Financial Statement Analysis Section 3. The analytical Balance sheet: the financial view From the Traditional Accounting to the Financial View Capital Employed and Invested Capital Market vs. Book Value Enterprise Value vs. Market Capitalization Asset and Capital Structure Ratios
Students version Fahmi Ben Abdelkader ©
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1
The analytical Balance sheet: the financial view
From the Traditional Accounting to the Financial View Capital Employed and Invested Capital Market vs. Book Value Enterprise Value vs. Market Capitalization Asset and Capital Structure Ratios
The Balance Sheet: a reminder Lists the firm’s assets and liabilities
Assets
Liabilities and Shareholders’ equity
Employments (uses of funds)
Financial Resources
What does the money get spent on?
Where does the money come from?
Total Assets
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Financial Statement Analysis
Liabilities + Shareholders’ equity
2
The analytical Balance sheet: the financial view
From the Traditional Accounting to the Financial View Capital Employed and Invested Capital Market vs. Book Value Enterprise Value vs. Market Capitalization Asset and Capital Structure Ratios
The Balance Sheet: a reminder A condensed presentation of the Balance Sheet Assets
Liabilities and Shareholders’ equity
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
Shareholders’ equity
Investment of Shareholders and accumulated reinvested profits
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
Cash and marketable short-term investments securities easily sold and converted to cash
Total Assets
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Fahmi Ben Abdelkader ©
The analytical Balance sheet: the financial view
…..
Liabilities + Shareholders’ equity
Financial Statement Analysis
3
From the Traditional Accounting to the Financial View Capital Employed and Invested Capital Market vs. Book Value Enterprise Value vs. Market Capitalization Asset and Capital Structure Ratios
The Balance Sheet date can be crucial !!!! Lists the firm’s assets and liabilities Provides a snapshot of the firm’s financial position at a given point in time. The Balance sheet does not reflect the firm’s financial position during the year The fiscal year may differ from one country to another
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Financial Statement Analysis
4
The analytical Balance sheet: the financial view
From the Traditional Accounting to the Financial View Capital Employed and Invested Capital Market vs. Book Value Enterprise Value vs. Market Capitalization Asset and Capital Structure Ratios
The Balance Sheet date can be crucial !!!! Lists the firm’s assets and liabilities Provides a snapshot of the firm’s financial position at a given point in time. The Balance sheet does not reflect the firm’s financial position during the year The fiscal year may differ from one country to another Seasonality factor
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?
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The analytical Balance sheet: the financial view
5
Financial Statement Analysis
From the Traditional Accounting to the Financial View Capital Employed and Invested Capital Market vs. Book Value Enterprise Value vs. Market Capitalization Asset and Capital Structure Ratios
The Balance Sheet and the Industry Example : the industry is critical Assets Intangible assets
1
2
3
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
1 230
196 036
443 397
175 451
135 238
Inventory Accounts receivable Cash and cash equivalents TOTAL ASSETS
112 686 6 590
181 773 1 032 364
194 596
731 214 2 236 326
Liabilities and Equity Shareholders’ Equity
Long-term debt Accounts payable Short –term debt
TOTAL LIABILITIES
1
2
3
150 054
360 111
893 324
369
41 137
416 912
201 809 860
194 596
198 738 1 050 157 131 228
0
731 214 2 236 326
EUROPAGES (produces agendas and office supplies based on paper) RFM (a network radio) TOUTCONFORT (an electrical goods retailer )
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Financial Statement Analysis
6
The analytical Balance sheet: the financial view
From the Traditional Accounting to the Financial View Capital Employed and Invested Capital Market vs. Book Value Enterprise Value vs. Market Capitalization Asset and Capital Structure Ratios
The Balance Sheet and the Industry Example : the business model has major implications on the relevant items in the balance sheet
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The analytical Balance sheet: the financial view
7
Financial Statement Analysis
From the Traditional Accounting to the Financial View Capital Employed and Invested Capital Market vs. Book Value Enterprise Value vs. Market Capitalization Asset and Capital Structure Ratios
The Balance Sheet: the traditional accounting form Example: JIT : Just-In-Time Computer Services Consolidated Statements of Financial Position Prepared According to IFRS in € millions Assets
Year 2
Year 1
0,0
0,0
41,0 78,7
14,0 66,9
1,0
0,0
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 Cash and cash equivalents
2,0 21,2
1,0 19,5
Total current assets
57,0
48,0
TOTAL NET ASSETS
177,7
128,9
Goodwill Intellectual property rights, brands and other intangible assets Net Property, Plant and Equipment Financial Assets (Equity in Joint ventures, investments in shares and participations, deferred tax assets, etc.) Total non-current assets
Liabilities and Shareholders' Equity
Year 2
Year 1
32,2
31,2
Long-term financial debt
106,0
61,8
Non-current liabilities
106,0
61,8
9,0
11,0
30,5
24,9
Total Shareholders' Equity
Short-term financial debt Accounts payable
Asset liquidity
Maturity dates Current liabilities
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Financial Statement Analysis
TOTAL LIABILITIES AND EQUITY
39,5
35,9
177,7
128,9
8
The analytical Balance sheet: the financial view
From the Traditional Accounting to the Financial View Capital Employed and Invested Capital Market vs. Book Value Enterprise Value vs. Market Capitalization Asset and Capital Structure Ratios
From the Traditional Accounting to the Financial View
Liabilities
Assets
Fixed Assets
Shareholders’ Equity
32
Long-Term Financial Debt
106
Current Liabilities Accounts Payable
31
121
Net Fin. Debt =
WCN = Inventory + Accounts receivable – Accounts Payable
Current Assets: Inventory Accounts receivable
34
Cash & short-term investments
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The analytical Balance sheet: the financial view
Financial Debt LT & ST – Cash & short-term investments
23 Short –Term Financial Debt
9
9
Financial Statement Analysis
From the Traditional Accounting to the Financial View Capital Employed and Invested Capital Market vs. Book Value Enterprise Value vs. Market Capitalization Asset and Capital Structure Ratios
Working capital needs of JIT Computer services
Year 1:
WC =
Year 2:
WC = 15.3 M€ + 18.5M€ – (29.9 + 0.6) = 3.3 millions €
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
5
6
Working Capital Needs (Days of sales)
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Financial Statement Analysis
10
The analytical Balance sheet: the financial view
From the Traditional Accounting to the Financial View Capital Employed and Invested Capital Market vs. Book Value Enterprise Value vs. Market Capitalization Asset and Capital Structure Ratios
The rationale behind using Net Debt rather than Gross debt
Net Fin. Debt = Financial Debt LT & ST – Cash & short-term investments
Net debt = 92
Cash & short-term investments
23
Long-Term Financial Debt
106
Short –Term Financial Debt
9
Example : World company Equity Net debt 10/4/2017 11:36 AM
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The analytical Balance sheet: the financial view
Year 1
Year 2
31,2 52,3
32,2 91,8 11
Financial Statement Analysis
From the Traditional Accounting to the Financial View Capital Employed and Invested Capital Market vs. Book Value Enterprise Value vs. Market Capitalization Asset and Capital Structure Ratios
The rationale behind using Net Debt rather than Gross debt Analyzing financial debt Risk of default Autonomy/independence of the management vs pressure/intervention of creditors
10/4/2017 11:36 AM
Firm 1
Firm 2
Gross fin debt
100 M€
100 M€
Cash
20 M€
100 M€
Net debt
+80 M€
0 M€
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Financial Statement Analysis
12
The analytical Balance sheet: the financial view
From the Traditional Accounting to the Financial View Capital Employed and Invested Capital Market vs. Book Value Enterprise Value vs. Market Capitalization Asset and Capital Structure Ratios
From the Traditional Accounting to the Financial View
Fixed Assets
Shareholders’ Equity
32
Net Financial Debt
92
Invested Capital
124
121
Net Working Capital
3
124
Capital Employed
The financial simplified presentation of the balance sheet
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The analytical Balance sheet: the financial view
13
Financial Statement Analysis
From the Traditional Accounting to the Financial View Capital Employed and Invested Capital Market vs. Book Value Enterprise Value vs. Market Capitalization Asset and Capital Structure Ratios
Capital Employed vs Invested Capital 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’ Equity + Net Fin. Debt
Shareholders’ Equity
Capital Employed
Fixed Assets
32
121 Net Financial Debt
Net Working Capital
92
Invested Capital
3
Quick Check Question : Calculate capital employed of JIT Company (What does the money spent on) ?
Fixed Assets Working Capital Capital Employed 10/4/2017 11:36 AM
N+1
N
120,7 3,3 124,0
80,9 2,6 83,5
Fahmi Ben Abdelkader ©
Shareholders' Equity Net Financial Debt Invested Capital
Financial Statement Analysis
N+1
N
32,2 91,8 124,0
31,2 52,3 83,5 14
The analytical Balance sheet: the financial view
From the Traditional Accounting to the Financial View Capital Employed and Invested Capital Market vs. Book Value Enterprise Value vs. Market Capitalization Asset and Capital Structure Ratios
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
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The analytical Balance sheet: the financial view
Financial Statement Analysis
15
From the Traditional Accounting to the Financial View Capital Employed and Invested Capital Market vs. Book Value Enterprise Value vs. Market Capitalization Asset and Capital Structure Ratios
Book Value or Market Value of a firm’s equity? 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 is not a good estimate 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 Example: the value of an office building Many of the firm’s valuable assets may not be captured on the balance sheet 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 could possibly be negative
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Financial Statement Analysis
16
The analytical Balance sheet: the financial view
From the Traditional Accounting to the Financial View Capital Employed and Invested Capital Market vs. Book Value Enterprise Value vs. Market Capitalization Asset and Capital Structure Ratios
Book Value or Market Value ?
Negative book value of Shareholders’ equity 10/4/2017 11:36 AM
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The analytical Balance sheet: the financial view
17
Financial Statement Analysis
From the Traditional Accounting to the Financial View Capital Employed and Invested Capital Market vs. Book Value Enterprise Value vs. Market Capitalization Asset and Capital Structure Ratios
Book Value or Market Value ?
Shareholders’ equity of Air France-KLM Group Negative book value of Shareholders’ equity
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Financial Statement Analysis
18
The analytical Balance sheet: the financial view
From the Traditional Accounting to the Financial View Capital Employed and Invested Capital Market vs. Book Value Enterprise Value vs. Market Capitalization Asset and Capital Structure Ratios
Book Value or Market Value of a firm’s equity? Traditional Accounting: Book value = Historical cost – depreciation Problems:
To make a long story short …
Historical cost ≠ current cost or value Depreciation ≠ value loss From a valuation perspective, book values are almost meaningless,except in a liquidation context
New approach (IFRS): Book value = Faire Value Problems: Fair value often impossible to define or arbitrary Frequent Fluctuations should be interpreted with caution
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The analytical Balance sheet: the financial view
Financial Statement Analysis
19
From the Traditional Accounting to the Financial View Capital Employed and Invested Capital Market vs. Book Value Enterprise Value vs. Market Capitalization Asset and Capital Structure Ratios
The Market Value: an accurate assessment of the “fair” value The market value of a firm’s equity: a company’s Market Capitalization
Market Capitalization = Market Price per Share x Number of Shares Outstanding
Cannot be negative Does not depend on historical cost of assets Often differs substantially from book value 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 =
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Financial Statement Analysis
20
The analytical Balance sheet: the financial view
From the Traditional Accounting to the Financial View Capital Employed and Invested Capital Market vs. Book Value Enterprise Value vs. Market Capitalization Asset and Capital Structure Ratios
The Market-to-book ratio (or Price-to-Book Ratio (PBR)) The ratio of a firm’s market capitalization to the book value of stockholders’ equity:
Market - to - Book Ratio =
Market Value of Equity Book Value of Equity
M/B Ratio > 1 The market value of the firm’s assets exceeds their historical cost (or liquidation value)
Quick Check Question : Compute the Market-to-book ratio of JIT Company?
Market - to - Book Ratio =
50.4 = 1.5 32.2
Investors are willing to pay one and a half times the book value of JIT’s shares
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The analytical Balance sheet: the financial view
21
Financial Statement Analysis
From the Traditional Accounting to the Financial View Capital Employed and Invested Capital Market vs. Book Value Enterprise Value vs. Market Capitalization Asset and Capital Structure Ratios
The Market-to-book ratio (or Price-to-Book Ratio (PBR)) Market-to-Book Ratios in 2010 of different firms and groups
Source: Berk & DeMarzo (2011), Fundamentals of Corporate Finance. Pearson
Value stocks (low M/B ratios) vs growth stocks (high M/B ratios)
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Financial Statement Analysis
22
The analytical Balance sheet: the financial view
From the Traditional Accounting to the Financial View Capital Employed and Invested Capital Market vs. Book Value Enterprise Value vs. Market Capitalization Asset and Capital Structure Ratios
The enterprise Value Versus Market Capitalization Capital Employed (= Shareholders’ Equity + Net Financial Debt) is a good estimate of a firm’s value Market value of Capital Employed = Market value of Equity + Net Financial Debt
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? Enterprise Value = It would cost € 142.4 million to buy all of JIT’s equity and pay off its debt
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The analytical Balance sheet: the financial view
Financial Statement Analysis
23
From the Traditional Accounting to the Financial View Capital Employed and Invested Capital Market vs. Book Value Enterprise Value vs. Market Capitalization Asset and Capital Structure Ratios
APPLE
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Financial Statement Analysis
24
The analytical Balance sheet: the financial view
From the Traditional Accounting to the Financial View Capital Employed and Invested Capital Market vs. Book Value Enterprise Value vs. Market Capitalization Asset and Capital Structure Ratios
APPLE
Source : The Wall Street Journal
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The analytical Balance sheet: the financial view
25
Financial Statement Analysis
From the Traditional Accounting to the Financial View Capital Employed and Invested Capital Market vs. Book Value Enterprise Value vs. Market Capitalization Asset and Capital Structure Ratios
APPLE
August 30, 2013
M/Book Ratio = 10/4/2017 11:36 AM
487.2 = 3 .5 135.8 Fahmi Ben Abdelkader ©
Market Cap
$ 487.2 B
Total Cash
$ 42.6B
Total Debt
$ 16.9 B
Book value of equity
$ 135.8
Enterprise Value =
Financial Statement Analysis
26
The analytical Balance sheet: the financial view
From the Traditional Accounting to the Financial View Capital Employed and Invested Capital Market vs. Book Value Enterprise Value vs. Market Capitalization Asset and Capital Structure Ratios
APPLE
May 27, 2015
M/Book Ratio = 10/4/2017 11:36 AM
Market Cap
$ 750.4 B
Total Cash
$ 33.4B
Total Debt
$ 43.8 B
Book value per Share
$ 22.3
Enterprise Value = Fahmi Ben Abdelkader ©
The analytical Balance sheet: the financial view
Financial Statement Analysis
27
From the Traditional Accounting to the Financial View Capital Employed and Invested Capital Market vs. Book Value Enterprise Value vs. Market Capitalization Asset and Capital Structure Ratios
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 firm uses its money? The ratio of fixed assets, the ratio of current assets, liquidity of assets, etc. How the money is raised ? Leverage, borrowing capacity, short-term cash needs, etc.
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Financial Statement Analysis
28
The analytical Balance sheet: the financial view
From the Traditional Accounting to the Financial View Capital Employed and Invested Capital Market vs. Book Value Enterprise Value vs. Market Capitalization Asset and Capital Structure Ratios
Asset Structure Ratios: How the firm uses its money? Used to assess the weight of each asset in the operating activity
Assets Structure Ratios =
Asset (i) Total Assets
Example of Just-In-Time Company
Fixed Assets Total Assets Inventory Inventory Ratio = Total Assets
Fixed Assets Ratio = Accounting approach
Receivable Ratio = Cash Ratio =
Receivable Total Assets
Cash Total Assets
Fixed assets (I) Financial approach
Working Capital (II) Capital Employed (I+II)
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The analytical Balance sheet: the financial view
N+1
N
67,9%
62,8%
8,6%
11,1%
10,4%
10,2%
13,1%
15,9%
120,7
80,9
3,3
2,6
124,0
83,5 29
Financial Statement Analysis
From the Traditional Accounting to the Financial View Capital Employed and Invested Capital Market vs. Book Value Enterprise Value vs. Market Capitalization Asset and Capital Structure Ratios
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
6
5
Working Capital Needs (Days of sales)
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Financial Statement Analysis
30
The analytical Balance sheet: the financial view
From the Traditional Accounting to the Financial View Capital Employed and Invested Capital Market vs. Book Value Enterprise Value vs. Market Capitalization Asset and Capital Structure Ratios
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 Example of Just-In-Time Company
N+1
Leverage (gearing) Ratio = Debt - Equity Ratio =
285,1%
167,6%
74,0%
62,6%
72,9%
63,3%
6,2%
11,3%
21,0%
25,5%
Shareholders' Equity
32,2
31,2
Net Fin. Debt = Financial Debt - Cash & Short term Investments
91,8
52,3
124,0
83,5
Debt - to - Capital Ratio = Accounting approach
Financial approach
Net Debt Total Equity
N
Net Debt Net Debt + Total Equity
Long term Debt Total Liabilities Short term Debt Short term Debt Ratio = Total Liabilities Payable Payable Ratio = Total Liabilities Long term Debt Ratio =
Capital invested = Shareholders' Equity + Net Debt 10/4/2017 11:36 AM
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The analytical Balance sheet: the financial view
31
Financial Statement Analysis
From the Traditional Accounting to the Financial View Capital Employed and Invested Capital Market vs. Book Value Enterprise Value vs. Market Capitalization Asset and Capital Structure Ratios
Capital Structure ratios: Where does the money come from? Financial leverage may increase because of a decrease in shareholder equity Example: Carrefour 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
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
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Financial Statement Analysis
32
The analytical Balance sheet: the financial view
From the Traditional Accounting to the Financial View Capital Employed and Invested Capital Market vs. Book Value Enterprise Value vs. Market Capitalization Asset and Capital Structure Ratios
Leverage Ratio: book value or market value?
Because of the difficulty interpreting the book value of 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
… it is more informative to compare the firm’s debt to the market value of its equity
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Financial Statement Analysis
33
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?
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Financial Statement Analysis
34
Concept Check and Critical Thinking Samsung profit warning: Q3 profits to fall by a third after the Galaxy Note 7 problems
A substantial drop of the stock price of a company will inevitably reduce its cash True 10/4/2017 11:36 AM
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False 35
Financial Statement Analysis
Appendix – decrease of the fixed assets, the example of Twitter
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.
2011
2012
2013
2014
2015
17.3%
33.3%
23.5%
23.8%
32.0%
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%
Fixed Assets / Total Assets Inventory / Total Assets
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Financial Statement Analysis
36
Appendix – Increase in fixed assets, the example of Yahoo!
•
•
The growth rate of net sales began to be positive from 2015 and keep increasing, which indicates the improvement of the core business. The growth rate of total assets keep increasing in total, and has its peak in 2014. In 2014, the total assets increased much faster than the net sales, due to the appreciation of fair value for Alibaba’s shares through its IPO.
•
The growth rate of net income suffered from fluctuations:
500,00% 400,00% 300,00% 200,00% 100,00% 0,00% 2013
2014
2015
2016
-100,00% -200,00% Net Sales
Total Assets
Net Income
In 2014, Yahoo increased its net income by selling Alibaba Group ADSs for $9.4 billion . •
We can conclude that Yahoo!’s wealth creation ability is not very stable, their ability to gain income from daily operating activities is not good and mostly rely on other income means to maintain the growth of net income.
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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%
Financial Statement Analysis
37
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 to the depreciation of the exchange rate of the pound sterling. 10/4/2017 11:36 AM
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Financial Statement Analysis
38
