Financial Statement Analysis - Freefahmi.ba.free.fr/docs/Courses/HEC FSA/fba_hec_fsa...Net Fin. Debt...

Financial Statement Analysis

Fahmi Ben Abdelkader ©

Section 3.

The analytical Balance sheet: the financial view

From the Traditional Accounting to the Financial Vi ewCapital Employed and Invested CapitalMarket vs. Book ValueEnterprise Value vs. Market CapitalizationAsset and Capital Structure Ratios

Section 3.

The analytical Balance sheet: the financial view

From the Traditional Accounting to the Financial Vi ewCapital Employed and Invested CapitalMarket vs. Book ValueEnterprise Value vs. Market CapitalizationAsset and Capital Structure Ratios

10/4/2017 11:36 AM 1

Students version

Fahmi Ben Abdelkader © Financial Statement Analysis10/4/2017 11:36 AM 2

The Balance Sheet: a reminder

The analytical Balance sheet: the financial view Fro m the Traditional Accounting to the Financial ViewCapital Employed and Invested CapitalMarket vs. Book ValueEnterprise Value vs. Market CapitalizationAsset and Capital Structure Ratios

Lists the firm’s assets and liabilities

Employments (uses of funds) Financial Resources

Assets Liabilities and Shareholders’ equity

Where does the money come from?What does the money get spent on?

Total Assets Liabilities + Shareholders’ equity


The Balance Sheet: a reminder


A condensed presentation of the Balance Sheet

Shareholders’ equity

Assets Liabilities and Shareholders’ equity

Total Assets Liabilities + Shareholders’ equity

Investment of Shareholders and accumulated reinvestedprofits

Long-Term Financial Debt

Loan or debt obligation with maturities beyond one year

Short-Term Financial Debt

Loan that must be repaid in one year

Accounts Payable Amounts owed to suppliers purchases made on credit

Long-lived Assets Assets (physical or intangible) that produce benefits for more than one year

Inventories Items held for sale or used in the manufacture of products that will be sold

Accounts receivable amounts owed to the firm by customers who have purchased on credit

Cash and marketablesecurities

short-term investments easily sold and converted to cash

… …..


The Balance Sheet date can be crucial !!!!



The Balance sheet does not reflect the firm’s financial position during the year

Provides a snapshot of the firm’s financial position at a given point in time .

The fiscal year may differ from one country to another


The Balance Sheet date can be crucial !!!!



The Balance sheet does not reflect the firm’s financial position during the year

Provides a snapshot of the firm’s financial position at a given point in time .

The example of the LEGO Toy company

80% of Lego’s annual sales occur between September and December. What could be the impact of the seasonality factor on some of the components of the Balance Sheet?

The fiscal year may differ from one country to another

Seasonality factor


The Balance Sheet and the Industry


Example : the industry is critical

Assets 1 2 3

Intangible assets 2 853 2 050 36 084

Tangible fixed assets 19 765 112 426 294 487

Financial assets 40 263 63 478 294 755

Fixed assets 62 881 177 954 625 326

Inventory 1 230 196 036 443 397

Accounts receivable 112 686 175 451 135 238

Cash and cash equivalents 6 590 181 773 1 032 364

TOTAL ASSETS 194 596 731 214 2 236 326

EUROPAGES (produces agendas and

office supplies based on paper)

RFM (a network radio)

TOUTCONFORT (an electrical goods

retailer )

Liabilities and Equity 1 2 3

Shareholders’ Equity 150 054 360 111 893 324

Long-term debt 369 41 137 416 912

Accounts payable 201 809 198 738 1 050 157

Short –term debt 860 131 228 0

TOTAL LIABILITIES 194 596 731 214 2 236 326


The Balance Sheet and the Industry


Example : the business model has major implications on the relevant items in the balance sheet


The Balance Sheet: the traditional accounting form


Example: JIT : Just-In-Time Computer ServicesConsolidated Statements of Financial Position Prepared According to IFRS in € millions

Asset liquidity

Maturity dates

Assets Year 2 Year 1

Goodwill 0,0 0,0Intellectual property rights, brands and other intangible assets 41,0 14,0Net Property, Plant and Equipment 78,7 66,9Financial Assets (Equity in Joint ventures, investments in shares and participations, deferred tax assets, etc.) 1,0 0,0

Total non-current assets 120,7 80,9

Inventories 15,3 14,3

Accounts receivables 18,5 13,2

Other current assets 0,0 0,0

Short-term investments 2,0 1,0Cash and cash equivalents 21,2 19,5

Total current assets 57,0 48,0

TOTAL NET ASSETS 177,7 128,9

Liabilities and Shareholders' Equity Year 2 Year 1

Total Shareholders' Equity 32,2 31,2

Long-term financial debt 106,0 61,8

Non-current liabilities 106,0 61,8

Short-term financial debt 9,0 11,0

Accounts payable 30,5 24,9

Current liabilities 39,5 35,9

TOTAL LIABILITIES AND EQUITY 177,7 128,9


From the Traditional Accounting to the Financial Vi ew


Assets Liabilities

Fixed Assets

Current Assets:InventoryAccounts receivable

Cash & short-term investments

121

23

Shareholders’ Equity

Long-Term Financial Debt

Current LiabilitiesAccounts Payable

32

106

31

Short –Term Financial Debt 9

34

WCN = Inventory + Accounts

receivable –Accounts Payable

WCN = Inventory + Accounts

receivable –Accounts Payable

Net Fin. Debt = Financial Debt LT & ST – Cash & short-term investments


Working capital needs of JIT Computer services


Year 2: WC = 15.3 M€ + 18.5M€ – (29.9 + 0.6) = 3.3 millions €

Year 1: WC =

Working Capital Needs in days’ worth of sales

Year 1 Year 2

Inventory (Days of sales) 30 30

+ Accounts Receivable (Days of sales) 27 36

- Accounts Payable (Days of sales) 52 60

Working Capital Needs (Days of sales) 5 6


The rationale behind using Net Debt rather than Gro ss debt


Net Fin. Debt = Financial Debt LT & ST – Cash & short- term investments

Example : World company

Cash & short-term investments 23

Long-Term Financial Debt 106

Short –Term Financial Debt 9

Year 1 Year 2

Equity 31,2 32,2

Net debt 52,3 91,8

Net debt = 92


The rationale behind using Net Debt rather than Gro ss debt


Analyzing financial debt

Risk of default

Autonomy/independence of the management vs pressure/intervention of creditors

Firm 1 Firm 2

Gross fin debt 100 M€ 100 M€

Cash 20 M€ 100 M€

Net debt +80 M€ 0 M€


From the Traditional Accounting to the Financial Vi ew


Fixed Assets

Net Working Capital

121


Net Financial Debt

32

92

3

Invested Capital124Capital Employed 124

The financial simplified presentation of the balance sheet


Capital Employed vs Invested Capital

The analytical Balance sheet: the financial view From the Traditional Accounting to the Financial Vi ewCapital Employed and Invested CapitalMarket vs. Book ValueEnterprise Value vs. Market CapitalizationAsset and Capital Structure Ratios

Total assets do not reflect necessarily the economic real value of the firm

Capital Employed (or Operating Assets) is a better indicator than Total Assets

Capital Employed = Invested Capital

Fixed Assets + Working Capital = Shareholders’ Equi ty + Net Fin. Debt

Fixed Assets 121


Net Financial Debt

32

92

3Net Working Capital

Invested Capital

Capital Employed

Quick Check Question : Calculate capital employed of JIT Company (What does the money spent on) ?

N+1 NFixed Assets 120,7 80,9

Working Capital 3,3 2,6

Capital Employed 124,0 83,5

N+1 NShareholders' Equity 32,2 31,2

Net Financial Debt 91,8 52,3

Invested Capital 124,0 83,5


Book Value or Market Value of a firm’s equity?


The two most important things in any company do not appear in its balance sheet: its reputation and its people

Henry Ford




The book value of a firm’s equity is not a good est imate of its “true” value

Many of the assets listed on the balance sheet are valued based on their historical cost rather than their true value today

Many of the firm’s valuable assets may not be captured on the balance sheet

Example: the value of an office building

Example: the expertise of the firm’s employees, the firm’s reputation in the marketplace, the relationships with customers and suppliers, etc.

The book value of a firm’s equity: a reminder

Shareholders’ equity = Total assets - Liabilities

An accounting measure of a shareholder’s net worth

The book value of a firm’s equity could possibly be negative


Book Value or Market Value ?


Negative book value of



Book Value or Market Value ?


Negative book value of


Shareholders’ equity of Air France-KLM Group




Book value = Historical cost – depreciation

From a valuation perspective, book values are almost meaningless,

Traditional Accounting:

Problems:

Historical cost ≠ current cost or value

Depreciation ≠ value loss

Book value = Faire Value

should be interpreted with caution

New approach (IFRS):

Problems:

Fair value often impossible to define or arbitrary

Frequent Fluctuations

To make a long story short …

except in a liquidation context


The Market Value: an accurate assessment of the “fa ir” value


The market value of a firm’s equity: a company’s Ma rket Capitalization

Cannot be negativeDoes not depend on historical cost of assetsOften differs substantially from book value

Market Capitalization = Market Price per Share x Number of Shares Outstanding

It depends on what investors expect those assets to produce in the future

Quick Check Question : On December 31, JIT had 3.6 million shares outstanding, and these shares are trading for a price of €14 per share. what was the JIT’s market capitalization? How does the market capitalization compare to book value of equity?

JIT’s Market Cap =

The book value of equity =


The Market-to-book ratio (or Price-to-Book Ratio (P BR))


The ratio of a firm’s market capitalization to the book value of stockholders’ equity:

Quick Check Question : Compute the Market-to-book ratio of JIT Company?

Equity of ValueBook

Equity of ValueMarket RatioBook -to-Market =

5.132.2

50.4RatioBook -to-Market ==

Investors are willing to pay one and a half times the book value of JIT’s shares

M/B Ratio > 1

The market value of the firm’s assets exceeds their historical cost (or liquidation value)


The Market-to-book ratio (or Price-to-Book Ratio (P BR))


Market-to-Book Ratios in 2010 of different firms and groups

Value stocks (low M/B ratios) vs growth stocks (high M/B ratios)

Source: Berk & DeMarzo (2011), Fundamentals of Corporate Finance. Pearson


The enterprise Value Versus Market Capitalization


Capital Employed (= Shareholders’ Equity + Net Financial Debt) is a good estimate of a firm’s value

Enterprise Value = Market cap + Debt - Cash

Quick Check Question : JIT’s Market Cap = € 50.4 million. What was the JIT’s Enterprise Value in N+1?

It would cost € 142.4 million to buy all of JIT’s equity and pay off its debt

Enterprise Value =

Market value of Capital Employed = Market value of Equity + Net Financial Debt


APPLE



APPLE


Source : The Wall Street Journal


APPLE


5.3135.8

487.2RatioM/Book ==

August 30, 2013

Market Cap $ 487.2 B

Total Cash $ 42.6B

Total Debt $ 16.9 B

Book value ofequity

$ 135.8

Enterprise Value =


APPLE


=RatioM/Book

May 27, 2015

Market Cap $ 750.4 B

Total Cash $ 33.4B

Total Debt $ 43.8 B

Book value per Share

$ 22.3

Enterprise Value =


Asset Structure Ratios and Capital Structure Ratios


What can we learn from analyzing a firm’s balance sheet (book value)?

Estimate the liquidation value : the value of the firm after its assets are sold and liabilities paid

Useful information on :

How the money is raised ?

Leverage, borrowing capacity, short-term cash needs, etc.

How the firm uses its money?

The ratio of fixed assets, the ratio of current assets, liquidity of assets, etc.

Fahmi Ben Abdelkader © Financial Statement Analysis

Example of Just-In-Time Company N+1 N

67,9% 62,8%

8,6% 11,1%

10,4% 10,2%

13,1% 15,9%

Fixed assets (I) 120,7 80,9

Working Capital (II) 3,3 2,6

Capital Employed (I+II) 124,0 83,5

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Asset Structure Ratios: How the firm uses its money ?


Used to assess the weight of each asset in the operating activity

Assets Total

Assets Fixed Ratio Assets Fixed =

Assets Total

Inventory RatioInventory =

Assets Total

Receivable Ratio Receivable =

Assets Total

Cash RatioCash =

Assets Total

(i)Asset Ratios Structure Assets =

Accounting approach

Financial approach


Asset Structure Ratios: How the firm uses its money ?


Working Capital Needs in days worth of sales – JIT

N+1 N

Working Capital Needs ($ million) 3,3 2,6

Inventory (Days of sales) 30 30

Accounts Receivable (Days of sales) 36 27

Accounts Payable (Days of sales) 60 52

Working Capital Needs (Days of sales) 6 5

Fahmi Ben Abdelkader © Financial Statement Analysis

Example of Just-In-Time Company N+1 N

167,6%

74,0% 62,6%

72,9% 63,3%

6,2% 11,3%

21,0% 25,5%

32,2 31,2

91,8 52,3

124,0 83,5

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Capital Structure ratios: Where does the money come from?


Used to assess the weight of the debt as a source of financing

Indicate the level of dependence vis-à-vis of creditors

Equity Total

DebtNet RatioEquity -Debt Ratio (gearing) Leverage ==

Equity TotalDebtNet

DebtNet Ratio Capital-to-Debt

+=

sInvestment Short term &Cash -Debt FinancialDebt Fin.Net =

sLiabilitie Total

Debt termLongRatioDebt termLong =

sLiabilitie Total

Debt Short termRatioDebt Short term =

sLiabilitie Total

PayableRatio Payable =

Equity 'rsShareholde

DebtNet Equity 'rsShareholde invested Capital +=

Accounting approach

Financial approach

285,1%


Capital Structure ratios: Where does the money come from?


Financial leverage may increase because of a decrease in shareholder equity

The significant fall in equity between 2010 and 2011 (-31%) is due to the distribution of Dia shares, which reduced shareholder’s equity by €2.2B and the payment of €0.8B in cash dividends

2014 2013 2012 2011 2010

Financial Leverage 604,4% 689,1% 746,8% 841,5% 614,4%

Debt-to-capital ratio 85,8% 87,3% 88,2% 89,4% 86,0%

Long-term debt / Total Liabilities 24,2% 27,4% 29,6% 22,8% 22,7%

Short-term debt / Total Liabilities 15,7% 14,0% 14,3% 5,5% 6,4%

Accounts payable / Total Liabilities 38,5% 37,9% 34,9% 38,8% 39,7%

Shareholders' Equity 9191 7925 7181 6618 9584

Net Financial Debt 55552 54614 53624 55693 58887

Invested Capital 64743 62539 60805 62311 68471

Example: Carrefour


Leverage Ratio: book value or market value?


Because of the difficulty interpreting the book value of equity…

… it is more informative to compare the firm’s debt to the market value of its equity

Example:

Domino’s Pizza has, based on the strength of its cash flow, consistently borrowed in excess of the book value of its assets.

In 2012, it had debt of $ 1.6 billion, with a total book value of assets of only $ 600 million and an equity book value of -$ 1.4 billion


Concept Check and Critical Thinking

1. What is depreciation designed to capture?

2. The book value of a company’s assets usually does not equal the market value of those assets. What are some reasons for this difference?

3. What does a high debt-to-equity ratio tell you?

4. What is a firm’s enterprise value?


Concept Check and Critical Thinking

A substantial drop of the stock price of a company will inevitably reduce its cash

True False

Samsung profit warning: Q3 profits to fall by a third after the Galaxy Note 7 problems


Appendix – decrease of the fixed assets, the example of Twitter

2011 2012 2013 2014 2015

Fixed Assets / Total Assets 17.3% 33.3% 23.5% 23.8% 32.0%

Inventory / Total Assets 0% 0% 0% 0% 0%

Accounts Receivable / Total Assets 5.5% 13.5% 7.3% 7.5% 9.9%

Cash & Equivalent / Total Assets 76.3% 51.1% 66.4% 64.9% 54.3%

Asset Analysis

• Fixed Assets to Total Assets decreased in 2013 when Twitter reinvested new capital into short term investments but it has since then invested in fixed assets raising the level back to 33%.

• As company with no physical products, Twitter has no inventory.

• The accounts receivables the main reason working capital is high and increasing; it decreased in 2013 when total assets increased but has also grown back since implying Twitter has not improved its positioning with advertisers.


Appendix – Increase in fixed assets, the example of Yahoo!

-200,00%

-100,00%

0,00%

100,00%

200,00%

300,00%

400,00%

500,00%

2013 2014 2015 2016

Net Sales Total Assets Net Income

2012 2013 2014 2015 2016

Net Sales -6.16% -1.32% 7.58% 4.05%

Total

Assets-1.74% 268.71% -27.04% 6.37%

Net

Income-65.36% 450.26% -157.95% 95.09%

• The growth rate of net sales began to be positivefrom 2015 and keep increasing, which indicates theimprovement of the core business.

• The growth rate of total assets keep increasing intotal, and has its peak in 2014.

� In 2014, the total assets increased muchfaster than the net sales, due to theappreciation of fair value for Alibaba’s sharesthrough its IPO.

• The growth rate of net income suffered fromfluctuations:

� In 2014, Yahoo increased its net income byselling Alibaba Group ADSs for $9.4billion .

• We can conclude that Yahoo!’s wealth creationability is not very stable, their ability to gain incomefrom daily operating activities is not good andmostly rely on other income means to maintain thegrowth of net income.


Net financial debt and the exchange rate

Change in net financial debt of EDF

The Group’s net financial debt was €36.2 billion at 30 June 2016 compared to €37.4 billion on 31 December 2015. This decrease of €1,187 million was mainly due to a positive Group cash flow (+€107 million) and to a favorable currency effect (+€1,036 million) due t o the depreciation of the exchange rate of the pound sterling .

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