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TiE Institute Session:Managing by the Numbers – Finance for Entrepreneurs
TiE Institute Session:Managing by the Numbers – Finance for Entrepreneurs
TiE Institute Session:Managing by the Numbers – Finance for Entrepreneurs
TiE Institute Session:Managing by the Numbers – Finance for Entrepreneurs
TiE Institute Session:Managing by the Numbers – Finance for Entrepreneurs
TiE Institute Session:Managing by the Numbers – Finance for Entrepreneurs
TiE Institute Session:Managing by the Numbers – Finance for Entrepreneurs
TiE Institute Session:Managing by the Numbers – Finance for Entrepreneurs
TiE Institute Session:Managing by the Numbers – Finance for Entrepreneurs
TiE Institute Session:Managing by the Numbers – Finance for Entrepreneurs
TiE Institute Session:Managing by the Numbers – Finance for Entrepreneurs
TiE Institute Session:Managing by the Numbers – Finance for Entrepreneurs
TiE Institute Session:Managing by the Numbers – Finance for Entrepreneurs
TiE Institute Session:Managing by the Numbers – Finance for Entrepreneurs
TiE Institute Session:Managing by the Numbers – Finance for Entrepreneurs
TiE Institute Session:Managing by the Numbers – Finance for Entrepreneurs
TiE Institute Session:Managing by the Numbers – Finance for Entrepreneurs
TiE Institute Session:Managing by the Numbers – Finance for Entrepreneurs
TiE Institute Session:Managing by the Numbers – Finance for Entrepreneurs
TiE Institute Session:Managing by the Numbers – Finance for Entrepreneurs
TiE Institute Session:Managing by the Numbers – Finance for Entrepreneurs
TiE Institute Session:Managing by the Numbers – Finance for Entrepreneurs
TiE Institute Session:Managing by the Numbers – Finance for Entrepreneurs
TiE Institute Session:Managing by the Numbers – Finance for Entrepreneurs
TiE Institute Session:Managing by the Numbers – Finance for Entrepreneurs
TiE Institute Session:Managing by the Numbers – Finance for Entrepreneurs
TiE Institute Session:Managing by the Numbers – Finance for Entrepreneurs
TiE Institute Session:Managing by the Numbers – Finance for Entrepreneurs
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TiE Institute Session:Managing by the Numbers – Finance for Entrepreneurs

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TiE Institute session covered the following crucial challenges faced by most entrepreneurs on managing finances.1.Reading & Interpreting Financial Statements, 2.Deciphering Key Financial Ratios, 3.How …

TiE Institute session covered the following crucial challenges faced by most entrepreneurs on managing finances.1.Reading & Interpreting Financial Statements, 2.Deciphering Key Financial Ratios, 3.How much time to spend on managing finances (vs. sales, product development, marketing.

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  • 1. Deciphering Financial Statementsand RatiosDecember 2012
  • 2. Agenda • Financial Analysis • Overview of Financial Statements • Overview of Financial Ratios • Performance Management2 © 2012 Deloitte Touche Tohmatsu India Private Limited
  • 3. Introduction to Financial Analysis
  • 4. Financial Analysis is an integral part of business … Diagnosis Strategy Action Planning Development Market/Competitor Analysis  Strategic assessment of competitive environment Option Development Action Planning  Strategic assessment of and Selection market potential  Scenario definition  Strategy statement  Summary of customer  Communication needs and demand and strategic vision  Scenario evaluations process drivers Value Profiling  Business case  Modification of current  Competitive cost analysis development initiatives/programs  Total Shareholder and installation of Returns  Refined plans to new programs  Stock Price enhance short-term Internal Analysis value creation  High-level action plans  Financial analysis and  Recommendations, interpretation priorities, and guiding  Performance target  Core competencies assumptions setting  Capability assessment  Key issues for consideration in strategy development  Identification and rapid implementation of savings opportunities4 © 2012 Deloitte Touche Tohmatsu India Private Limited
  • 5. Primary Financial objectives of Entrepreneurial Firms/New ventures Profitability Liquidity Efficiency StabilityA company’s ability to A company’s ability to How Productively a The overall health of make a profit meet its short term firm utilizes its assets the financial structure obligations of the firm, particularly as it relates to its debt-to- equity ratio Many start‐ups are not  Even if a firm is  How productively a firm  For a firm to be stable, it profitable during their first profitable, it is often a utilizes its assets relative must not only earn a one to three years while challenge to keep to its revenue and its profit and remain liquid they are training enough money in the profits but also keep its debt in employees and building bank to meet its routine check their brands obligations in a timely manner However, a firm must become profitable to  However, a firm must remain viable and become profitable to provide a return to its remain viable and owners provide a return to its ownersSources: Premier in Entrepreneurship - University of Zurich5 © 2012 Deloitte Touche Tohmatsu India Private Limited
  • 6. How does a business work in general? Sources of funds to Resources for creating acquire resources products (Assets) (Liabilities)  From capital markets, debt markets and creditors Financing Income Generation Income Distribution  Turning assets into revenue- generating  To Creditors (interest goods or services and principal payments)  To Owners (dividends and capital gains) Income Revenues Costs Ultimately, the purpose of a business is to transform resources into cash.6 © 2012 Deloitte Touche Tohmatsu India Private Limited
  • 7. Financial Analysis analyzes how well a business works How efficiently is the company able to generate cash? – How big is the company‟s cash flow “engine?” – How efficiently can the engine generate cash? How many assets are required to generate a certain amount of cash? – Is the company getting better or worse at this over time? How well is the company able to grow? – What is the company‟s growth engine? Sustainable growth rate? – How is growth being financed? – What factors may limit growth? How much growth is „optimal‟? How well is the company performing relative to peers or to the industry as a whole? – Are Sales or COGS growing faster or slower than the industry/peers? – How does the balance sheet look in comparison to peers? – What level of profitability should be expected?7 © 2012 Deloitte Touche Tohmatsu India Private Limited
  • 8. Overview of Financial Statements
  • 9. Financial Statements: “The Big 3”A financial statement is a written report that quantitatively describes a firm‟s financial health. The incomestatement, the balance sheet, and the statement of cash flows are the financial statements entrepreneursuse most commonly Summarizes revenues and expenses for a period of Income Statement time, typically one year. Reports the profit performance of a business. Reports the balance of assets, liabilities and equity at a Balance Sheet precise moment in time. Shows the financial condition of the business. Reflects the flow of funds received and paid out over a Cash Flow Statement period of time, typically one year. Shows changes in a firm‟s investments and financial structure.9 © 2012 Deloitte Touche Tohmatsu India Private Limited
  • 10. Key Users of Financial statements  Managers and owners need the financial reports essential to make business decisions Internal Users Managers & Owners  The financial statement is used to formulate contractual terms between the company and other organizations  Immense use to the employees of the company for making collective bargaining Employees agreements  Such statements are used for discussing matters of promotion, rankings and salary hike.  Investors use the financial statements to assess the financial strength of a company Institutional Investors  This would help them to make logical investment decisions  Key users are different financial institutions like banks and other lending institutions Financial Institutions  Used for decision making to help the company with working capital or to issue debt security to it External Users  Organizations such as the Securities and Exchange Commission, government tax and business licensing agencies Government  The financial statements of different companies are also used by the government to analyze whether the tax paid by them is accurate and is in line with their financial strength  Major customers and suppliers, to evaluate the financial strength and staying power of the Vendors company as a dependable resource for their business  The vendors who extend credit to a business require financial statements to assess the creditworthiness of the business  The common people as well as media also make part of the users of financial statements General Mass & Media  Rating agencies (such as Moodys, Standard & Poors, and Dun & Bradstreet), to assign credit ratings Sources: Finance Maps of World10 © 2012 Deloitte Touche Tohmatsu India Private Limited
  • 11. The Income StatementThe Income Statement shows how a company has performed over a given accounting period. Sales: The earnings of a company before any costs or expenses are deducted. Includes all net sales plus any other revenue associated with the main operations Cost of Goods Sold Costs and Expenses: Includes the cost of goods sold (COGS); and salaries, commissions, and Expense travel expenses for executives and salespeople, advertising costs, and payroll expenses (SG&A). Sales Interest & Tax Operating Profit: Earnings before interest and Gross taxes (EBIT). Measures a company‟s earning Profit Operating Dividend power from ongoing operations. Profit (PBIT) Net Earnings Retained Interest expense: The expense incurred to cover Earnings the interest on loans. Net Earnings: Sales minus taxes, interest, depreciation, and other expenses. Also called net Reflects results of managing Retained for further the operations aspect of the growth of the income, net profit, or bottom line. business company11 © 2012 Deloitte Touche Tohmatsu India Private Limited
  • 12. Income statement Detail Income Statement Relationship to (USD „000) 2011 2010 2009 Business ActivitiesNet Sales 5,450 5,273 4,847  Total sales, net of any returns or allowances Cost of products sold 3,104 3,098 2,756  Number of units sold x cost per unitGross Profit 2,346 2,175 2,091  Profit before operating costs and expenses Selling and administrative expenses 715 690 642  Sales and other overhead costs Advertising costs 499 486 474  Sales & marketing costs Research and development costs 114 111 108  R&D (investment in new technology/products) Restructuring and asset impairment 20 36 13  Restructuring costs – asset write-offs, relocation costs expenses, severance costs, etc. Interest expense 161 168 113  Payment for the interest on loans Other expense (income), net 26 (9) (2)  Miscellaneous income/expenseEarnings from continuing operations 811 693 743  Earnings before taxesbefore income taxes Income taxes on continuing operations 274 232 247  What the IRS takesEarnings from continuing operations 537 461 496  Income from continuing ops Earnings from discontinued operations - - 5  Income from discontinued opsNet earnings 537 461 501  Net incomeThe 3 numbers namely net Sales, cost of sales and operating expenses (Advertising cost, administrative cost and other expenses) receive the most attention when evaluating an income statement for an entrepreneurship firm12 © 2012 Deloitte Touche Tohmatsu India Private Limited
  • 13. The Balance Sheet The Balance Sheet presents a financial “snapshot.” It details where the company‟s money came from and where it is deployed (at period end). The balance sheet consists of Assets, Liabilities, and Equity – Assets always equal liabilities plus equity Liabilities + Assets = Shareholder Current Assets: The sum of cash and cash Equity equivalents, accounts receivable, inventory, marketable securities, prepaid expenses, and Current other assets that could be converted to cash in Liabilities less than one year. Current Assets Fixed Assets: includes Property, plant, and equipment (PP&E) Where the Long-term Where the Liquidity money is Liabilities money is Other Assets: Includes other assets such as coming from going to Intangibles Fixed Assets Shareholder‟s Current Liabilities: The sum of all obligations Equity & owed by a company and due within one year. Retained Long-term: Debt not due to be paid within the Other Earnings next year. Assets Shareholders equity: stock Retained Earnings: Earnings not paid out as dividends but instead reinvested in the core business or used to pay off debt. 13 © 2012 Deloitte Touche Tohmatsu India Private Limited
  • 14. Balance Sheet Detail Balance Sheet (USD „000) 2011 2010 Cash and short-term equivalents 206 214 Current Net Receivables 486 505 Uses of Working Assets Inventories 366 384 Capital Other current assets 122 150 Total current assets 1,180 1,253 Property, plant, and equipment, net 955 960 Long - Uses of PhysicalDeclining Order of Liquidity Goodwill 1,630 1,658 Term Trademarks, net 557 560 and other Capital Assets Other intangible assets, net 105 123 Other assets 149 158 Total assets $4,576 $4,712 Notes and loans payable 421 755 Current maturities of long-term debt 577 -- Sources of Accounts payable 381 418 Working Capital Debt Accrued liabilities 472 440 Income taxes payable 86 52 Total current liabilities 1937 1665 Long-term debt 2151 2720 Sources of Long- Other liabilities 640 632 Term Capital Deferred income taxes 23 65 Total liabilities 4,751 5,082 Stockholders‟ deficit (175) (370) Total liabilities and stockholders‟ deficit $4,576 $4,712 14 © 2012 Deloitte Touche Tohmatsu India Private Limited
  • 15. The Cash Flow StatementThe Cash Flow Statement is a statement presenting all of the cash received and paid during the year. It issimilar to a month‐end bank statement. It reveals how much cash is on hand at the end of the month aswell as how the cash was acquired and spent during the month Sources and Uses of Cash Description Examples • Based largely on net income, these items reflect Operating money generated (and used) by operations Selling of and payment for Activities • Useful for assessing a company‟s ability to goods and services generate future net cash inflows • These items primarily reflect the purchase and Purchase of non-current Investing disposal of assets used to generate revenues assets such as property and Activities • Useful for appraising the company‟s ability to pay equipment debts and dividends • These items reflect sources of financing (e.g., Financing debt and equity) as well as their repayment Borrowing of funds (short- or Activities • Useful for evaluating the company‟s requirements long-term) and sale of stock for external financing The Cash Flow Statement helps us understand how much cash is available for future growth investments, after operating expenses and financing obligations have been paid.15 © 2012 Deloitte Touche Tohmatsu India Private Limited
  • 16. The Cash Flow Statement (contd.)• The Cash Flow Statement is generated from the Income Statement and Balance Sheet Net Income and Non-Cash Charges (Income Statement) Cash Inflows / Outflows (Cash Flow Statement) Changes in Asset / Debt Levels (Balance Sheet)• The Cash Flow Statement adds a level of detail, however, including the following key items: Operating Activities Investing Activities Financing Activities Equity Repurchase / Depreciation Capital Expenditures Issuance Sale / Disposal of Debt Repayment / Amortization Assets Issuance Working Capital Dividends16 © 2012 Deloitte Touche Tohmatsu India Private Limited
  • 17. Cash Flow Statement Detail Cash flow statement (USD „000) 2011 2010 2009 Operating activities Net Earnings $ 537 $461 $501 Deduct: Earnings from discontinued operations - - 5 Earning from continuing operations 537 461 496 Depreciation and amortization 190 205 192 Share-based compensation 58 47 49Cash from Deferred Income tax (1) (51) (19)Operations Asset Impairment cost 3 29 4 Changes in: Receivables, net (2) (8) (15) Inventories, net - (26) (8) Other Current assets (4) 11 13 Accounts payable and accrued liabilities (40) 63 (30) Income tax payable (6) (24) 11 Pension Contribution to qualified plans (30) - (10) Net cash provided by operations 738 730 709 Investing activities Capital expenditure (197) (170) (147)Cash from Businesses Acquired - (913) (123)Investing Others - 1 2 Net cash used for investing activities (197) (1,082) (268) Financing activities Notes and Loan Payable, net (334) 681 (87) Long-term debt borrowings 11 1,256 - Long-term debt repayments - (500) (150)Cash from Treasury stock purchased - (868) (155)Financing Cash dividends paid (258) (228) (183) Issuance of common stock for employees stock plan and others 41 39 119 Net cash (used for) provided by financing activities (540) 380 (456) Effect of exchange rate changes on cash and cash equivalents (9) 4 5 Net (decrease) increase in cash and cash equivalents (8) 32 (10) Cash and cash equivalents: Beginning of year 214 182 192 Cash and cash equivalents: End of year $206 $214 $182 17 © 2012 Deloitte Touche Tohmatsu India Private Limited
  • 18. Financial Statement Linkages Understanding the linkages between specific accounts first requires an understanding of the approach of the core statements Statement Description Information Timing “Flow” of revenues and Sums of transactions (e.g., Period of time Income costs over a period of time net revenue, cost of goods (e.g., quarter, year) Statement sold) “Static snapshot” of Ending account balances Specific date Balance balances at a specific point (e.g., cash, accounts (e.g., quarter ending 3/31, year Sheet in time receivable) ending 12/31) “Flow” of physical cash Changes between beginning Period of time Cash Flow over a period of time and ending period balances (e.g., quarter, year) Statement of each account (e.g., net income, working capital)  Balance sheet at beginning of period plus/minus items on income statement leads to balance sheet at end of period  Cash flow statement shows net-income and non-cash charges from the income statement and changes in asset/debt levels from period beginning and period ending balance sheets Understanding how the core statements are intricately linked is necessary for performing financial analysis18 © 2012 Deloitte Touche Tohmatsu India Private Limited
  • 19. Financial Ratios
  • 20. Financial Ratios • Return on Equity (ROE) Also called Growth and Profitability metrics. • Return on Net Assets (RONA) Used to set goals and measure performance against • Gross Profit Margin, Operating Profit them. Range from general indicators to industry- Margin, Net Profit Margin specific ratios. Performance Ratios • Asset Turnover Measure a company‟s ability to earn a return on • Inventory Turnover investment and the company‟s efficiency in turning over • Receivables Turnover its assets. • Days Sales Outstanding (DSO) • Debt Ratio Calculations that help to demonstrate the ability of a • Debt to Equity Ratio firm to cover its liabilities as they come due. Solvency Ratios • LT Debt to Capitalization Ratio Measure of how much a company is relying on • Interest Coverage Ratio creditors to fund required asset levels at any point in time. • Payables Coverage Ratio • Current Ratio Availability of cash or near-cash assets for the purpose • Quick Ratio of meeting obligations. Liquidity Ratios • Working Capital Ratio Measure a company‟s ability to pay maturing • Cash Flow Ratio obligations. • Earnings Per Share (EPS) Also called Market Ratios, reflect performance of the • Price/Earnings (P/E) Ratio shareholders‟ investment in terms of stock price Investment Ratios performance and dividend activity. • Dividend Yield • Dividend Cover20 © 2012 Deloitte Touche Tohmatsu India Private Limited
  • 21. Performance Ratios Ratio Explanation Calculation Desired Value NET INCOME Return on Equity Return generated on a shareholder‟s investment. AVG TOTAL EQUITY Return on Net Assets EBIT Percent return on money tied up in a business. (RONA) AVG NET ASSETS Indicates the proportion of sales that contribute to GROSS PROFIT Gross Profit Margin fixed costs and profits, as opposed to variable SALES costs. Indicates margin for operating activities, not EBIT Operating Profit Margin including interest or tax expense. SALES NET INCOME Net Profit Margin Calculates the total margin including all expenses. SALES Indicates how well fixed assets are used to SALES Fixed Asset Turnover generate sales. AVG FIXED ASSETS Indicates how well a company uses all of its assets SALES Total Asset Turnover to generate sales. AVG TOTAL ASSETS Indicates how quickly a company sells its inventory COGS Inventory Turnover items. Measured in terms of how many times an AVG INVENTORY item is sold in a period (typically yearly). Demonstrates company‟s ability to collect SALES (on account) Receivables Turnover receivables quickly. AVG RECEIVABLES Shows both the average time it takes to turn the Days Sales RECEIVABLES * No. of Days receivables into cash and the age, in terms of Outstanding (DSO) TOTAL CREDIT SALES days, of a companys accounts receivable21 © 2012 Deloitte Touche Tohmatsu India Private Limited
  • 22. Solvency Ratios Ratio Explanation Calculation Desired Value Calculates the percentage of the company‟s assets TOTAL LIABILITIES Debt Ratio that are financed by debt. TOTAL ASSETS Indicates the amount of debt held by a company TOTAL LIABIILITIES Debt to Equity Ratio relative to the funding provided by the TOTAL EQUITY shareholders. LT Debt to Separates long-term debt and compares it to LONG TERM DEBT Capitalization Ratio company‟s total capital. LTD + TOTAL EQUITY Indicates the size of the interest expense relative EBIT Interest Coverage Ratio to earnings by showing the number of times that INTEREST EXPENSE earnings will “cover” interest expenses in a year. Indicates the size of the payables expense relative Payables Coverage EBIT to earnings by showing the number of times that Ratio ACCOUNTS PAYABLE earnings will “cover” payables.22 © 2012 Deloitte Touche Tohmatsu India Private Limited
  • 23. Liquidity Ratios Ratio Explanation Calculation Desired Value Indicates short-term liquidity by comparing CURRENT Current Ratio obligations due within one year with assets that will ASSETS turn into cash within one year. CURRENT LIABILITIES Similar to the Current Ratio, but a more QUICK ASSETS Quick Ratio conservative view. The numerator here excludes CURRENT LIABILITIES inventory. Refers to capital available to address immediate CURRENT ASSETS Working Capital operating needs of the company. CURRENT LIABILITIES Compares average liabilities due within one year CASH + M/S + CFO Cash Flow Ratio to cash generated in the course of a year by CURRENT LIABILITES operations.23 © 2012 Deloitte Touche Tohmatsu India Private Limited
  • 24. Investment Ratios Ratio Explanation Calculation Desired Value NI – PFD DIV Earnings Per Share Provides a measure of firm profitability. AVG # SHARES (COMMON) Used to understand the relationship of the market MKT PRICE (COMMON) P/E Ratio price for a share of stock and the earnings EPS (COMMON) generated by the share. Provides a view of the share performance in terms DIVIDENDS Dividend Yield of dividends paid versus the current market price MKT PRICE of the share. A measure of how much of the retained earnings EPS Dividend Cover are being reinvested versus paid out to DIVIDENDS PER SHARE shareholders.24 © 2012 Deloitte Touche Tohmatsu India Private Limited
  • 25. Financial Ratio Analysis: Five Caveats Be selective in your choice of ratios. Know what you are measuring, and why that measure 1. is important to the company. Ratios may have more than one name and more than one definition. Return on Capital is 2. the same as Return on Net Assets; Accounts Receivable Days on Hand (ARDOH) is the same as Average Collection Period. There are often different ways of calculating the same ratio. Take ratios at face value, but be aware that they may be subject to accounting 3. distortions. Pay attention to the financial footnotes and any irregular items that may or may not have been included in the numbers. Use ratios with care. Always compare “like” with “like,” and realize different industries may 4. have very different characteristics. Ratios, like financials, must not be looked at in isolation. Identifying trends or making 5. comparisons is where you get value and understanding. Individual ratios, with no frame of reference, are meaningless.25 © 2012 Deloitte Touche Tohmatsu India Private Limited
  • 26. Value framework for Performance Management26 © 2012 Deloitte Touche Tohmatsu India Private Limited
  • 27. Illustrative Performance Metrics Income Statement Balance Sheet / Statement of Cash Flows Focus Area KPIs Focus Area KPIs 1) Organic Sales Growth Asset / Capital Efficiency 11) ROIC 12) Cash Conversion Days Sales 2) Unit Volume Growth Cash Flow 13) Free Cash Flow 3) Key Brand Sales Focus New Product Sales 4) Performance Innovation Other 5) New Product Pipeline Strength Focus Area KPIsPricing Strength 6) Key Brand Price per Pound Shareholder Return 14) Total Shareholder Return Gross Profit 7) Gross Profit Margin People 15) Employee Loss Consumer 8) Consumer Investment Level 16) Bench Strength1 Investment SG&A 9) SG&A EfficiencyOperating Income 10) Operating Margin27 © 2012 Deloitte Touche Tohmatsu India Private Limited
  • 28. “Deloitte refers to one or more of Deloitte Touche Tohmatsu Limited, a UK private company limited by guarantee, and its network of member firms, each of which isa legally separate and independent entity. Please see www.deloitte.com/about for a detailed description of the legal structure of Deloitte Touche Tohmatsu Limitedand its member firms.This material and the information contained herein prepared by Deloitte Touche Tohmatsu India Private Limited (DTTIPL) is intended to provide general informationon a particular subject or subjects and is not an exhaustive treatment of such subject(s) and accordingly is not intended to constitute professional advice orservices. The information is not intended to be relied upon as the sole basis for any decision which may affect you or your business. Before making any decision ortaking any action that might affect your personal finances or business, you should consult a qualified professional adviser.None of DTTIPL, Deloitte Touche Tohmatsu Limited, its member firms, or its and their affiliates shall be responsible for any loss whatsoever sustained by anyperson who relies on this material.”©2010 Deloitte Touche Tohmatsu India Private Limited. Member of Deloitte Touche Tohmatsu Limited”

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