL Group.

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Balance Sheet of MOL Group.

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 Balance sheet
• Financial statement showing a firm’s SOLVENCY and the value of its ECONOMIC RESOURCES on a
particular date.

• Book value vs. Market Value: for transactions and other evaluation situations

• The market value of assets equals the market value of equity and liabilities:
• Cash flows generated by assets are paid to equity owners and creditors.
• Risk of assets equals the risk of equity and liabilities.

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 Thank you
for your attention!

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