The document discusses the question of what to do with wealth. It suggests that the only real question around wealth is how it is used. The summary conveys the core idea in the document in a concise manner in 3 sentences.

1. The only question with wealth is what you
do with it.
LOGIC Executive Program LEP
Finance Module
Tarek Fahim

2. Breaking The Ice
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3. Are you Wondering :
• Who cares about financial statements?
• What do people mean by “top line growth”?
• What do people mean by “bottom line growth”?
• What are assets?
• What is the difference between profit and cash flow? Which one is more important?
• What is the difference between operating profit and net income?
• What is “overhead”?
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4. The Framework
FS Review
Financial Ratio
Analysis
Time Value
Capital Budgeting &
Decision Making
Valuation
Investment &
Portfolio Management
Tarek Fahim 4

5. The Framework
FS Review
Financial Ratio
Analysis
Time Value
Capital Budgeting &
Decision Making
Valuation
Investment &
Portfolio Management
Tarek Fahim 5

6. There are four basic components of financial statements
2. Statement Of
1. Profit And Loss Account 3. Balance Sheet
Cash Flows
Matches revenues with costs Shows the changes in cash a) Lists the assets owned by
• Profit: revenue > cost • Over the accounting period the firm
• Loss: revenue < cost
b) Details how these assets are
financed
• Shareholders (equity)
• Lenders (liability)
States the results of the firm's States actual transactions Snapshot of firm’s financial
operations without accounting position
• Over a period of time adjustments • On the day the statement
• Including accounting was prepared
adjustments, e.g. • Cumulative - represents
depreciation result of all transactions
that have taken place up to
that point
4. Notes To The Accounts
Contain explanatory information in addition to or in respect of the above statements
e.g. revenue split by geography/segment, financials of acquisitions/discontinued businesses etc.
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7. What can we get out of them?
• At the most basic level, financial statements tell you
• How much it sells and at what cost
predominantly
• How much cash it generates
quantitative
• How many assets it has and whether these
are owned by banks or shareholders
• However, they also provide insight into
• Who owns it/major stakeholders
• How it is organised/key decision makers some qualitative
• Market share/growth targets data given
• Level of concern for its employees/community
• What the Chairman looks like (!)
•
And if you look really hard, they may provide
reading between
• A window into the company’s strategy
the lines required
• Economics of the industry/competitors
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8. FS Review
The Profit And Loss Account
The Cash Flow Statement
The Balance Sheet
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9. The Infamous Profit & Loss Formula
Revenues Costs
Profits
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10. Conventional form of Profit & Loss Account
Revenues
less: costs of goods sold (COGS), incl. raw
Generation of profit materials, direct labour, ...
Result of sales and
Gross margin
costs of providing
goods/services
less: operating expenses, incl. admin,
marketing, depreciation, ...
Operating profit (EBIT)
Interest (income and expense)
Distribution of profit Tax
State Net income
Banks
Shareholders Dividends
Retained profit
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11. Common profit measures
Profit measure Definition Benefits/comments
Gross margin Revenues • When comparing companies, be sure to
less: Cost Of Goods Sold understand what’s in COGS
EBITDA Gross margin • Often used as approximation of cash flow,
Earnings before interest, tax, less: operating expenses, except e.g. in Discounted Cash Flow analysis
depreciation and amortisation
depreciation and amortisation
EBITA EBITDA • Safe bet when doing cross-border
Earnings before interest, tax and less: depreciation comparisons, given treatment of amortisation
amortisation
in different countries
EBIT EBITA • This is what most people mean when they
Earnings before interest and tax less: amortisation say “operating profit"
or:
Gross margin
less operating expenses
NOPAT EBIT • After tax measure of operating profit
Net operating profit after tax less: tax • Often used in financial ratios
PBT EBIT • Used by some companies as key profit
Profit before tax less: interest measure
Net income EBIT • “The bottom line”
less: interest and tax • Profit that goes to shareholders
• Used for earnings per share and P/E
multiples
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12. What to look for in a P&L
Cost and Margin
Cost and Margin
Trends
Trends Discontinuities
Discontinuities structure
structure
By comparing one year to the These can draw your Looking at individual line
next, it is possible to tell attention to areas where the items, it is possible to gain
• Whether a company is company was making change insight into the cost and
growing or contracting or decisions. This focus can margin structure of a
• Whether or not it has aid in understanding company
improved efficiency • What a company’s • What is the breakdown
• How it may do in the operating strategy is between fixed and
future, based on • How competitors’, variable costs?
qualitative or extrapolated suppliers’ or customers’ • How much overhead does
values behaviour has affected a the company carry?
company • What is its operating
Trends may also provide margin?
insight into • Does it have high interest
• Changes in supply or expenses?
demand
• The competitive
environment
• The broader economy
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13. P&L walk-through
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14. FS Review
The Profit And Loss Account
The Cash Flow Statement
The Balance Sheet
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15. Cash Flow Statement reports inflows and outflows of cash
during a period
Cash flows generated/paid out during the
1. Operating normal course of the business
Cash Flows • Eg receipts from customers, payments
to suppliers
Cash flows generated/paid out from dealing with
Total Cash 2. Investing investments or fixed assets
Flows + Cash Flows • Eg purchase of plant/machinery, proceeds
from sale of investments
Cash flows associated with the funding of the
3. Financing assets of the business
Cash Flows • Eg proceeds from bank loan, dividends paid
to shareholders
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16. Difference between Cash Flow Statement and P&L
P&L adjusts by allocating income and costs to
the year in which they theoretically occur:
• Fixed assets: cash flow statement registers
when fixed assets are paid; P&L shows when
they are used
• Taxes: cash flow statement shows when you
send a cheque to the tax man; P&L shows
when they are theoretically generated
• Other differences include provisions,
accounts payable/receivable, ...
Companies pay taxes and are assessed for
profitability based on figures in the P&L
The P&L focuses on profitability,
while the cash flow statement focuses on liquidity
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17. Uses of the Cash Flow Statement
• Management uses a forecast of cash flows
• When a company is growing, it may need more cash
• When a company is in financial difficulty, it may have to convince suppliers that it will be able
to pay the bills
• Lenders want to know if cash flows are adequate to pay interest on debt and repay the
principal when it becomes due
• Shareholders want to know about adequacy of cash flow to pay dividends
• Private equity investors are particularly interested in cash flow!
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18. What to look for in a Cash Flow Statement?
• Timing of key events
• The cash flow statement is the only financial statement which provides a clear picture of when
cash actually enters or exits the business
• For projections, a key measure is often when a company or project becomes cash flow positive
• Mix of sources and uses of cash
• Provides insight into how a company operates
– how does the company finance capacity expansions?
– what are the major cash drains on the company?
• Ability to cover costs
• Measures like cash flow interest coverage are useful here
• Value of the company
• Many analysts will value a company based on the net present value of its cash flows
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19. Cash Flow Statement walk-through
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20. FS Review
The Profit And Loss Account
The Cash Flow Statement
The Balance Sheet
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21. The Infamous Balance Formula
Total Liabilities Total Equities
Total Assets
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22. The Balance Sheet is a snapshot of a company’s
financial position
Represents financial picture as it stands on one particular day, e.g. 31 December, 2007
Balance sheet
Liabilities
• Obligations or legal debts due
– Suppliers
Assets – Banks
• Goods, property and financial
assets owned (net of
= – Revenue & Customs
depreciation)
Shareholder’s Equity
• The amount left over after
liabilities are subtracted from
assets
What is owned? How is it financed?
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23. Movement in the Balance Sheet can be seen in the P&L
Balance Sheet: 31 Dec 2006 P&L: 2007 Balance Sheet: 31 Dec 2007
Profit Profit
Liability Liability
Assets = =
Revenue
Expenses
Assets
Equity Equity
Profit = Equity
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24. Assets can be classified into a number of different categories
Cash And Cash
Equivalents
Receivables
Current
Investments
Usually
converted to Inventories
cash within
12 months
Assets + Other
Property, Plant
And Equipment
Tangible Investments
Non-current
Intangible Other
Physical or
intellectual/
non-physical
assets
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25. Liabilities are claims by creditors on the resources
(assets) of a firm
Key Classification Of Liabilities
Interest-bearing
Accounts Payable
Liabilities
Non-interest Bearing
Provisions
Liabilities
Total Liabilities +
Deferred Income Tax
Contingent Liabilities
Liability
Off-balance Sheet
Financing
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26. Like assets, liabilities can be divided into current and
non-current
Element Definition Example
Current Liabilities Liabilities that will require settlement (in Short term debt
cash or otherwise) within 12 months of Accounts payable
the balance sheet date
Non-current Liabilities which are longer term in Long term debt
Liabilities nature, ie those which will not require Provision for deferred tax
settlement within the next 12 months
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27. Equity is the residual after all claims against the firm’s
assets have been satisfied
Assets Liabilities Equity
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28. Microsoft Has NO Debt !
Major U.S. companies ranked
by debt to total capital
Two key reasons Microsoft has no debt
1 Microsoft is a cash rich company able to fund
itself from its own operations
2 Software companies typically have very low
debt levels
• WC dominates software companies’
balance sheets
• Fixed asset requirements are low
• Therefore, debt is minimal
The other companies all have much larger
fixed costs (production facilities, branch
outlets, etc.) making it difficult to rely on
equity alone.
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29. Balance Sheet walk-through
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30. P&L and Cash Flow Statement are part of the Balance Sheet
• Balance sheet is an amalgamation of many
different accounts, incl. equipment, fleet,
property, fuel, cash, payables, receivables,
loans, shareholders’ equity ...
• Every business transaction is recorded in two
accounts:
• A change in one asset must result in a change in
another asset or a change in liabilities or equity
• This is called double entry book-keeping
• The majority of transactions affect either cash
or shareholders’ equity
• The cash account is called Cash Flow Statement
• The shareholders’ equity account is called P&L
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31. The Framework
FS Review
Financial Ratio
Analysis
Time Value
Capital Budgeting &
Decision Making
Valuation
Investment &
Portfolio Management
Tarek Fahim 31

32. Ratio Analysis can be divided into five key ‘Buckets’
Financial Ratio
Analysis
Purpose
Description How much How much How hard is Does the With what
profit is the profit is a the company proportion
business business company have of debt or
generating generating working its enough shareholder
relative to relative to assets? short-term s’ equity is
its asset its sales? funds to the business
base? How finance its funding its
efficiently is operating assets?
it managing require-
• Earnings its ments?
and assets inventories/
must be receivables
consistent ?
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33. Using BoY versus EoY Balance Sheet Entries Can Make a
Big Difference Example: Return on Assets.
“Return”
Income
statement Σ = 4
ROA based on:
BOY AVG EOY
4 4 4
“Assets” 30 40 50
13% 10% 8%
Balance
50
sheet 30 Which is correct? Average
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34. 1
Ratio Analysis (Performance Ratios)
Acronym Title Definition Typical values Comments
ROA Return on assets After-tax, 3% to 25% Expected to be stable. Increases are
Return depending on company good. As assets age, measure may
Avg total assets and industry increase without true economic gains
ROE Return on equity -5% to 30% depending Expected to be stable. Increases are
Return on company, industry, good. Due to leverage, numbers are
Avg shareholder’s and leverage often erratic
equity
EVA % Percent of -10% to 10% depending Expected to be stable. Increases are
economic value NOPAT - Cap Chrg on company and good. As assets age, measure may
added Avg capital industry increase without true economic gains
(EVA Spread) employed
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35. 2
Ratio Analysis (Profitability Ratios)
Acronym Title Definition Typical values Comments
GM % Gross margin 40% to 60% depending Expected to be stable. High numbers
percentage Rev - COGS on product, company are good. Increases are good.
Revenue and industry Influenced by competition significantly
and costs
EBITDA % Earnings before 20% to 35% depending Expected to be stable. High numbers
interest tax EBITDA on product, company are good. Should increase
depreciation and Revenue and industry significantly with scale. Significantly
amor. margin influenced by competition and costs
Op margin Operating margin 10% to 30% depending Expected to be stable. High numbers
% NOPAT on product, company are good. Should increase
Revenue and industry significantly with scale. Significantly
influenced by competition and costs
SGA % Selling general and 5% to 20% depending on Should decline significantly with scale
Sales admin as % of sales SG&A product, company and
Revenue industry
Net income Net income margin 5% to 25% depending on Expected to be stable. High numbers
% Net Income product, company and are good. Increases are good
Revenue industry Influenced by competition significantly
and costs
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36. 3
Ratio Analysis (Productivity Ratios)
Acronym Title Definition Typical Values Comments
A/R days Account receivable 30-90 depending on Expected to be steady if properly
days outstanding Avg Recv company, industry and managed. Decreases are good.
x365
Revenue country Usually a function of terms and active
management
A/P days Account payable 20 to 65 depending on Expected to be stable. Increases are
days outstanding Avg Payables company, industry and good. If number get too large the
x365
Purchases country company is having trouble and/or their
suppliers are not happy
Inv turns 4x to 15x depending on Expected to be stable and decreasing.
company and industry Will vary with seasonal businesses. If
(INVx) COGS
Inventory turns too low, products get old, and or
Avg Inventory
company is having sales troubles
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37. DuPONT Analysis Disaggregate Key Performance Ratios Into
Their Underlying Business Drivers
Profit margin
How much earnings are being
Return generated from sales?
Sales What type of business is it
Return on assets • High volume, low margin
• High margin, low volume
Return
Total Assets x
Asset turnover
Return on equity How hard is the business working its
assets?
Sales
Return
x Depends on type of industry
Total Assets
Shareholders’
Equity E/A ratio
Total Assets How is the business financing its
assets?
Shareholders’
Equity How much debt is the business
using relative to shareholders’
funds?
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38. DuPONT Analysis - Level 1 ROE
What return is the
business generating
What return is the from the resources
business generating that it is using?
for the funds that its
shareholders have Return on assets
contributed?
Return(1)
Total Assets
Return on equity
Return
x
Shareholders’
Equity E/A ratio
How are the assets being
Total Assets
funded?
Shareholders’ What magnification of
Equity
return (or loss) do we
expect due to use of debt?
Tarek Fahim 38

39. DuPONT Analysis – Level 2 ROA
What return is the What are the costs
business generating associated with the
from the resources Profit margin products/ services a
that it is using? company sells?
Return(
Sales
Return on assets
Return
Total Assets x
Asset turnover
Return on equity
Sales What does the
Return company derive
x from its assets?
Total Assets
Shareholders’
Equity E/A ratio
Total Assets
Shareholders’
Equity
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40. Ratios Can Be Cascaded Down Below The Typical DuPont
Levels
Revenue
Profit margin
e.g., Revenue/Unit (Price)
Return
Sales f
Cost
e.g., Cost/Unit
Inventory turnover
Cost Of Goods Sold(2)
ROA Average Inventory
Asset turnover
Receivables turnover
Sales Sales
Total Assets
f
Average Receivables
Fixed asset turnover
Sales
Average Fixed Assets
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41. Displaying Driver Trees Over Time Often Provides Additional
Insight - Example: Profit Growth Lagging Increases in Capital Employed
NOPAT margin (%) Delta 1.6%
NOPAT ($M) CAGR 11.8%
Return on capital is
X declining
Sales ($M) CAGR 5.8%
Year Return on capital (%) Change (6.2) %
Growth in capital ÷
Net working capital ($M) CAGR N/A employed has significantly
outpaced profit growth
Year
Capital employed ($M) CAGR 23.5%
+
Total fixed capital ($M) CAGR 21.8%
CAGR 21.8%
Year
Driven by a constant
Year increase in fixed capital
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42. 4
Ratio Analysis (Liquidity Ratios)
Acronym Title Definition Typical values Comments
WC Working Capital Accts receivables Greater than zero Not technically a ratio but related to
+ inventory liquidity, working capital is the margin
- accts payable of current assets over current liabilities
OR that a firm maintains
C. Assets - C. Liab
Current ratio Current Ratio 1.0 - 2.0 Measures ability to pay current
liabilities from current assets. Should
Depends on the industry
Current Assets be stable. A higher ratio means lower
and activity cycle
Current Liab risk but, too high a ratio could indicate
excess inventory or failure to collect
payment
Quick ratio Quick Ratio 0.2 - 1.0 Similar to current ratio but more
accurate. Excludes less liquid assets
Cash + Marketable Depends on the industry
such as inventories. Answers the
Securities + A/R and activity cycle
question: “if sales stopped, could this
Current Liab. firm meet its obligations with readily
accessible assets on hand?”
Tarek Fahim 42

43. 5
Ratio Analysis (Capital Structure Ratios)
Acronym Title Definition Typical values Comments
D/E Debt to Equity Ratio 0.2-1.0 depending on the Commonly used to indicate bankruptcy
industry and company risk, the higher the ratio, the riskier the
Balance sheet debt
company
Shareholders Equity
D/A Debt to Asset Ratio 0.1 - 0.5 depending on Measures the proportion of a firms
the industry and assets that are funded by debt
Balance sheet debt
company
Total Assets
Tarek Fahim 43

44. Let’s Crunch Some Numbers: 2003-2005
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45. Ratio Analysis (Performance Ratios) : ROI - ROE
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46. Performance Analysis !!
• ROI curves are showing that both
companies are doing very well, their
numbers are very close to each other. Year
2004 shows a small drop for both that was
recovered very soon in year 2005.
• ROE, in the contrary is very different
between both companies. We can observe
that ROE of Mobinil is much higher that
ROE of Vodafone. The numbers in 2005 are
93% (Mobinil) and 56% (Vodafone). It is
very clear that this difference is due
primarily to the big financial leverage
Mobinil practiced.
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47. Ratio Analysis (Profitability Ratios) :
Tarek Fahim 47

48. Profitability Analysis !!
• Mobinil is better managing its COGS than
Vodafone (Know why ?)
• Vodafone has higher Net Income Margin
than Mobinil due to its financing strategy.
Tarek Fahim 48

49. Ratio Analysis (Productivity Ratios) : A/R Days – Inv Turns X
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50. Productivity Analysis !!
• Days in account receivable amount is
decreasing for both companies which
indicates that the efficiency of the account
receivable department is improving.
However, this amount is much less in
Mobinil than Vodafone, which either
means Mobinil is doing better in collecting
the money or Vodafone is using a longer
credit terms.
• Vodafone is better managing its
inventories while Mobinil Inventory
turnover is decreasing.
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51. Ratio Analysis (Liquidity Ratios) : WC – Current ratio
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52. Liquidity Analysis !!
• It is clear from the numbers that Mobinil
and Vodafone are not having much
liquidity to cover their liabilities. Current
ratio is below 1 and declining, acid test
ratio is even below 0.5.
• It is clear from the charts that Vodafone
did a better job than Mobinil to reduce this
shortage in liquidity in year 2005, as their
ratios improved a little bit, while Mobinil’s
ratios are getting worse
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53. Ratio Analysis (Capital Structure Ratios) : D/A – D/E ratios
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54. Capital Structure Analysis !!
• From Debt/Equity chart, it is easy to tell
that Mobinil is taking big risks as this ratio
reached 3.2 in year 2005. Vodafone is
taking less and more consistent risk.
• Mobilinil is highly leveraged compared to
Vodafone.
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55. Ratio Analysis (Investment) : EPS – P/E ratios
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56. Investment Analysis !!
• Vodafone’s P/E ratio was higher than
Mobinil’s on year 2003 and 2004, while
Mobinil succeeded to achieve a better
result in year 2005.
• P/E ratio shows how much people are
willing to pay for a stock.
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57. Linking Financial Ratios to Balanced Scorecards (I)
• The balanced scorecard is a way for managers to view the organization from four
interrelated perspectives of operational drivers for future performance:
• Financial perspective. How are we doing using traditional financial performance measures?
1
How do shareholders view us?
2 • Customer perspective. How satisfied are our customers?
3 • Internal perspective. What ways do we, and in what ways should we, excel?
4
• Innovation and improvement perspective. How can we continue to improve and create
value in the future?
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58. Linking Financial Ratios to Balanced Scorecards (II)
• The balanced scorecard is linked to the
Financial ratios and the budget process in
the following ways:
• It highlights leading indicators, such as new
product development, customer complaints,
or direct mail response rates, instead of only
sales or cost figures
• It balances the four perspectives so that, for
example, pressure to develop new products
doesn’t overshadow the need for quality
products and customer satisfaction
• It helps management to communicate
strategic goals and mission to all the
stakeholders in the organization
Tarek Fahim 58

59. Balanced Scorecards 9 Steps Method
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60. Enron Case !!
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61. The Framework
FS Review
Financial Ratio
Analysis
Time Value
Capital Budgeting &
Decision Making
Valuation
Investment &
Portfolio Management
Tarek Fahim 61

62. Time Value of Money
Money that the firm
has today is more
valuable than future
payments because
current money can
be invested to earn
money
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63. Time Value of Money
Money that the firm has today is more valuable than future payments
because current money can be invested to earn money
Compounding
Future
Value
End of
Year
0 1 2 3 4 5 6 7
Present
Value
Discounting
Tarek Fahim 63

64. The Framework
FS Review
Financial Ratio
Analysis
Time Value
Capital Budgeting &
Decision Making
Valuation
Investment &
Portfolio Management
Tarek Fahim 64

65. Capital Budgeting
The process of
evaluating and
selecting long-
term investments
consistent with
the firm’s goal of
owner wealth
maximization
Tarek Fahim 65

66. Business Decisions
Expansion of Operations Replacement of Assets
Key Motives for
CapEx
Other Purposes as MKTG Renewal of Assets
Tarek Fahim 66

67. Capital Budgeting Process
1
Proposal Generation
2
Review & Analysis
3
Decision Making
4
Implementation
5
Follow Up
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68. Relevant Cash Flows
Initial Operating Cash Terminal Cash
Investment Flows Flow
Terminal Cash
Operating Cash Flows Flow
End of
Year
0 1 2 3 4 5 6 7
Initial
Investment
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69. Time To Play !
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70. Payback Period
The exact amount of time
required for a firm to cover its
initial investment in a project as
calculated from cash inflows
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71. Payback Decision
Terminal Cash
Operating Cash Flows Flow
End of
Year
0 1 2 3 4 5 6 7
Initial Investment
Payback Period
Less than Acceptable Period Greater than Acceptable Period
Accept Reject
71
Tarek Fahim 71

72. Net Present Value
A sophisticated capital budgeting
technique found by subtracting a
project’s initial investment from
the present value of its cash
inflows discounted at the firm’s
cost of capital
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73. Net Present Value Decision (NPV)
Terminal Cash
Operating Cash Flows Flow
End of
Year
0 1 2 3 4 5 6 7
Initial Investment Discounted at the cost of capital
NPV
Greater than Zero Less than Zero
Accept Reject
Tarek Fahim 73

74. The Framework
FS Review
Financial Ratio
Analysis
Time Value
Capital Budgeting &
Decision Making
Valuation
Investment &
Portfolio Management
Tarek Fahim 74

75. Valuation…
Discounted
Multiples
Assets' based Cash
based
Valuation Flow Valuation
Valuation
(DCF)
Most simple Most accurate
Tarek Fahim 75

76. Let’s Play Again
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77. The Framework
FS Review
Financial Ratio
Analysis
Time Value
Capital Budgeting &
Decision Making
Valuation
Investment &
Portfolio Management
Tarek Fahim 77

78. The Chinese symbols for risk
The first symbol is the symbol for “danger”, while the second is the symbol for
“opportunity”, making risk a mix of danger and opportunity
Tarek Fahim 78

79. Portfolio Components
Land Stocks Real Estate
Mutual Funds Bonds
Portfolio
Management
Currencies Cars
Ownerships Partnerships Cash
Tarek Fahim 79

80. Portfolio Management Definition
The process of
managing the assets,
including choosing
and monitoring
appropriate
investments and
allocating funds
accordingly
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81. Portfolio Management Goals
Maximize Profitability of Portfolio Maximize Value of Portfolio
Portfolio Management
Provide Balance between Risk and
Support the Firm Strategy
Return
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82. Tips & Tricks
• Diversification is a risk-management
technique that mixes a wide variety of
investments within a portfolio in order to
minimize the impact that any one security
will have on the the overall performance of
the portfolio.
• Diversification lowers the risk of your
portfolio.
• There are three main practices that can help
you ensure the best diversification:
• Spread your portfolio among multiple
investment vehicles such as cash, stocks,
bonds, mutual funds and perhaps even some
real estate.
• Vary the risk in your securities.
• Vary your securities by industry.
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83. Portfolio Management Sheet
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84. Final Word…
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85. Thanks...
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