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Cf ii interpreting_fs_2009_pre_lecture

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Cf ii interpreting_fs_2009_pre_lecture

  1. 1. Corporate Finance Interpreting Financial Statements Dr. Markus R. Neuhaus Dr. Marc Schmidli, CFA Winter Term 2009 Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch
  2. 2. Corporate Finance: Course overview <ul><li>18.09. Fundamentals (4 hours) M. Neuhaus & M.Schmidli </li></ul><ul><li>25.09 Investment Management M. Neuhaus & P. Schwendener </li></ul><ul><li>02.10. Business Valuation (4 hours) M. Neuhaus & M. Bucher </li></ul><ul><li>09.10. No Lecture No Lecture </li></ul><ul><li>16.10. Value Management M. Neuhaus, R. Schmid & F. Monti </li></ul><ul><li>23.10. No Lecture No Lecture </li></ul><ul><li>30.10. No Lecture No Lecture </li></ul><ul><li>06.11. No lecture No Lecture </li></ul><ul><li>13.11. Mergers & Acquisitions I&II (4 hours) M. Neuhaus & D. Villiger </li></ul><ul><li>20.11 Tax and Corporate Finance (4 hours) Markus Neuhaus </li></ul><ul><li>27.11. Legal Aspects R. Watter </li></ul><ul><li>04.12. Financial Reporting M. Neuhaus & M. Jeger </li></ul><ul><li>11.12. Turnaround Management M. Neuhaus & Markus Koch </li></ul><ul><li>18.12. </li></ul>Summary, repetition M. Neuhaus
  3. 3. Winter Term 2009 Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch <ul><li>Grade CEO </li></ul><ul><li>Qualification Doctor of Law (University of Zurich), Certified Tax Expert </li></ul><ul><li>Career Development J oined PwC in 1985 and became Partner in 1992. </li></ul><ul><li>Subject-related Exp. Corporate Tax </li></ul><ul><li>Mergers + Acquisitions </li></ul><ul><li>Lecturing SFIT: Corporate Finance, University of St. Gallen: Tax Law </li></ul><ul><li>Multiple speeches on leadership, business, governance, commercial and tax law </li></ul><ul><li>Published Literature Author of commentary on the Swiss accounting rules Publisher of book on transfer pricing Author of multiple articles on tax and commercial law, M+A, IPO, etc. </li></ul><ul><li>Other professional roles: Member of the board of économiesuisse, member of the board and chairman of the tax chapter of the Swiss Institute of Certified Accountants and Tax Consultants </li></ul>Markus R. Neuhaus PricewaterhouseCoopers AG, Zürich  Phone: +41 58 792 4000 Email: markus . neuhaus @ch.pwc.com
  4. 4. Winter Term 2009 Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch Marc Schmidli PricewaterhouseCoopers AG, Zürich  Phone: +41 58 792 15 64 Email: marc.schmidli @ch.pwc.com <ul><li>Grade Director </li></ul><ul><li>Qualification Dr oec. HSG., CFA charterholder </li></ul><ul><li>Career Development Corporate Finance PricewaterhouseCoopers since July 2000 </li></ul><ul><li>Lecturing Euroforum – Valuation in M&A situations </li></ul><ul><li>Guest speaker at ZfU Seminars, Uni Zurich, ETH, etc. </li></ul><ul><li>Published Literature Finanzielle Qualität in der schweizerischen Elektrizitätswirtschaft </li></ul><ul><li>Various articles in „Treuhänder“, HZ, etc. </li></ul>
  5. 5. Contents <ul><li>Learning targets </li></ul><ul><li>Pre-course reading </li></ul><ul><li>Lecture „Interpreting Financial Statements“ </li></ul><ul><li>Pre-course reading case studies / questions </li></ul><ul><li>Solutions to case studies </li></ul>Winter Term 2009 Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch
  6. 6. Learning targets <ul><li>Framework for financial statement analysis </li></ul><ul><ul><li>Understanding the need for financial statement analysis </li></ul></ul><ul><ul><li>Understanding the financial reporting system </li></ul></ul><ul><ul><li>Refreshing principal elements of financial statements (Balance sheet, income and cash flow statements) </li></ul></ul><ul><li>Analysis of financial statements </li></ul><ul><ul><li>Understand the purpose and use of ratio analysis </li></ul></ul><ul><ul><li>Being able to apply the various ratio analyses </li></ul></ul><ul><ul><li>Being able to evaluate corporate performance by the integrated analysis of ratios </li></ul></ul>Winter Term 2009 Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch
  7. 7. Contents <ul><li>Learning targets </li></ul><ul><li>Pre-course reading </li></ul><ul><li>Lecture „Interpreting Financial Statements“ </li></ul><ul><li>Pre-course reading case studies / questions </li></ul><ul><li>Solutions to case studies </li></ul>Winter Term 2009 Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch
  8. 8. Pre-course reading <ul><li>Books </li></ul><ul><ul><li>Mandatory reading: </li></ul></ul><ul><ul><ul><li>Brigham, Houston (2009): Chapter 4 (pp. 84-109) </li></ul></ul></ul><ul><ul><ul><li>White, Sondhi, Fried (2003): Chapter 3 (pp. 74-99) </li></ul></ul></ul><ul><ul><li>Optional reading: </li></ul></ul><ul><ul><ul><li>Brigham, Houston (2009): Chapter 3 (pp. 53-75) </li></ul></ul></ul><ul><li>Slides </li></ul><ul><ul><li>Slides 1 to 11 – mandatory reading </li></ul></ul><ul><ul><li>Other Slides – optional reading, will be dealt within the lecture </li></ul></ul>Winter Term 2009 Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch
  9. 9. Contents <ul><li>Learning targets </li></ul><ul><li>Pre-course reading </li></ul><ul><li>Lecture „Interpreting Financial Statements“ </li></ul><ul><li>Pre-course reading case studies / questions </li></ul><ul><li>Solutions to case studies </li></ul>Winter Term 2009 Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch
  10. 10. Agenda I <ul><li>1. Introduction </li></ul><ul><ul><li>Financial analysis </li></ul></ul><ul><ul><li>Classes of users </li></ul></ul><ul><ul><li>Need for financial statement analysis </li></ul></ul><ul><li>2. Ratio analysis </li></ul><ul><ul><li>Significance of ratio analysis </li></ul></ul><ul><ul><li>Sources </li></ul></ul><ul><ul><li>Financial reporting systems and standards </li></ul></ul><ul><ul><li>Important groups of ratio analysis </li></ul></ul>Winter Term 2009 Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch
  11. 11. Agenda II Winter Term 2009 Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch <ul><li>3. Case study </li></ul><ul><ul><li>Beans Incorporation vs. Garlic Incorporation </li></ul></ul><ul><li>4. Q&A and discussion </li></ul>
  12. 12. Agenda: Introduction <ul><li>Financial analysis </li></ul><ul><li>Classes of users </li></ul><ul><li>Need for financial statement analysis </li></ul>Winter Term 2009 Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch
  13. 13. Winter Term 2009 Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch <ul><li>Evaluation of a firm‘s performance and development mainly by </li></ul><ul><ul><li>identifying the key drivers of a firm‘s performance and financial position </li></ul></ul><ul><ul><li>calculating and interpreting important ratios of the firm </li></ul></ul><ul><ul><li>Balanced Scorecard (soft – hard) </li></ul></ul><ul><li>A well rounded financial analysis takes into account not only the financials alone but also surrounding factors which can have significant influence on the firm’s development. Financial management does not operate in a vacuum. </li></ul>Financial analysis Source: White, Sondhi, Fried (2003), 2ff. Environment Financial Statements Business Macroeconomic situation, industry, market Balance sheet, income statement, cash flow, stockholders’ equity, budget Management, products, margins, technology, knowledge base, competition Financial Analysis
  14. 14. Winter Term 2009 Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch <ul><li>Internal users (such as managers or board members) </li></ul><ul><li>External users of financial information encompass a wide range of interests but can be classified into three general groups: </li></ul><ul><ul><li>Credit and equity investors </li></ul></ul><ul><ul><li>Government, regulatory bodies, tax authorities </li></ul></ul><ul><ul><li>General public and special interest groups, labor unions and consumer groups </li></ul></ul>Classes of users Source: White, Sondhi, Fried (2003), 4.
  15. 15. Winter Term 2009 Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch Need for financial statement analysis <ul><li>Internal: </li></ul><ul><li>financial statements provide the company with information on its performance and development over time and are a crucial basis for most financial decisions (i.e. investment, financing) </li></ul><ul><ul><li>Costs </li></ul></ul><ul><ul><li>Efficiency </li></ul></ul><ul><ul><li>Profitability </li></ul></ul><ul><ul><li>Investments </li></ul></ul><ul><ul><li>Financing (needs) </li></ul></ul><ul><li>External: </li></ul><ul><li>financial statements facilitate the interaction between the company and its business environment by providing third parties with essential information on the company’s development </li></ul><ul><ul><li>Creditors </li></ul></ul><ul><ul><li>Investors </li></ul></ul><ul><ul><li>Shareholders </li></ul></ul><ul><ul><li>Government </li></ul></ul>Financial analysis has great significance and impact on a company‘s development as it influences expectations on the capital markets
  16. 16. Agenda: Ratio analysis <ul><li>Significance of ratio analysis </li></ul><ul><li>Sources </li></ul><ul><li>Financial reporting systems and standards </li></ul><ul><li>Important groups of ratio analysis </li></ul>Winter Term 2009 Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch
  17. 17. Winter Term 2009 Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch Ratio analysis <ul><li>Financial statements help predict the future development of a company </li></ul><ul><li>Firm A has total debt of $ 200m whereas firm B has total debt of $ 2mm. Which firm is stronger, more liquid? Or which firm is more likely to generate higher cash flows? </li></ul><ul><li>  Figures standing alone, such as total debt, are not really helpful </li></ul><ul><li>  By putting debt into perspective with other appropriate figures, we are able to predict which firm is more likely to succeed </li></ul><ul><li>  such comparisons are ratio analysis </li></ul>The debt burden can be evaluated (a) by comparing each firm‘s debt with its assets and (b) by comparing the interest the company has to pay with the income it has available Source: Brigham, Houston (2009), 103.
  18. 18. Winter Term 2009 Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch Significance of ratio analysis <ul><li>As a company’s value is determined by its ability to generate cash today and in the future , ratio analysis has great importance </li></ul><ul><ul><li>Share price development </li></ul></ul><ul><ul><li>Credit rating </li></ul></ul><ul><li>However, there is no generally used list of ratios that could be applied to any company </li></ul><ul><li>Groups of ratios 1) : </li></ul><ul><ul><li>Liquidity ratios </li></ul></ul><ul><ul><li>Asset management ratios </li></ul></ul><ul><ul><li>Debt or financing ratios </li></ul></ul><ul><ul><li>Profitability ratios </li></ul></ul><ul><ul><li>Market value ratios </li></ul></ul>„ help predict the future development of a company” 1) Details later: see page 25ff.
  19. 19. Winter Term 2009 Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch Principal elements of financial statements as primary source for financial analysis <ul><li>Balance sheet </li></ul><ul><li>Income statement </li></ul><ul><li>Statement of cash flows </li></ul><ul><li>Statement of stockholders‘ equity </li></ul><ul><li>Further sources: Broker/analyst reports, Bloomberg, Reuters, Factset etc. </li></ul>Collectively, these interrelated financial statements provide relevant and timely information about the past and are essential for making crucial business decisions about investment or financing activities today and in the future. Financial statements are a key component to build trust in the financial community. Source: White, Sondhi, Fried (2003), 5.
  20. 20. Winter Term 2009 Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch Financial reporting systems and standards <ul><li>Reporting systems and standards compel the company to meet a great number of requirements in order to ensure that the financial statements are, above all, transparent and comparable </li></ul><ul><li>The two most commonly used standards are: </li></ul><ul><ul><li>IFRS (International Financial Reporting Standards) </li></ul></ul><ul><ul><li>US GAAP (United States Generally Accepted Accounting Principles) </li></ul></ul><ul><li>Differences are found mainly in the classification of certain events (e.g. whether an interest payment is reported under operating costs or financing costs etc.). Both aim to provide a “true and fair view”of the company’s performance. </li></ul><ul><li>In addition, there are local GAAPs (Generally Accepted Accounting Principles). In Switzerland we have rules in the Code of Obligation which permit hidden reserves and the FER (Fachempfehlung für Rechnungslegung) which is a light form of IFRS. </li></ul>Source: White, Sondhi, Fried (2003), 5ff.
  21. 21. Winter Term 2009 Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch Balance sheet <ul><li>Snapshot of the company‘s assets and liabilities at a certain reporting date </li></ul><ul><li>Assets = Liabilities + Equity </li></ul>Source: Brigham, Houston (2009), 58.
  22. 22. Winter Term 2009 Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch Income statement <ul><li>Reports on the performance of a firm, the results of its operating activities </li></ul><ul><li>Matching principle = revenues and related costs must be accounted for during the same period of time. This requires the recognition of expenses incurred to generate revenues in the same period as the related revenues (revenue recognition, accrual method). </li></ul>Source: Brigham, Houston (2009), 61.
  23. 23. Winter Term 2009 Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch Statement of cash flow <ul><li>The cash flow statement represents the cash generated by a company during the given accounting period </li></ul><ul><li>Separated into three categories: (I) operating activities, (II) investing activities, (III) financing activities </li></ul><ul><li>The investment section illustrates how cash was spent whereas section III, financing shows how those investments were financed </li></ul><ul><li>In the long run, cash flows from operating activities should considerably increase; investments should be equal to depreciation (plus a bit more to support stable growth) </li></ul><ul><li> In this example, the company has an operating problem as the cash flow from operating activities is negative </li></ul><ul><li>CAPEX = capital expenditures </li></ul>Source: Brigham, Houston (2009), 63.
  24. 24. Winter Term 2009 Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch Statement of retained earnings <ul><li>Changes in retained earnings occur because stockholders allow the management to retain and invest funds that otherwise would be paid out as dividend </li></ul><ul><li>Thus, the retained earnings position is not cash and is not available for spending </li></ul>Source: Brigham, Houston (2009), 66.
  25. 25. Winter Term 2009 Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch Important groups of financial ratios <ul><li>Liquidity ratios </li></ul><ul><li>Is the company able to pay its debts as they become due this year? </li></ul><ul><li>Asset management ratios </li></ul><ul><li>Does the amount of assets seem to be reasonable in relation to current and projected sales? And how efficiently does the company use its assets?” </li></ul><ul><li>Debt or financing ratios </li></ul><ul><li>To what extent is the company using financial leverage? Risk from capital structure? </li></ul><ul><li>Profitability ratios </li></ul><ul><li>How profitable is the company? How much output does the company generate in relation to a certain input? </li></ul><ul><li>Market value ratios </li></ul><ul><li>How do the earnings and results appear in relation to the stock price? </li></ul>Source: Brigham, Houston (2009), 84ff.
  26. 26. Winter Term 2009 Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch Liquidity ratios <ul><li>Inventories are a firm’s least liquid current asset and therefore most likely to suffer losses if they have to be sold in liquidation. A company should be able to pay current liabilities with current assets less inventories. </li></ul><ul><li>If a company is getting into financial difficulties, it will pay its bills more slowly, borrowing money from banks and from suppliers. This leads to increased current liabilities which causes the current ratio to decrease. If current liabilities grow faster than current assets, this is a an indication of financial difficulties. </li></ul>Source: Brigham, Houston (2009), 87f.
  27. 27. Winter Term 2009 Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch Balance sheet and income statement Source: Brigham, Houston (2009), 58. Source: Brigham, Houston (2009), 61.
  28. 28. Winter Term 2009 Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch Liquidity ratios <ul><li>Inventories are a firm’s least liquid current asset and therefore most likely to suffer losses if they have to be sold in liquidation. A company should be able to pay current liabilities with current assets less inventories. </li></ul><ul><li>If a company is getting into financial difficulties, it will pay its bills more slowly, borrowing money from banks and from suppliers. This leads to increased current liabilities which causes the current ratio to decrease. If current liabilities grow faster than current assets, this is a an indication of financial difficulties. </li></ul>Source: Brigham, Houston (2009), 87f.
  29. 29. Winter Term 2009 Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch Balance sheet and income statement Source: Brigham, Houston (2009), 61. Source: Brigham, Houston (2009), 58.
  30. 30. Winter Term 2009 Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch Asset management ratios <ul><li>DSO shows the “average collection period” or how long customers usually take to pay their bills. The higher the DSO, the more money is lost, because the company has to finance the gap with expensive loans etc. </li></ul><ul><li>Inventory turnover indicates whether a company (compared with peer companies) holds too much inventory, which is very unproductive and represents an investment with a low return </li></ul><ul><li>The fixed assets turnover ratio indicates how effectively the company is using its fixed assets compared with peer companies. </li></ul>Source: Brigham, Houston (2009), 88ff.
  31. 31. Winter Term 2009 Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch Balance sheet and income statement Source: Brigham, Houston (2009), 61. Source: Brigham, Houston (2009), 58.
  32. 32. Winter Term 2009 Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch Asset management ratios <ul><li>DSO shows the “average collection period” or how long customers usually take to pay their bills. The higher the DSO, the more money is lost, because the company has to finance the gap with expensive loans etc. </li></ul><ul><li>Inventory turnover indicates whether a company (compared with peer companies) holds too much inventory, which is very unproductive and represents an investment with a low return </li></ul><ul><li>The fixed assets turnover ratio indicates how effectively the company is using its fixed assets compared with peer companies. </li></ul>Source: Brigham, Houston (2009), 88ff.
  33. 33. Winter Term 2009 Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch Balance sheet and income statement Source: Brigham, Houston (2009), 61. Source: Brigham, Houston (2009), 58.
  34. 34. Winter Term 2009 Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch Asset management ratios <ul><li>DSO shows the “average collection period” or how long customers usually take to pay their bills. The higher the DSO, the more money is lost, because the company has to finance the gap with expensive loans etc. </li></ul><ul><li>Inventory turnover indicates whether a company (compared with peer companies) holds too much inventory, which is very unproductive and represents an investment with a low return </li></ul><ul><li>The fixed assets turnover ratio indicates how effectively the company is using its fixed assets compared with peer companies. </li></ul>Source: Brigham, Houston (2009), 88ff.
  35. 35. Winter Term 2009 Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch Balance sheet and income statement Source: Brigham, Houston (2009), 61. Source: Brigham, Houston (2009), 58.
  36. 36. Winter Term 2009 Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch Debt or financing ratios <ul><li>Creditors prefer a low debt to equity ratio whereas stockholders may want more leverage as it can magnify expected earnings (  pecking order theory). The optimal ratio between debt and assets is highly dependent on the firm’s business and industry. </li></ul><ul><li>The TIE ratio measures the extent to which operating costs can decline before the firm is unable to meet its interest costs. Not being able to pay interest costs will bring legal troubles and can result in bankruptcy. </li></ul>Source: Brigham, Houston (2009), 91ff.
  37. 37. Winter Term 2009 Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch Balance sheet and income statement Source: Brigham, Houston (2009), 61. Source: Brigham, Houston (2009), 58.
  38. 38. Winter Term 2009 Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch Debt or financing ratios <ul><li>Creditors prefer a low debt to equity ratio whereas stockholders may want more leverage as it can magnify expected earnings (  pecking order theory). The optimal ratio between debt and assets is highly dependent on the firm’s business and industry. </li></ul><ul><li>The TIE ratio measures the extent to which operating costs can decline before the firm is unable to meet its interest costs. Not being able to pay interest costs will bring legal troubles and can result in bankruptcy. </li></ul>Source: Brigham, Houston (2009), 91ff.
  39. 39. Winter Term 2009 Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch Balance sheet and income statement Source: Brigham, Houston (2009), 61. Source: Brigham, Houston (2009), 58.
  40. 40. Winter Term 2009 Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch Profitability ratios <ul><li>The profit margin on sales shows the profit per unit of sales </li></ul><ul><li>Stockholders want to earn a return on their money invested. This ratio indicates the profitability of a stockholders’ invested money from an accounting perspective </li></ul><ul><li>This ratio shows the raw earning power of the firm’s assets excluding potential influence from interest payments or leverage effects. </li></ul>Source: Brigham, Houston (2009), 95ff.
  41. 41. Winter Term 2009 Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch Balance sheet and income statement Source: Brigham, Houston (2009), 61. Source: Brigham, Houston (2009), 58.
  42. 42. Winter Term 2009 Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch Profitability ratios <ul><li>The profit margin on sales shows the profit per unit of sales </li></ul><ul><li>Stockholders want to earn a return on their money invested. This ratio indicates the profitability of a stockholders’ invested money from an accounting perspective </li></ul><ul><li>This ratio shows the raw earning power of the firm’s assets excluding potential influence from interest payments or leverage effects. </li></ul>Source: Brigham, Houston (2009), 95ff.
  43. 43. Winter Term 2009 Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch Balance sheet and income statement Source: Brigham, Houston (2009), 61. Source: Brigham, Houston (2009), 58.
  44. 44. Winter Term 2009 Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch Profitability ratios <ul><li>The profit margin on sales shows the profit per unit of sales </li></ul><ul><li>Stockholders want to earn a return on their money invested. This ratio indicates the profitability of a stockholders’ invested money from an accounting perspective </li></ul><ul><li>This ratio shows the raw earning power of the firm’s assets excluding potential influence from interest payments or leverage effects. </li></ul>Source: Brigham, Houston (2009), 95ff.
  45. 45. Winter Term 2009 Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch Balance sheet and income statement Source: Brigham, Houston (2009), 61. Source: Brigham, Houston (2009), 58.
  46. 46. Winter Term 2009 Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch Market value ratios <ul><li>This ratio shows how much an investor is willing to pay per unit of reported earnings. Thus, the P/E ratio indicates, by comparison with its peers, whether a company is regarded as being risky or expected to have poor growth. </li></ul><ul><li>The market to book ratio typically exceeds 1.0 as the balance sheet does not reflect inflation or goodwill. In addition, this ratio provides an indication whether a company is able to earn high returns. </li></ul><ul><li>Depending on the industry, a firm’s stock price is tied more closely to cash flow than net income. </li></ul><ul><li>Remember: Net income + D&A = cash flow </li></ul>Numbers of shares: 50m Share price: 23 Cash flow = net income + D&A Source: Brigham, Houston (2009), 98ff.
  47. 47. Winter Term 2009 Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch Balance sheet and income statement Source: Brigham, Houston (2009), 61. Source: Brigham, Houston (2009), 58.
  48. 48. Winter Term 2009 Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch Market value ratios <ul><li>This ratio shows how much an investor is willing to pay per unit of reported earnings. Thus, the P/E ratio indicates, by comparison with its peers, whether a company is regarded as being risky or expected to have poor growth. </li></ul><ul><li>The market to book ratio typically exceeds 1.0 as the balance sheet does not reflect inflation or goodwill. In addition, this ratio provides an indication whether a company is able to earn high returns. </li></ul><ul><li>Depending on the industry, a firm’s stock price is tied more closely to cash flow than net income. </li></ul><ul><li>Remember: Net income + D&A = cash flow </li></ul>Numbers of shares: 50m Share price: 23 Cash flow = net income + D&A Source: Brigham, Houston (2009), 98ff.
  49. 49. Winter Term 2009 Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch Balance sheet and income statement Source: Brigham, Houston (2009), 61. Source: Brigham, Houston (2009), 58.
  50. 50. Winter Term 2009 Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch Market value ratios <ul><li>This ratio shows how much an investor is willing to pay per unit of reported earnings. Thus, the P/E ratio indicates, by comparison with its peers, whether a company is regarded as being risky or expected to have poor growth. </li></ul><ul><li>The market to book ratio typically exceeds 1.0 as the balance sheet does not reflect inflation or goodwill. In addition, this ratio provides an indication whether a company is able to earn high returns. </li></ul><ul><li>Depending on the industry, a firm’s stock price is tied more closely to cash flow than net income. </li></ul><ul><li>Remember: Net income + D&A = cash flow </li></ul>Numbers of shares: 50m Share price: 23 Cash flow = net income + D&A Source: Brigham, Houston (2009), 98ff.
  51. 51. Winter Term 2009 Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch Balance sheet and income statement Source: Brigham, Houston (2009), 61. Source: Brigham, Houston (2009), 58.
  52. 52. Agenda: Case study <ul><li>Beans Incorporation vs. Garlic Incorporation </li></ul>Winter Term 2009 Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch
  53. 53. Winter Term 2009 Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch Case study: Interpretation of financial statements <ul><li>Your client tells you he is interested in investing in a company from the food industry as he sees great growth potential in this industry </li></ul><ul><li>He has already selected two potential targets and now wants your professional advice on which company is more likely to report good results in the future </li></ul><ul><li>Please try to give your client your opinion based on what you have learned in this course </li></ul><ul><ul><li>Read the financial statements and calculate the ratios based on 2008 figures </li></ul></ul><ul><ul><li>Compare these ratios with those of the other company and with those of the industry average </li></ul></ul>Beans Inc. Garlic Inc. vs.
  54. 54. Winter Term 2009 Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch Case study: Beans Incorporation I Beans Inc.
  55. 55. Winter Term 2009 Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch Case study: Beans Incorporation II Beans Inc. <ul><li>By analyzing its financial statements, what are the strengths and weaknesses of this company? </li></ul><ul><li>Where do you see risks or opportunities? </li></ul>
  56. 56. Winter Term 2009 Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch Case study: Garlic Incorporation I Garlic Inc.
  57. 57. Winter Term 2009 Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch Case study: Garlic Incorporation II Garlic Inc. <ul><li>By analyzing its financial statements, what are the strengths and weaknesses of this company? </li></ul><ul><li>Where do you see risks or opportunities? </li></ul>
  58. 58. Winter Term 2009 Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch Case study: Solution guideline <ul><li>Liquidity ratios </li></ul><ul><li>Asset management ratios </li></ul><ul><li>Debt ratios </li></ul><ul><li>Profitability ratios </li></ul><ul><li>Market value ratios </li></ul><ul><li>Try to assess whether the given company shows a healthy relation between profitability, liquidity and risk </li></ul><ul><ul><li>If a company shows high exposure to risky investments, one expects the profitability to be accordingly </li></ul></ul><ul><li>Try to come to a conclusion on which company is more likely to pursue an expansive strategy and strengthen its position within the market </li></ul><ul><ul><li>In terms of ability to generate cash flows, capital structure and working capital management </li></ul></ul>Value Creation Liquidity Security/Risk Profitability
  59. 59. Winter Term 2009 Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch Case study: Solution guideline II <ul><li>Try to compare the companies with each other and put the results into perspective using the industry average values on the right </li></ul><ul><li>Industry average figures can be seen as a guide </li></ul><ul><ul><li>Why is the company less profitable than average peer companies? </li></ul></ul><ul><ul><li>Why does one company have such a high P/E multiple and what does that mean for the operating business? </li></ul></ul><ul><ul><li> Financial statements can never fully answer such questions. However, they can raise the right questions </li></ul></ul>Source: Brigham, Houston (2009), 103.
  60. 60. Contents <ul><li>Learning targets </li></ul><ul><li>Pre-course reading </li></ul><ul><li>Lecture „Interpreting Financial Statements“ </li></ul><ul><li>Pre-course reading case studies / questions </li></ul><ul><li>Solutions to case studies </li></ul>Winter Term 2009 Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch
  61. 61. Solutions to Case Study <ul><li>Will be distributed after lecture </li></ul>Winter Term 2009 Markus Neuhaus I Corporate Finance I neuhauma@ethz.ch

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