Chapter 2

Financial Analysis
(I)

1
Contents
1. Introduction
2. Balance sheet and P&L's statement
3. Analysis of Vertical and Horizontal
percentages
4. Cash Flow Analysis
5. Financial Ratio Analysis
6. Long-Term Financial Planning
2
Contents
1. Introduction
2. Balance sheet and P&L's statement
3. Analysis of Vertical and Horizontal
percentages
4. Cash Flow Analysis
5. Financial Ratio Analysis
6. Long-Term Financial Planning
3
1. Introduction
 The aim of economic & financial
analysis:
 Two types of analysis:
 The evolution of the company during a
particular period of time
 To compare our company with the
evolution of others:
 Comparing companies in the same sector
 Leading company in the sector
 Main competitor
4
1. Introduction
 Bank application of economic
financial analysis:
 System used by banks to give or not
credits
 The banks want to minimize their
credit risk:
 Failure to repay a loan
 “Qualify” our risk (Basilea II,III)
 More risk More Equity (Reserves or
Capital)
5
Contents
1. Introduction
2. Balance sheet and P&L's statement
3. Analysis of Vertical and Horizontal
percentages
4. Cash Flow Analysis
5. Financial Ratio Analysis
6. Long-Term Financial Planning
6
 The Balance Sheet Model of a firm

ROA>cost of capital

assets liabilities

current
investments

Current liabilities
Net working
Assets capital

financing
Long-term
debt
Fixed
Assets;
Shareholder’s
Tangible, equity
Intangible

The value of assets Total value of the firm

to investor
7
2. The Balance and P&L:
 Assets
 Listed in order from lower to higher liquidity
 Fixed Assets:
 Those assets which will remain in the company more than 1 year
 Net Fixed Assets Value: deducted accumulated depreciation.
 Intangible assets
 Tangible assets
 Long-term financial investments
 Current Assets:
 Those assets which will remain in the company less than 1 year
 Receivables:
 Inventories
 Customers
 Cash and other cash equivalents :
 Short-term investment assets
 Cash

8
2. The Balance and P&L:
 Liabilities
 Listed in order from lower to higher urgency on payment
[maturity]
 Total equity:
 Those resources contributed by the shareholders or generated
by the company.
 Share Capital
 Reserves: retained earnings
 Long-term debt:
 Those liabilities which will remain in the company more than 1
year
 Bank loans, provisions, lease payable…
 Current Liabilities:
 Those liabilities which will remain in the company less than 1
year
 Bank loans
 Suppliers
 Taxes 9
2. The Balance and P&L:
Balance

10
2. The Balance and P&L:
 P&L:
Turnover
- Overhead (cost of sales)
---------------------------------------------------------
= EBITDA (earnings before interest, tax and
depreciation)
----------------------------------------------------------
- Depreciation
----------------------------------------------------------
= EBIT (earnings before interest and taxes
- Interest paid
-----------------------------------------------------------
= Taxable income
-----------------------------------------------------------
- Taxes
-------------------------------------------------
= Net Income
(To: dividends or Retained earnings)
11
2. The Balance and P&L:
 P&L. Example:

12
2. Profit and Losses. Net Income
 Net Income is shared between:

 Dividends
 Payments to shareholders

 Reserves
 Retained Earnings
 Applications
 Capital increases
 Cancelation of debt
 Investment in assets

13
2. Depreciation
 Accounting point of view:
 Loss in value of non-current assets because of their use, the
time and technologic obsolescence.
 Share of the purchasing cost of the asset during its shelf life

 Financial point of view:

 It creates a “fund” of money in order to substitute the Non
Current Asset at the end of its life.
 Implies tax saving as it diminishes EBT
 It does not imply a cash outflow
 Money in Accumulated Depreciation account is not at Treasury
Account

14
2. The Balance and P&L:
 Book value vs. Market value:
 Book value (BV):
 The values shown on the balance sheet generally are not
what the assets are actually worth:
 BV = (Assets) – (Long-term debt + currents liabilities)
 BV= (Total equity)
 Show assets as historical cost, i.e.: what the firm actually
paid for them. It’s not the real value
 Market value (MV):
 It is the actual current value (acv):
 MV = acv(Assets) – acv(Long-term debt + currents liabilities)
 For current assets and liabilities BV and MV might be
similar
 THE VALUE OF THE FIRM IS NOT IN THE
BALANCE SHEET.
15
Contents
1. Introduction
2. Balance sheet and P&L's statement
3. Analysis of Vertical and Horizontal
percentages
4. Cash Flow Analysis
5. Financial Ratio Analysis
6. Long-Term Financial Planning
16
3. Percentages
 Percentages Analysis:
 Vertical:
 These allow us to identify the main accounts
 How to calculate:
 In the Balance sheet they are a % of Total Assets
 In the P&L they are a % of Total Sales
 Horizontal:
 These allow us to analyze over a period of time the
main accounts
 How to calculate:
 Evolution of absolute values
 Evolution of relative percentages

17
3. Percentage Analysis
Firm X: Balance

Assets Liabilities
2009 2010 2009 2010
Shareholders'
1644 1709 Equity 962 1718
Equipment 1644 1709 Share Capital 200 240
Reserves 350 659,0
P&L 412,0 819,0
Long Term
Debt 1144 624
Long term
loans 1144 624
Current
1112 1403 Liabilities 650 770
Inventory 553 555 Creditors 250 350
Customers 455 688 Suppliers 400 420
Treasury 104 160

Total Total
Assets 2756 3112 Liabilities 2756 3112
3. Percentage Analysis
Firm X: P&L
2009 2010

Sales 1.509,0 2.200,0

Cost goods sold 740,0 850,0
Oth operating costs 10,0 50,0

Depreciation 65,0 70,0

EBIT 694,0 1.230,0

Interests 70,0 60,0

EBT 624,0 1.170,0

Taxes 212,0 351,0
Net Income 412,0 819,0

Dividends 103,0 655,2

Reserves 309,0 163,8
3. Percentage Analysis
Assets

Assets
Evolution Evolution
2009 % 2010 % value %

Non Current 1644 59,7% 1709 54,9% 4,0% -7,94%

Equipment 1644 59,7% 1709 54,9% 4,0% -7,94%

Current 1112 40,3% 1403 45,1% 26,2% 11,74%

Inventory 553 20,1% 555 17,8% 0,4% -11,12%

Customers 455 16,5% 688 22,1% 51,2% 33,91%
Treasury 104 3,8% 160 5,1% 53,8% 36,25%

Total Assets 2756 100,0% 3112 100,0% 12,9% 0,00%

3. Percentage Analysis
Liabilities

Evolution Evolution
2009 % 2010 % value %
Shareholders'
Equity 962 34,9% 1718 55,2% 78,6% 58,16%
Share Capital 200 7,3% 240 7,7% 20,0% 6,27%
Reserves 350 12,7% 659,0 21,2% 88,3% 66,75%
P&L 412,0 14,9% 819,0 26,3% 98,8% 76,05%
Non Current 1144 41,5% 624 20,1% -45,5% -51,69%
Long term
loans 1144 41,5% 624 20,1% -45,5% -51,69%

Current 650 23,6% 770 24,7% 18,5% 4,91%

Creditors 250 9,1% 350 11,2% 40,0% 23,98%
Suppliers 400 14,5% 420 13,5% 5,0% -7,01%

Total
Liabilities 2756 100,0% 3112 100,0% 12,9% 0,00%
3. Percentage Analysis
Profit and Losses

Evolution
2009 % 2010 % value Evolution %

Sales 1.509,0 100,0% 2.200,0 100,0% 45,8% 0,0%

Cost goods sold 740,0 49,0% 850,0 38,6% 14,9% -21,2%
Oth operating costs 10,0 0,7% 50,0 2,3% 400,0% 243,0%

Depreciation 65,0 4,3% 70,0 3,2% 7,7% -26,1%

EBIT 694,0 46,0% 1.230,0 55,9% 77,2% 21,6%

Interests 70,0 4,6% 60,0 2,7% -14,3% -41,2%

EBT 624,0 41,4% 1.170,0 53,2% 87,5% 28,6%

Taxes 212,0 14,0% 351,0 16,0% 65,6% 13,6%
Net Income 412,0 27,3% 819,0 37,2% 98,8% 36,3%

Dividends 103,0 6,8% 655,2 29,8% 536,1% 336,3%

Reserves 309,0 20,5% 163,8 7,4% -47,0% -63,6%
Contents
1. Introduction
2. Balance sheet and P&L's statement
3. Analysis of Vertical and Horizontal
percentages
4. Cash Flow Analysis
5. Financial Ratio Analysis
6. Long-Term Financial Planning
23
4. Cash Flow Analysis
 Accounting profit
 It does not measure the cash balance (Unit 1)
 Cash Flow from Assets (CFA or Cash Flow)
 It
tries to measure the cash balance
 CFA=Cash Flow = Come in $ - went out $
 Main applications:
 To know the cash balance
 To carry out companies valuation (NPV)
 To carry out project valuation (NPV and IRR)

24
4. Cash Flow Analysis
Cash Flow from Assets

 To be shared between
 Shareholders: dividends and net equity returned

 Creditors: net interests and net debt cancellation

CFA = Cash Flow Creditors (CFC) + Cash Flow

Stockholders (CFS)

25
4. CFA Analysis

Cash Flow from Assets

CFA

Cash Flow Creditors Cash Flow Stockholders

CFC CFS
4. Cash Flow Analysis
 Cash flows from assets
Involves:
 1.
Operating Cash Flow (OCF); from
day-to-day activities

 2.
Capital spending; net spent and
sale of fixed assets

 3.Change in net working capital;

change on current assets and
liabilities
27
4. Cash Flow Analysis
 Cash flow from assets:

Cash flow from assets

=
Operating Cash Flow
–
Capital spending
–
Change in net working capital

28
4. Cash Flow Analysis
 I. Operating Cash Flow (OCF)
 Revenues minus costs
 Do not include depreciations (is not cash outflows)
 Do not include interest (it’s a finance spending)
 Do not include taxes (are paid in cash)
Operating cash flow = EBIT + depreciation – taxes
 Accounting OCF:
Accounting Operating cash flow =
Net Income + depreciation

29
4. Cash Flow Analysis
 II. Capital spending
 Money spent on fixed assets (FA) less money
received from the sale of fixed assets:
Capital spending
=
Net FA(t)-Net FA(t-1)+Depreciation(t)
=
FA(t)-FA(t-1)
 Could net capital spending be negative?, yes
if the firm sold off more assets than it
purchased
30
 4. Cash Flow Analysis
 III.
Change in net working capital
(NWC)
Change in Current Assets
 Part of the OCF goes to new inventories purchase
 Computation: Inventories(t) – Inventories (t-1)
 OCF includes all sales
 But a part of them may not be collected
 Computation: Customers(t) – Customers(t-1)

Change in Current Liabilities

 Some expenses may not be paid
 Computation: Suppliers(t) – Suppliers(t-1)

DNWC (t) = D Current Assets(t) – D Current

Liabilities(t)
31
4. Cash Flow Analysis
EBIT + depreciaton - taxes

Operating
Capital Change
- -
Cash flow spending NWC

Free cash flow; free

Cash flow from assets to distribute, is not
needed for
WC and fixed
assets
Cash flow to creditors Cash flow to shareholders
+

32
4. Cash Flow Analysis
 Cash flow to creditors (CFC):
Net payment to creditors
 Interests payment = I(t)
 Debt Cancelation = D(t-1) – D(t)
 Positive: net debt cancelled
 Negative: debt augments.

Computation
CFC
=
I(t) + [D(t-1)-D(t)]
33
4. Cash Flow Analysis
 Cash flow to shareholders:
Net payment to owners
 Dividends
 Net Equity returned: Capital(t-1) – Capital(t)
 Positive. Capital returned
 Negative: increment of capital

 Computation
Shareholders Equityt  Shareholders Equityt 1  Net Incomet  CFS

Cash Flow Shareholders  Net Incomet  Shareholders Equityt 1  Shareholders Equityt 

 Net Incomet  Capitalt 1  Re servest 1  Capitalt  Re servest 
 Net Incomet  Re servest 1  Re servest  Capitalt 1  Capitalt 
 Dividends*  Capitalt 1  Capitalt  Dividends*  Net Equity Re turned

34
4. Cash Flow from Assets analysis

Cash flow from assets Cash Flow Creditors Cash Flow

= + Shareholders

OCF Interests Net Income

+ Equity t-1 - Equity t

- ΔNon Curr. Assets + Debt Cancellation

- ΔNWC

EBIT

+ Depreciation

- Taxes
4. Cash Flow from Assets analysis

 The following equation identifies origin and

application of the funds:

CFA (t) + DD(t) + DK(t) = d(t) + I(t)

ORIGIN APPLICATION

Where D=Debt, K=capital, d=dividends, I=interests

 Assets Liabilities

2009 2010 2009 2010

Non
Current 1.644 1.709 Equity 962 1.718
equip 1.644 1.709 Capital 200 240
Reserves 350 659
Result 412 819

Non Current 1.144 624

Long term 1.144 624
Current 1.112 1.403 Current 650 770
stocks 553 555 Suppliers 250 350
clients 455 688 creditors 400 420
treasury 104 160

Total 2.756 3.112 Total 2.756 3.112

37
 2009 2010

Turnover 1.509,00 2.200,00

Cost of sales 740,00 850,00
Other expenses 10,00 50,00

Depreciation 65,00 70,00

EBIT 694,00 1.230,00

Interest 70,00 60,00

Ebt 624,00 1.170,00

Tax 212,00 351,00
Net Profit 412,00 819,00

Dividends 103,00 655,20

Reserves 309,00 163,80
38
• CASH FLOW ANALYSIS
– Cash Flow from Assets (CFA):
• I. Operating Cash Flow (OCF):
– EBIT = 1.230
» OCF = 1.230 + 70 – 351 = 949
• II. Net Capital Spending (NCS):
– NCS (2010) = 1.709
– NCS Net (2009) = 1.644
– Depreciation (2010) = 70
» NCS = (1.709-1.644) + (70) = 135
• III. Change Working Capital CWC:
– WC(2010) = 1.403 – 770 = 633
– WC(2009) = 1.112 – 650 = 462
» CWC = 633 – 462 = 171
» Increase clients
– CFA = 949 – 135 – 171 = 643

39
– Cash Flow to creditors:
• Net payment to creditors = 1.144 – 624 =
520
• Interest paid= 60
– CF creditors = 520 + 60 = 580
– Cash flow to shareholders:
• Net Income = 819
• Change total equity (Et-Et-1)= 1718-962
– CF shareholders = 819-(1718-962)=63

40
Cash Flow Assets= 643 Cash Flow Creditors= Cash Flow
= 580 + Shareholders= 63

OCF = 949 INT = 60 Net Income = 819

- ΔNCA = - 135 +Dev. Cancel.= 520 +Equity t-1 – Equity

t=-756

- ΔNWC = - 171

EBIT = 1.230

+ Depreciat = 70

-Taxes= - 351

41
 Conclusions:
 Company generates OCF of 949 :
 135 (14,22%) to Capital spending
 171 (18,01%) to more working capital
 CF from Assets = 643 (67,75%)
 CFA (643) distributed to:
 580 (90,20%) to creditors
 interests = 60 (9,33%)
 Payment credits = 520 (80,87%)
 63 (9,79%) to shareholders
 Shareholders increase the share capital 40
(dividends 2009-increase capital= 103-40=63)

42
4. Cash Flow from Assets analysis

 OCF of an unlevered firm (unlevered OCF)

 It
is the OCF in case the company has no debts
 They are the OCF used in calculating NPV and IRR
 They are dropped:
 The effect of the debt interests
 Tax saving associated with them
4. Cash Flow from Assets analysis

 OCF  OCF unlevered:

Drop tax savings from interests

paid:

Operating Cash Flow OCF unlevered

= =
EBIT EBIT
+ Depreciation + Depreciation
- Taxes - Taxes
- (T)*(Interests)