Abc co case study 20150320

1.
INTRO TO CORPORATE FINANCE
Professor
BITBOL-­‐SABA
Nathalie
ABC Co. Case Study
Corporate
Finance
Woojin
KIM
/
Emma
DIETERLEN
/
Charles
GUERIN
Class
13
/
Year
2014-­‐15

2. ABC
Co.
Case
Study
2
1.
Is
this
a
British
or
an
American
company?
American
company
There
are
two
reasons:
1) Currency
used
in
the
financial
statements
is
Dollar,
not
Pound.
2) The
term
“income
statement”
is
used
in
the
U.S.
whereas
it
is
called
“profit
and
loss
account”
in
the
U.K.
2.
Is
the
summary
income
statement
built
by
nature
or
by
activity?
By
activity
The
income
statement
presented
categorises
costs
by
the
company’s
principles
activities.
On
the
other
hand,
the
by-­‐nature
income
statement
offers
a
more
detailed
breakdown
of
costs.
3.
What
are
the
4
costs
corresponding
to
the
4
functions
listed
in
an
income
statement
by
activity?
Activity
Corresponding
cost
Production
Cost
of
sales
Administration
Administrative
expenses
Financing
Finance
costs
4.
Fill
in
the
enclosed
table
with
formulae,
ratios
and
figures.
(All
numbers
in
results
are
rounded
off
to
three
decimal
places.)
STAGE
1
Ratios
and
formulae
DRAFT
YEAR
N
(N)
ACTUAL
YEAR
N-­‐1
(N-­‐1)
VARIANCE
(N)
–
(N-­‐1)
Revenue
Growth
-­‐5.1%
(=10,971–
11,560/11,560)x100
10,971
11,560
-­‐589

3. ABC
Co.
Case
Study
3
Margins
Gross
profit
/
revenue
7%
(=(768/10,971)
x
100)
9.4%
(=1,086/11,560)
-­‐2.4
percent
point
(=-­‐240
bps
1
)
(=7-­‐2)
Cost
of
sales
/
revenue
93%
(=768/10,971)
90.6%
(=1,086/11,560)
+2.4
percent
point
(=+240
bps)
(=93-­‐90.6)
EBIT
(in
value)
profit
(loss)
of
the
period
in
value
-­‐14
(=-­‐249-­‐(-­‐235))
307
(=122-­‐(-­‐185))
by
value:
-­‐321
(=-­‐14-­‐307)
by
percentage:
-­‐
104.56%
(=(-­‐14-­‐307/307)x100)
Profit
(loss)
of
the
period
/
revenue
-­‐2.3%
(=-­‐249/10,971)
1.06%
(=122/11,560)
-­‐3.36
percent
point
(=-­‐336
bps)
(=-­‐2.3-­‐1.06)
Cost
of
debt
(loans,
leases
and
overdraft)
Finance
costs
/
revenue
2.1%
(=235/10,971)
1.6%
(=185/11,565)
+0.5
percent
point
(=50
bps)
(=2.1-­‐1.6)
STAGE
2
Ratios
and
formulae
DRAFT
YEAR
N
(N)
ACTUAL
YEAR
N-­‐1
(N-­‐1)
VARIANCE
(N)
–
(N-­‐1)
Inventories
Day’s
inventory
=
(inventories
and
work
in
progress(WIP)
/
annual
sales
(excl.
VAT))
x
365
3.16
(=(95/10,971)x365)
1.93
(=(61/11,560)x365)
+1.23
days
(=3.16-­‐1.93)
Receivables
(from
clients)
Days/receivables
ratio
=
(receivables
/
annual
sales
(incl.
VAT))
x
365
98.98
(=(2,975/10,971)x365)
74.80
(=(2,369/11,560)x365)
+24.18
days
(=98.98-­‐74.80)
Trade
payables
(to
suppliers)
Days/payables
ratio
=
(payables
/
annual
sales
(incl.
VAT))
x
365
50.34
(=(1,513/10,971)x365)
39
(=(1,245/11,560)x365)
+11.34
days
(=50.34-­‐39)
Working
capital
(Operating)
working
capital
=
inventories
+
trade
receivables
–
trade
payables
1,557
(=95+2,975-­‐1,513)
1,185
(=61+2,369-­‐1,245)
by
value:
+372
(=1,557-­‐1,185)
by
percentage:
+31%
(=(1,157-­‐
1,185)/1,185)x100)
Working
capital
turnover
ratio
Working
capital
/
annual
sales
14.19%
(=1,557/10,971)
10.25%
(=1,185/11,560)
+3.94
1
http://www.investopedia.com/terms/b/basispoint.asp

4. ABC
Co.
Case
Study
4
Working
capital
(in
number
of
days)
Working
capital
turnover
x
365
51.79
(=0.1419x365)
37.41
(=0.1025x365)
+14.38
days
(=5179.35-­‐3741.25)
Capital
employed
Non-­‐current
assets
+
working
capital
10357.35
(=5,178+5179.35)
8411.25
(=4,670+3741.25)
+1946.1
(=10357.35-­‐8411.25
STAGE
3
&
4
Ratios
and
formulae
DRAFT
YEAR
N
(N)
ACTUAL
YEAR
N-­‐1
(N-­‐1)
VARIANCE
(N)
–
(N-­‐1)
Financing
Net
debt*
/
EBITDA*
-­‐116.71
(=[(1,223+3,481)-­‐3,070]/-­‐
14)
2.86
(=[(1,000+2,307)-­‐
2,430]/307)
-­‐119.57
(-­‐116.71-­‐2.86)
Invested
capital
profitability
ROCE*
-­‐2%
(=(-­‐249/10,357)x100)
1%
(=(122/8,411.25)x100)
-­‐3
percent
point
(=-­‐300
bps)
(=-­‐2-­‐1)
ROE*
-­‐7%
(=(-­‐249/3,544)x100)
3.2%
(=(122/3,793)x100)
-­‐10.2
percent
point
(=1020
bps)
(=-­‐7-­‐3.2)
*
Net
debt
=
short
term
debt
+
long
term
debt
–
cash
&
cash
equivalents
–
marketable
securities
2
Cash
equivalents
are
liquid
assets,
which
can
be
readily
converted
into
cash.
Therefore,
In
this
case
study,
we
considered
“current
asset”
as
cash
&
cash
equivalents.
*
EBITDA
=
Earnings
Before
Interest,
Taxes,
Depreciation,
and
Amortization
In
the
given
summary
income
statement,
there
is
no
information
about
depreciation
and
armotaization
so
that
the
EBITDA
is
equal
to
EBIT
which
is
profit
before
tax
–
financial
expense
net
of
financial
income
(during
the
debt
financing
cycle).
*
ROCE
=
Net
income
after
tax
/
capital
employed
*
ROE
=
Net
income
/
shareholders’
equity
5.
Give
a
short
interpretation
of
your
results.
The
company
is
on
the
edge
of
solvency
risk
which
can
lead
to
a
very
dangerous
situation.
In
the
first
stage,
let’s
first
see
how
the
company
creates
wealth
using
trend
analysis.
We
can
mainly
observe
how
operating
profit
is
formed
in
the
income
statement.
Revenues
in
Year
N
has
decreased
by
5.1%
compared
to
Year
N-­‐1.
The
fall
in
revenues
could
mean
that
the
business
has
shrunk.
Yet,
margin
tends
to
be
better
indicators
to
understand
how
profitable
the
business
is.3
In
this
sense,
the
decreases
in
Gross
profit,
EBIT,
and
(net)
profit
are
a
bad
signal
to
the
company’s
profitability.4
Also,
an
increase
in
cost
of
sales
shows
scissors
effect
as
revenues
and
costs
moved
in
diverging
directions.
2
Vernimmen,
Pierre,
Corporation
Finance
4
th
Edition,
2014,
p.49
3
https://www.linkedin.com/groups/Whats-­‐more-­‐important-­‐margin-­‐gross-­‐4908476.S.253311307
4
http://wiki.scn.sap.com/wiki/display/KPI/Gross+Profit+Margin+-­‐+Earned

5. ABC
Co.
Case
Study
5
Moving
on
to
the
next
stage,
we
need
to
pay
attention
to
a
rise
of
working
capital
between
the
two
years.
Since
working
capital
accounts
are
composed
of
uncollected
sales,
unsold
production
and
unpaid-­‐for
purchases,
an
increment
in
working
capital
is
caused
by
augmentations
of
inventories,
trade
receivables
and
payables.
Higher
portion
of
working
capital
means
that
higher
amount
of
company’s
annual
sales
volume
is
“frozen”.
As
seen
from
the
working
capital
turnover
ratio,
the
company
needs
to
have
14.19%
of
its
annual
sales
in
Year
N
which
is
around
51.79
days
of
its
annual
sales.
Lastly,
ROE
and
especially
ROCE
show
effectively
a
drop
in
the
company’s
profitability.
In
addition,
net
debt/EBITDA
ratio
has
soared
to
a
critical
level
so
that
it
is
likely
that
the
company
would
make
a
vicious
cycle
and
never
be
able
to
pay
off
its
debt
if
it
continues.
6.
What
does
going
concern
principle
mean?
In
corporate
finance,
it
is
important
to
know
the
concept
of
going
principle.
The
going
concern
principle
states
that
businesses
should
be
treated
as
if
they
will
continue
to
operate
indefinitely
or
at
least
long
enough
to
accomplish
their
objectives.
In
other
words,
the
going
concern
concept
assumes
that
businesses
will
have
a
long
life
and
not
close
or
be
sold
in
a
foreseeable
future.
Companies
that
are
expected
to
continue
are
said
to
be
a
going
concern.
Companies
that
are
expected
to
close
in
the
near
future
are
not
a
going
concern.
It
is
the
management
of
a
company’s
responsibility
to
determine
if
the
going
concern
assumption
is
appropriate
in
the
preparation
of
financial
statements.
Without
the
going
concern
assumption,
companies
wouldn't
have
the
ability
to
prepay
or
accrue
expenses.
One
of
the
most
significant
contributions
that
the
going
concern
makes
is
in
the
area
of
assets.
The
entire
concept
of
depreciating
and
amortizing
assets
is
based
on
the
idea
that
businesses
will
continue
to
operate
well
into
the
future.
Assets
are
also
reported
on
the
balance
sheet
at
historical
costs
because
of
the
going
concern
assumption.
If
we
disregard
the
going
concern
and
assume
the
business
could
be
closed
within
the
next
year,
a
liquidation
approach
to
valuing
assets
would
be
more
appropriate.
Assets
would
be
recorded
at
net
realizable
values
and
all
assets
would
be
considered
current
assets
rather
than
being
segregated
into
current
and
long-­‐term
categories.
However,
some
businesses
do
close
and
go
bankrupt.
If
the
business
is
in
a
financial
position
that
suggests
the
going
concern
assumption
can't
be
followed
(the
business
might
go
bankrupt),
the
financial
statements
should
have
a
disclosure
discussing
the
going
concern.
Here
are
some
examples
of
the
going
concern
principle:

6. ABC
Co.
Case
Study
6
• General
Motors
was
experiencing
big
financial
difficulties
and
was
ready
to
declare
bankruptcy
and
close
operations
all
over
the
world
in
the
early
2000s.
The
Federal
government
stepped
in
and
gave
General
Motors
a
bailout
as
well
as
a
guarantee.
In
normal
circumstances,
General
Motors
would
not
be
considered
a
going
concern,
but
since
the
Federal
government
stepped
in,
we
have
no
reason
to
believe
that
General
Motors
will
cease
to
operate.
• Gibson
Guitar
Factory
was
raided
by
the
Federal
government
for
illegally
smuggling
endangered
wood
into
the
country
in
2011.
The
Federal
government
took
more
than
$250,000
worth
or
Gibson's
inventory
and
slapped
them
with
large
fines
for
violating
international
laws.
However,
Gibson
is
still
considered
a
going
concern,
because
it
is
not
likely
that
the
fines
and
punishment
will
stop
its
operations.
7.
From
the
scenario
+
your
own
financial
analysis,
identify
features
which
might
cause
you
to
have
doubts
about
ABC
Company’s
going
concern
status?
1)
Excessive
net
debt
/
EBITDA
ratio
The
ratio
in
Year
N,
-­‐116.71
(the
number
is
negative
because
of
negative
EBITDA,
not
negative
debt
debt.
When
EBITA
is
positive,
a
negative
ratio
can
mean
that
a
company
has
more
cash
than
debt,
but
it’s
not
the
case
in
this
case
study),
is
extremely
high
considering
that
ratios
higher
than
4
or
5
typically
set
off
alarm
bells.5
Therefore
the
company
is
less
likely
to
be
able
to
handle
its
debt
burden,
and
thus
is
less
likely
to
be
able
to
take
on
the
additional
debt
required
to
grow
the
business.
However,
it
is
better
off
checking
other
companies’
ratios
as
well
in
the
same
industry
using
comparative
analysis.
To
conclude,
a
high
level
of
debt
in
general
can
mean
a
company’s
inability
to
continue
as
a
going
concern.
2)
Negative
trends
in
operating
profits
The
problems
are
found
in
not
only
its
financing
activities
as
we
saw
above
in
the
net
debt
/
EBITDA
ratio
but
also
its
operating
outcomes.
What’s
striking
is
that
EBIT
has
dramatically
dropped
down
by
-­‐104.56%
in
Year
X
from
the
previous
year.
We
cannot
know
the
origin
of
these
problems
only
with
the
given
financial
statements
5
http://www.investopedia.com/terms/n/net-­‐debt-­‐to-­‐ebitda-­‐ratio.asp

7. ABC
Co.
Case
Study
7
whether
the
problems
came
from
external
factors
or
internal
factors6
but
it
is
needless
to
say
that
the
company
absolutely
has
to
take
measures
to
prevent
this
negative
flow.
In
addition
to
that,
negative
ROCE
and
ROE
mean
that
the
firm
had
made
a
loss.
Knowing
that
the
average
ROCEs
are
typically
between
5%
and
15%7
(of
course,
it
varies
depending
on
the
sector),
the
ABC
company’s
negative
results
on
its
profitability
could
cause
its
shareholders
and
investors
to
pull
remaining
finances
from
the
business
in
the
hope
of
mitigating
losses.8
Again,
a
business
with
diminishing
capital
has
a
difficult
time
securing
new
loans
to
sustain
operations
and
develop
new
avenues
as
a
going
concern.
6
Rittenberg,
Larry,
Auditing:
A
Business
Risk
Approach,
p.828
7
http://www.thestudentroom.co.uk/wiki/Revision:A_Level_Accounts_Module_4_-­‐_Ratio_Analysis
8
http://smallbusiness.chron.com/can-­‐calculate-­‐return-­‐equity-­‐negative-­‐net-­‐income-­‐35030.html

8. ABC
Co.
Case
Study
8
Bibliography
&
Webography
1.
http://www.investopedia.com/terms/b/basispoint.asp
2.
Vernimmen,
Pierre,
Corporation
Finance
4th
Edition,
2014,
p.49
3.
https://www.linkedin.com/groups/Whats-­‐more-­‐important-­‐margin-­‐gross-­‐
4908476.S.253311307
4.
http://wiki.scn.sap.com/wiki/display/KPI/Gross+Profit+Margin+-­‐+Earned
5.
http://www.investopedia.com/terms/n/net-­‐debt-­‐to-­‐ebitda-­‐ratio.asp
6.
Rittenberg,
Larry,
Auditing:
A
Business
Risk
Approach,
p.828
7.
http://www.thestudentroom.co.uk/wiki/Revision:A_Level_Accounts_Module_4_-­‐
_Ratio_Analysis
8.
http://smallbusiness.chron.com/can-­‐calculate-­‐return-­‐equity-­‐negative-­‐net-­‐income-­‐
35030.html