21 November 2021

Financial Analysis

Corporate Finance, Lecture 9

Chapter 28.
Kata Váradi, PhD Nóra
Felföldi-Szűcs, PhD Department
of Finance, CUB
2020
Corporate Finance, CUB - Nóra, Felföldi-Szűcs, PhD
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 Operating Cashflow computation
So we can (re-)convert accounting data (back) to cashflow data

Income Statement Δ Balance Sheet Operating Cashflows

Sales Income Δ Receivables Sales Receipts
1. Direct
Operating Expense Δ Payables
Method - Cash Operating Expenditure

Operating Profit [DA & Δ Short Term Operating (Pre-tax) 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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 Forecasting Cashflows
Direct forecasting Indirect forecasting
(line-by-line forecasting) (derived from Financial Statements)

• Requires detailed forecasting • Levers work done projecting Financial Statements

(No need for detailed forecasting of cash streams)
• Can be monitored minute-by-minute using
bank statements! • Used for
• Project and firm valuation
• Used for
• Liquidity planning for shortrun (less than one year) • Line items are less intuitive:
• Controlling Projects • INCREASES in Assets DECREASE the cash flow
• Increases in liabilities (and equity) Increase the cash flow
• BUT cannot be used for tax calculation
(financial statements needed)!

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

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 Calculations in this Corporate Finance course
Assumptions
• Financing of firms/projects is not considered: we assume that firms/projects are financed by equity
• Liabilities are only for operational, non-interest paying items
• There are not any credits, loans in the financial structure
• Interest payments to creditors and dividend to shareholders are not considered

Results (only in this special case!)

• EBIT will equal in this special case the EBT (no interest!), NOPLAT will equal EAT
• If we exclude financing, then FCFF=FCFE=change in Cash

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 21 November 2021

Header

Simple No-Interest No-Dividend Situation (Recall from

Seminar)
Income Statement Balance Sheet Change in Balance
Sheet from last year
Sales Income (SI) LongTerm Fixed Assets (FA) deltaFA
Assets:
Current expense (CE)
ShortTerm Inventory (IN) deltaNWC ← deltaIN
Depreciation & Amortization (DA) ← − deltaFA Assets (NWC)
EBIT = SI – CE – DA Liabilities Equity(EQ) deltaEQ ←
RetainedEarnings,
Tax (TA) ← TaxRate * EBIT
or initial investment
OpCF ← SI-CE-TA-deltaNWC
delta = later - earlier
CAPEX ← - deltaFA - DA
RetainedEarnings ← OpCF + CAPEX
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 21 November 2021

Cashflow Simple Format (Indirect Method)

PROFIT from Income Statement (can be PAT -- Balance sheet items involved
accountant, EBIT – corp planner)
Eliminate Non-Cash P&L items:
Add back: Non-Cash expenses X e.g. Depreciation
[Deduct: Non-Cash income] (X) [e.g. Revaluation Gains]
Cash released from NWC (STWC):
Add: Decrease in Assets X e.g. Accounts Receivables, Inventory
[Deduct: Increase in Assets] (X)
Add: Increase in Liabilities X e.g. Accounts Payable
[Deduct: Decrease in Liabilities] (X)

Eliminate Non-Operating items:

Add back: Non-Operating Losses X e.g. Loss on Sale of Assets
[Deduct: Non-Operating Gains] (X) [e.g. Gain on Sale of Assets]

OPERATING CASHFLOW X

INVESTING CASHFLOW X Revenue from Assets Disposals

Less: Capital Expenditure (CAPEX)
FINANCING CASHFLOW X New Finance - Repayment of old finance

NET CASHFLOW X Change in cash balances

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 Unlevered Cash Flow – FCFF
• Statement of cash flows: a firm’s financial statements that summarizes it’s cash movements (in and
out) over a specified period.
• In FCFF we asses two different aspects:
• How operations effect cash balance? (Intuitively: „How we are using our assets?”)
• How investment activity effects cash balance of the firm? (Intuitively: „How we are maintaining and improving our assets?”
• Effects of financing structure (equity or debt financing) are not included in FCFF.
• Free Cash Flow to Enterprise = FCFF but we use the acronym FCFE elsewhere
• We will use only FCFF for projects in this course.

+ Operating CF
+ Capital Expenditure (CAPEX)
= Free Cash Flow to Firm or Enterprise (FCFF)

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 21 November 2021

Cashflow Measures
Accountants’ view - GAAP Corporate Finance view – Non-GAAP
PROFIT X PAT EBIT
Eliminate Non-Operating items X e.g. Loss on Sale of Assets
Eliminate Non-Cash “Accounting” P&L items X Add back Depreciation Add back Depreciation

EBITDA
Tax, Interest N/A - taxes, interest
Cash released from NWC (STWC) X e.g. Accounts Receivables, Inventory e.g. Accounts Receivables, Inventory
OPERATING CASHFLOW Σ OPERATING CASHFLOW OPERATING CASHFLOW

INVESTING CASHFLOW X Revenue from Assets Disposals Revenue from Assets Disposals
- Capital Expenditure (CAPEX) - Capital Expenditure (CAPEX)
Σ FREE CASHFLOW TO FIRM (FCF-F) FREE CASHFLOW TO FIRM (FCF-F)
+ New debt finance
DEBT FINANCING CASHFLOW X - Repayment of old debt finance
Σ FREE CASHFLOW TO EQUITY (FCF-E)
EQUITY FINANCING CASHFLOW + equity issue - dividends
NET CASHFLOW Σ Change in cash balances

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 Cash Flow: FCFF and FCFE

FCFF debt service FCFE

8
7
7
FCFE 6 5.5
6
5.5
6

FCFF 5 4.5 4.5 4.5 4.5 4.5 4.5 4.5

4 3.5
3
Debt 3 2.5

2 1.5 1.5
Service 1 1
1
0
1 2 3 4 5 6 7
-1
-1
-2 -1.5

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How financial statements are linked to each other

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 Balance sheet

Liabilities & equity

Assets

Inventory Accounts payable

Accounts receivable Short-term debt Current liabilities

Current Assets
Cash & marketable
securities
Net Working Long-term debt
Capital (NWC) Bonds, Bank loans…

Tangible assets:
Fixed Assets
plant,equipment…
Common stock

Intangible Assets Addition to Shareholders Equity

retained earnings
Other assets Retained earnings
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 Balance sheet
Winery Hypermarket Real Estate Investor
Assets Liabilities & equity Assets Liabilities & equity Assets Liabilities & equity
Current
Current Current
Current liabilities
liabilities Assets
Assets Current
liabilities
Current Assets Long-term
debt
Long-term
Fixed debt
Fixed Assets
Assets Long-term
Shareholders debt
Fixed Assets Equity Shareholders Shareholders
Equity Equity

Net Working Positive Negative Positive

Capital (NWC)

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• RoA for asset heavy
• RoE for asset light

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 Financial ratios

• Leverage ratios
• Efficiency ratios
• Liquidity ratios
• Profitability ratios

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Leverage Ratios: snapshot

long term debt

Long term debt ratio =
long term debt + equity

long term debt + value of leases

Debt equity ratio =
equity

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 Leverage Ratios

total liabilities
Total debt ratio =
total assets

EBIT
Times interest earned =
interest payments

EBIT + depreciation EBITDA

Cash coverage ratio =
interest payments

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 Liquidity Ratios

Net working capital Net working capital

=
to total assets ratio Total assets

current assets
Current ratio =
current liabilities

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 Liquidity Ratios
Inventory not here
cash + marketable securities + receivables
Quick ratio =
current liabilities

cash + marketable securities

Cash ratio =
current liabilities

cash + m arketable securities + receivables

Interval m easure =
average daily expenditures from operations

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

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 Efficiency Ratios
both measured retail

Sales
Asset Turnover =
Assets (beginning of year or average)

Cost of Goods Sold

Inventory Turnover = both measured whole-sale
Inventory (beginning of year or average)

Sales
Receivables Turnover =
Receivables (beginning of the year or avg)

Average days in inventory = 365/InventoryTurnover

Average collection period = 365/ReceivablesTurnover

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 Profitability Ratios: The Du Pont System

• A breakdown of RoE and RoA into component ratios

RoA = EBIT - taxes

assets

RoE = EBIT - taxes - interest

equity

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 The DuPont System: RoA

sales x EBIT - taxes

R OA =
assets sales

asset profit
turnover margin

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 The DuPont System: RoE

assets x sales x EBIT - taxes x EBIT - taxes - interest

R OE =
equity assets sales EBIT - taxes

leverage asset profit debt

ratio turnover margin burden

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 What ratios to Use?
Use only consistent ratios!

Compare/pair values which are defined by the same effects of the firm’s activity

Illustration:
• Sales revenue is generated by using the entire asset volume. ~ operation of the firm
Profit after taxes ~ operation (EBIT), tax effects, financing structure (interest payment)
EBIT ~ operation
Assets ~ operation
Equity ~ operation, financing structure

• Profit after taxes ~ operation (EBIT), tax effects, financing structure (interest payment)
Assets ~ operation
Equity ~ operation, financing structure

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 Use consistent ratios!
RoA=? EAT=OperatingIncome*(1-TaxRate)

RoA for these two should be the same, they produce the same results with the same assets

Half way Ltd. 2019

Own way Ltd. 2019
Assets 1000 Assets 1000
Debt 500 Debt 0
Equity 500 Equity 1000
Sales 1200 Sales 1200
EBIT 360 EBIT 360
Interest 40 Interest 0
EAT 256 EAT 288

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Financial Ratios

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 21 November 2021

Thank you
for your attention!

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