Company Strategic Formula

Analysis
Dr Gine Das Prena,SE,M.Si,Ak,CA,CSRA,CAPM,CPA,CMA,CFMA,CERA
Strategic Formula of the Company

The company’s “health condition” in a defined period of time and its ability to create profit over time
requires an analysis based on two main elements:

the first is a qualitative analysis of the business mode

the second is a quantitative analysis of the effects of the business model choices on the economic and
financial dynamics over time

Therefore, the competitive advantage of the company on the basis of its business model must be
reflected in the economic and financial values over time

The qualitative analysis of the company’s business model proposed in this context is defined as a
“Company Strategic Formula” (CSF)
 The CSF

considered as the ideal conceptual place in which, on the basis of a systemic and dynamic paradigm

the ideas are developed

the decisions are made;

the operations are defined and planned.

The CSF defines the strategic profile of the company, by considering two different “strategic fronts

internal strategic front: it refers to the internal structure of the company;

*Corporate governance

*Organizational architecture

*Strategic resources
External Front of the CSF

1. Strategic Business Area;

Strategic Business Area (SBA) the company refers to the real market in which it carries out the business. The
company can operate in more than one business. In any case, any SBA can be defined on the basis of two
main elements
competitive players: it refers to the players with which the company defines relationships. Specifically, they
are customers, suppliers, competitors (both existing competitors and potential competitors entering the
business, as well as the producers of potential substitute products). The relationship between the company
and customers is characterized by continuity (due to the sale process) and stability (arising from the
possibility to identify a hard core of customers)

product system: it refers to the product offered by the company with regards to its material and
immaterial elements, service components and economic and non-economic terms. The product must also
incorporate the image and reputation of the company. Therefore, it should be defined as a “product
system” rather than a product because it incorporates the technical elements, as well as the image, the
value, and the history of the company
2. Capital Market

Capital Market refers to the ideal place in which a company looks for the capital, in equity and debt,
needed for its survival and development over time. The capital market can be defined according to two
main elements:

financial players: it refers to the investors in equity and debt. The relationship between company and
debtholders is of stable nature. The company normally defines a long-term debt level and parts of it
are constantly being replaced in the short-term period.

financial company profile: it refers to the risk return profile of the company. It is function of the
company’s expected cash flows on one side and investor expectations about risk and returns on the
other
Consonance of the Corporate Strategic Formula

Therefore, the CSF must be characterized by a “consonance” between all structural elements of the internal
and external strategic fronts. This consonance must be

Systemic: all elements of the internal and external strategic

fronts must be aligned between them;

Structural: there must always be correspondence between

the characteristics of each element of the strategic fronts,
both internal and external, based on well-defined and
structural bidirectional relationships;

Dynamic: the systemic-structural relationships between

elements of the internal and external strategic fronts must
be dynamic over time and never static.
Analytical Schemes for the Analysis of Company Performance
the analytical schemes used are defined based on the financial approach to company
assessment and they are defined in order to investigate the three main pillars:

Operating Income and Net Income;

Capital Invested and Capital Structure;

Free Cash-flow from Operations and Free Cash-flow to

Equity;

While the first defines the economic dynamic, the second and the third define the financial dynamic of the
company
the first step, is the collection and recognition of past values:

the first step, is the collection and recognition of past values: the aim is to build
Operating and Net Income, Capital Invested and Capital Structure, Free Cash-
flow from Operations and Free Cash-flow to Equity of the company in the past.
For this objective, the analyses should be based on the balance sheet, income
statement and cash flows statement on the one side, and on the internal
management accounts of the company on the other side. The combination of
these two data sources allows for an analysis of the real condition of the
company. An analysis of the management accounts is necessary for three main
reasons: (i) they are built to support management in the decision-making phase;
(ii) they are characterized by both monetary and non-monetary quantitative
data; (iii) they are well known in their composition and dynamics thanks to the
technique of the variance analysis implemented constantly;
the second step, is the “adjustment” of past values:

the aim of this step is to obtain the “normalized” value of Operating

and Net Income, Capital Invested and Capital Structure, Free Cash-
flow from Operations and Free Cash-flow to Equity of the company
in the past. The aim of the process is to define these values in stand-
alone conditions of the company. Therefore, their effects on
extraordinary events in the broadest sense are not considered;
the third step, is the estimate process of value in the future

the aim of this step is to build estimates on Operating and Net Income, Capital
Invested and Capital Structure, Free Cash-flow from Operations and Free Cash-
flow to Equity of the company in the future. A company business plan should be
defined in order to achieve this objective. It is created by defining the Company
Strategic Formula and by estimating its effects on future economic and financial
dynamics

The analytical schemes allow for analysis of composition of the Operating and Net Income, Capital
Invested and Capital Structure, Free Cash-flow from Operations and Free Cash-flow to Equity. An
analysis of the economic and financial dynamics requires the definition and the knowledge of the
connections between them.
Operating and Net Income
*The analysis of the economic dynamic requires an analysis of the Operating Income and Net Income over
time. It is the starting point for an analysis of company performance
*The aim of the analysis is to investigate into the drivers of the economic engine of the company and the
existence of a long-lasting competitive advantage.
*Specifically, an analysis of costs and revenues over time must be focused on in order to understand if the
company has a real competitive advantage and if it lasts over time. The competitive advantage must be
identified on the basis of its effects on revenues and costs. Only if the company confirms a dynamic of
revenues and costs that is better than that of its competitors for a long period, the company has a lasting
competitive advantage over time. Consequently, an analysis of the revenues and costs must consider a long
period of time ranging from 7 to 10 years
*The analytical scheme adopted to analyse the income of the company can be divided into four main
sections:

Section (1) Operating area (or Operations section): it refers to the operating revenue and costs due to
activities of the company’s core business. This is the most important section of income because it defines
the economic results of the company’s core business. In this section, it is important to distinguish between
cash operating costs and non-cash operating costs (such as amortizations, depreciations, accruals)
Operating and Net Income

Section (2) Non-Operating area (or Non-Operations section): in this section two
different types of revenues and costs are considered. The first are the revenues
and costs due to the execution of activities different from the company’s core
business; the second are the revenues and costs related to the core-business
but not repeated in time and thus considered as a one-off. It is worth noting
that in this context definition of the perimeter of the company core-business is
of a strategic assessment only. Therefore, in both cases, the difference between
operating and non-operating revenues and costs is based on the strategic
analysis only and it is independent of the accounting rules;
Operating and Net Income

Section (3) Financial area (or Financial section): it refers to the financial
revenues and costs. The first refers mainly to the dividend received and interest
on financial credit while the second refers mainly to the interest on debt and
other financial costs linked to it. Generally, for a non-financial company, the
financial revenues are low and the entire financial area refers to the cost of
debt

Section (4) Tax area (or Tax section): it refers to corporate taxes due to the
company activities. Usually, taxes are considered entirely in this part. But, more
appropriately, they should be divided among the three sections (Operating,
Non-Operating, Financial) as taxes arising from them. Often, in practice tax
splitting is difficult to perform and therefore corporate taxes are considered
entirely in this specific section
*The aim of the analytical scheme used is to distinguish between strictly
operating activities and others it can only be done with a deep analysis of
each item in a financial analysis perspective. In this sense, the EBITDA and
EBIT refer to Revenues and Costs strictly operating .

*The Gross Profit (or Gross Margin) is the difference between the revenues
from the sale of products, goods and services and the related production
costs

Gross Profit Margin =Gross Profit / Net Operating

Revenues
EBITDA
Capital Invested and Capital Structure
The aim of the analysis of the Capital Invested and Capital Structure is to investigate into the sources of
capital and their use.
The Capital Invested (CI) defines the amount of capital invested in company activities
Capital Structure (CS) defines the sources of capital used to finance these activities

*The aim of the analytical scheme proposed is to highlight the main figures whose variations can be
interpreted in terms of cash-flows immediately and therefore whose previsions are relevant for
company value.
*The analytical scheme proposed is based on separation between financial and non-financial assets-
liabilities and, with regards to this second category between operating and surplus assets-liabilities
with regards to those that are not linked with operating activities.
*There are two main implications of these separations:
– first, they allow for definition of the investments directly in company’s assets, both operating and
surplus as well as relative capital sources;
– second, they allow for an assessment of variations in the assets-liabilities directly in terms of
changes in cash flows
CAPITAL INVESTED & CAPITAL STRUCTURAL
CAPITAL INVESTED

The Capital Invested (CI) consists of investments in Capex

(capital expenditure), Net Working Capital, Surplus Assets, less
Provisions.
The Capital Structure (CS) is defined by Equity and Net Financial
Debt
*CI=CS

*CAPEX ±NWC ± Surplus Assets - Provisions =Equity + NFP

*CAPEX ±NWC ± Surplus Assets – Provisions+NFP=Equity

Free Cash Flow from Operations and Free Cash Flow to Equity

Free Cash Flow from Operations (FCFO): they are the Free Cash-flows from
Operating Area as derived by the company’s operating activities and they are
designed to pay all investors both in equity and debt. They represent the
monetary component of the Operating Income of the company. Therefore,
the FCFE is function of the Operating Income (there is no difference between
EBITDA and EBIT because the non-monetary costs are not considered) and
dynamics in the NWC and CAPEX. They are defined “free” because they
represent the cash that the company is free to distribute to debtholders and
shareholders and to pay taxes by having already covered the needs for
Investments and NWC;

The Capital Invested (CI) consists of investments in Capex (capital

expenditure), Net Working Capital, Surplus Assets, less Provisions.
The Capital Structure (CS) is defined by Equity and Net Financial Debt
FCFE

Free Cash Flow to Equity (FCFE): they are the remaining free cash flows after
having covered all company requirements including payments on debt, and
therefore they are designed to pay the shareholders in terms of dividends. They
represent the monetary component of the net income of the company. They show
how the FCFF’s are divided between bondholders, stockholders and taxes. If the
FCFE are negative, they represent the company’s capital need to continue its
business. Therefore, it is the amount of the capital required for recapitalization
Thank you