The document provides an agenda for a two-day credit training seminar covering various topics related to understanding financial statements and their use in lending decisions. Day one includes sessions on cash flow, understanding financials, and group exercises. Day two focuses on more group exercises and examples of analyzing example client financial statements.

1. Credit TrainingDejanJeremićDejanJeremićdejan.jeremic@hold4aim.com

2. Financial ServicesCredit TrainingDay 1.09.45 – 10.00Welcome10.00 – 11.00Why & How Financials are used11.00 – 13.00 Understanding Cash Flow 13.00 – 14.00 (Lunch)14.00 – 18.00Group ExercisesDay 2.08.00 – 10:00Group Exercises10.00 – 13.00 Example clients13.00 – 14.00 (Lunch)14.00 – 15.00Wrap-up

3. Why and How Financials are UsedUnderstanding Financial StatementsPresented by:Dejan Jeremić, Regional manager at Volvo Financial Services Financial consultant at HOLD 4 Aim Business, life and Wingwave coach

4. Understanding Financial StatementsSection #1How are Financial Statements used in theLending Decision?Confidential

7. Cash FlowIndustry ReviewTime in businessAML RiskFleet AnalysisDeal StructureAffiliatesBalance Sheet ReviewPay HistoryCollateral AnalysisPricingOwnersEconomic CrisisIncome Statement Review

8. Putting the Pieces TogetherWe are trying to assemble the puzzle pieces to get a clear picture of the firm.We are trying to determine if they can, based on the available information, repay the money we lend to them.

9. Often, the picture is incomplete because we lack the time to obtain the information, the customer is unable or unwilling to provide the information, or we have not asked for the information.

10. Your role as an analyst is to complete as much of this picture as you can so that a committee is convinced that the customer will be able to repay the money we have loaned them.One Puzzle Piece: Financial StatementsAs the financial reports of a business contain a wealth of financial information, it is important to consider why we are analyzing and interpreting the financial reports. By looking at a financial statement, credit analysts can determine the following:Is the business profitable?

11. Does the company have the ability to pay its bills?

12. Should we loan them money?

13. What is the capital structure of the business?

14. How does this year’s financials compare to last year?

15. How does their financial performance compare with their competitors?

16. How does the business compare to the industry norms? Composition of a Financial StatementAt a minimum, a complete financial statement contains the following items:An Income Statement covering a period of time.A Balance Sheet as of the last day in the period of time.Both the Balance Sheet and Income Statement should be from the same time period. An Income Statement for the 12-month period ended December 31, 2008A Balance Sheet as of December 31, 2008Additional information in a complete financial statement :A cover letter from the accountant who prepared the statement

17. Notes to the financial statements

18. Cash Flow Statement

19. Statement of the Changes in Retained EarningsUnderstanding Financial StatementsSection #2Balance Sheet StructureConfidential

20. Balance Sheet: StructureA balance sheet provides a snapshot, at a SPECIFIC POINT IN TIME, of a firm’s financial position. By financial position we mean:Assets - The quantity of assets the firm has; Liabilities - How much the firm owes to those who financed those assets; and Equity – After the firm satisfies those who financed its assets, what is left for the residual owners.These three items are a snapshot as of a specific day in the year. Recall our earlier example where we said the Balance Sheet was prepared as of December 31, 2008.

21. Balance Sheet: StructureFundamental Accounting Equation: Assets = Liabilities + EquityAssetsLiabilities + Equity

22. Balance Sheet: StructureFundamental Accounting Equation: Assets = Liabilities + EquityWhat does it mean? The equation that is the foundation of double-entry accounting. The accounting equation shows that all Assets are either financed by borrowing money (a Liability) or paid for with the money of the company’s shareholders (Equity).

23. The balance sheet is a complex display of this equation, showing that the total assets of a company are equal to the total of liabilities and shareholder equity. Any purchase or sale by an accounting entity has an equal effect on both sides of the equation, or offsetting effects on the same side of the equation.

24. The equation can be rewritten several ways:Liabilities = Assets - Equity Equity = Assets - Liabilities

25. Balance Sheet: StructureFundamental Accounting Equation: Assets = Liabilities + EquityThe Fundamental Accounting Equation shows that a company can: Fund the purchase of an asset with assets (a $50 purchase of equipment using $50 of cash) or

26. Fund it with liabilities (a $50 purchase of equipment by borrowing $50) or

27. Fund it with equity (a $50 purchase of equipment by using $50 of retained earnings).

28. In the same vein, liabilities can be paid down with assets, like cash, or by taking on more liabilities, like debt.

29. Balance Sheet - StructureQuick Discussion:What impact does it have on the other financial statements if the company fund purchases with current assets, loans, or equity?

30. Example Balance Sheet (U.S.)

31. Balance Sheet: AssetsAn entity needs, cash, equipment and other resources in order to operate. These resources are its assets.The asset portion of the balance sheet is subdivided into:Current Assets – are cash and assets that are expected to be converted into cash or used up in the near future, usually within one year.

32. Long Term Assets – are assets that will not be converted into cash or used up in within one year.Balance Sheet: Current AssetsCashMoney on hand and money in bank accounts that can be withdrawn at any time.Accounts ReceivableMoney, which is owed to a company by a customer for products and services, provided on credit. It is expected that this current asset will be converted into Cash within 1 year.

33. Balance Sheet: Current AssetsInventory (Stock)On a balance sheet, the inventory item is the sum of costs of all raw materials, work in process, and finished goods. It is expected that this current asset will be converted into Cash or used up within 1 year. Prepaid ExpensesWhen companies prepay for goods or services that will be used up within one year, they are classified as a prepaid expense. An example would be paying your annual insurance premium in advance.

34. Balance Sheet: Long Term AssetsLong Term Assets include Fixed Assets and Non-Current AssetsFixed assets can include:Land

35. Building

36. Transportation Equipment

37. Office Equipment

38. SoftwareBalance Sheet: Long Term AssetsIf certain assets accounts cannot be liquidated, in our analysis and presentation of the balance sheet, shouldn’t we “write-down” or reduce the value of these assets? Yes, we should reduce the value of the assets but only when we analyze the Tangible Net Worth. The Balance Sheet must balance. What does this mean?If a company has 100,000 in Assets, 60,000 in Liabilities and 40,000 in Equity but we learn that 25,000 of the Assets are Goodwill, how would we evaluate the true Equity position of the company.We subtract the values we cannot liquidate from Equity:Equity – Intangible Assets = Tangible Net WorthTangible Net Worth (“TNW”) is a more accurate measurement of a firm’s true net worth and is often used in place of Equity. Note you do not reduce the Equity account in your extraction. This is an analysis technique. TNW can be used to evaluate leverage, assess risk of default, and structure transactions.

39. Balance Sheet: Long Term AssetsIf certain assets accounts cannot be liquidated, in our analysis and presentation of the balance sheet, shouldn’t we “write-down” or reduce the value of these assets? Yes, we should reduce the value of the assets but only when we analyze the Tangible Net Worth. The Balance Sheet must balance. What does this mean?If a company has 100,000 in Assets, 60,000 in Liabilities and 40,000 in Equity but we learn that 25,000 of the Assets are Goodwill, how would we evaluate the true Equity position of the company.We subtract the values we cannot liquidate from Equity:Equity – Intangible Assets = Tangible Net WorthTangible Net Worth (“TNW”) is a more accurate measurement of a firm’s true net worth and is often used in place of Equity. Note you do not reduce the Equity account in your extraction. This is an analysis technique. TNW can be used to evaluate leverage, assess risk of default, and structure transactions.

40. Balance Sheet - AssetsQuick discussion:What impact does a growing A/R have on the cash flow, compared to the balance sheet? What impact does the placement of assets as Current or Long Term have on the cash flow?

41. Balance Sheet: Current LiabilitiesLike Current Assets, Current Liabilities are usually repaid within 1 year. Examples of current liability accounts include but are not limited to:Line of Credit Balances (Revolving and Non Revolving)

42. Current Portion of Long Term Debt Balances (CPLTD)

43. Accounts Payable, and Accruals.

44. Other Current LiabilitiesBalance Sheet: Current LiabilitiesLine of Credit (LOC)Lines of credit extended by banks and other lending institutions usually provide the company with short term liquidity to meet its operating needs. These lines can be structured in any number of ways but generally are renewed annually. Sometimes they revolve. Sometimes they don’t revolve. Let’s discuss the following items that relate to lines of credit:How is it similar to a Credit Card?

45. Repayment and the Impact on Cash Flow

46. Secured versus Unsecured

47. Borrowing Base

48. Availability and Utilization

49. Financial and Non Financial CovenantsIt is imperative that LOC are not included with term debt when extracting financial statements.

50. Balance Sheet: Current Liabilities ContinuedAccounts PayableMoney which a company owes to vendors for products and services purchased on credit. It is important that you not include any other accounts besides Accounts Payable in the financial extraction report.AccrualsOn accrual based statements, the Company records expenses when they arise not when they are paid. When you see accrual, think “owed but not yet paid”. Examples of Accrued Expenses:Income taxes

51. Payroll

52. InterestBalance Sheet: Current Liabilities ContinuedCurrent Portion of Long Term Debt (CPLTD)On the Balance Sheet, the principal that is to be repaid within the next 12 months is listed in the CPLTD account.Example: $6.0MUSD note. 0% interest. No Balloon at the end of the term. 60 equal payments of principal. The current portion of long term debt would be: $6.0MUSD / 5 = $1.2MUSD The Long Term portion would be: $6.0MUSD - $1.2MUSD = $4.8MUSD It is imperative that CPLTD is distinguished from long term debt when extracting financial statements.

53. Balance Sheet: Long Term LiabilitiesThe portion that does not have to be repaid within 12 months is listed in the Long Term Debt (LTD) account in the Long Term Liability section of the balance sheet. We introduced the concept that debt that does not have to be repaid within 1 year is considered long term. The liabilitysection of the balance sheet contains several accounts, that can include term debt, that do nothave to be repaid within 1 year. These accountscan vary but all are considered long term liabilities.

54. Balance Sheet: Long Term LiabilitiesExamples of Long Term Liabilities include but are not limited to:Long Term Debt

55. Subordinated Debt

56. Deferred Income Contingent Liabilities and Off Balance Sheet FinancingContingent Liabilities and Off Balance Sheet Financing are similar in that neither item is included among Current or Long Term Liabilities on the Balance Sheet. If you have an audited financial statement, it is fairly easy to determine whether or not a firm is contingently liable by reading the notes to the statements. Otherwise, you must interview the customer to discover this. An example of contingent liability would be if our firm guaranteed another party’s debt. In the event that party defaults, our firm becomes contingently liable for the debt. Off Balance Sheet financing often takes the form of operating lease debt or rentals. This information appears on the incomestatement.It is imperative that we extract this information in our analysis because it impacts our understanding of leverage & cash flow coverage.

57. Balance Sheet: EquityEquity consists of: Common Stock, an equity security that represents ownership in a corporation. (or preferred stock, not discussed here)Paid-in Capital - Funds obtained from equity investors who are ownersRetained Earnings resulting from the entity’s profitable operations. The accumulated profits of a company. These may or may not be reinvested in the business.

58. Understanding Financial StatementsSection #2-2How to analyze the Balance SheetConfidential

59. Balance Sheet: Accounts Receivable DOHA/R*Salesx 365 = A/R DOH*Ideally we should use Average A/R to calculate this formula. A/R Days on Hand (“abbrevieated “DOH”) indicates how quickly a company collects cash from customers that owe it money; i.e how long it takes to covert A/R to Cash.The sooner it is collected, the sooner the company can put it to work to purchase more inventory or to pay for current orders. It is helpful in analyzing the collectability of receivables, or how fast a business can increase its cash supply. Although businesses establish credit terms, customers do not always adhere to them. In analyzing a business, you must know the credit terms it offers before determining the quality of receivables. While each industry has its own average collection period (number of days it takes to collect payments from customers), there are observers who feel that more than 10 to 15 days over stated terms should be of concern to you.When extracting A/R for analysis, no other assets should be included on the line item.

60. Balance Sheet: Accounts Receivable DOHYou can supplement the analysis of A/R DOH by also reviewing the firm’s Accounts Receivable Aging Report. Again, ideally we should calculate A/R DOH using average A/R but this is very difficult to do in practice. We want average A/R because A/R on a specific balance sheet date might not reflect the average A/R the firm carries (due to seasonality) which in turn may skew our understanding of how timely they collect A/R. An A/R Aging Report allows us to directly view:Whether or not payments are being collected in a timely manner

61. Perform an A/R Aging analysis in order to indentify customer concentrations which also

62. Allow you to identify which customers they are having collection problems with.Balance Sheet – A/R DOHDiscussion item:Can a client who has A/R DOH of 70 days have no overdue receivables?Why do we care when the A/R DOH is in an increasing trend?

63. Balance Sheet: Accounts Payable TurnoverA/P*COGSx 365 = A/P DOH*Ideally, we should use average A/P for the same reasons as given for the first two ratios.Accounts Payable DOH measures how the company pays its suppliers in relation to the cost of sales (or Sales when COGS not available) volume being transacted. A low payable turnover would indicate a healthy ratio. Conversely, a high payable ratio could mean the company must delay payments beyond granted terms in order to preserve Cash. Like A/R DOH, you should know the credit terms the firm was granted by its supplier to put this ratio into the proper context. Figures significantly higher than credit terms should be addressed in your presentation as well as significant swings in the figure period over period.

64. Balance Sheet: Working Capital and Liquidity Working Capital is a measure of both a company's efficiency and its short-term financial health. Many lenders use working capital to determine a firm’s liquidity….or how easily its Current Assets can be converted into Cash which in turn is used to cover its Current Liabilities. The more liquid the assets are the higher the probability they can cover current liabilities. Illiquidity is a risk that a company might not be able to convert its assets into Cash when most needed and in turn, not be able to cover Current Liabilities.Moreover, having to wait for the sale of an asset can pose an additional risk if the price of the asset decreases while waiting to liquidate. Working Capital is the Difference between Current Assets and Current Liabilities.Working Capital = Current Assets – Current Liabilities

65. Current AssetsCurrent Ratio = Current LiabilitiesBalance Sheet: Working Capital & LiquidityWorking Capital can either be expressed as the difference between Current Assets and Current Liabilities or the Working Capital Ratio which can be expressed as Current Assets divided by Current Liabilities. The common name for the Working Capital Ratio is the Current Ratio.Tip: Ratios are useful because they are a relative measurements which can be used to compare a firm to its peers as well as to its past performance in order to analyze the trend.Example: If a firm has $100,000 in current assets and $80,000 in current liabilities Its Working Capital is $100,000 - $80,000 = $20,000. If for some reason, all current liabilities were due and payable today, the firm could cover its current liabilities with an additional $20,000 to fund short term operations

66. Its current ratio would be ($100,000 / $80,000) = 1.25 to 1.00. What does a current ratio of 1.25 mean? How can you use it in your analysis?Balance Sheet: Working Capital and LiquidityPositive working capital means that the company is able to pay off its short-term liabilities by liquidating its current assets. Negative working capital means that a company currently is unable to meet its short-term liabilities with its current assets (cash, accounts receivable and inventory).If a company's current assets do not exceed its current liabilities, then it may run into trouble paying back creditors in the short term. The worst-case scenario is bankruptcy. A declining working capital ratio trend over a longer time period could also be a red flag that warrants further analysis. If this trend is observed when the financials are extracted, it should be addressed in your presentation.

67. Balance Sheet: LeverageTotal LiabilitiesLeverage = EquityThe leverage ratio (known as Gearing in the UK) is a financial ratio indicating the relative proportion of equity and debt used to finance a company's assets.Leverage is a relative measure of a company’s risk of default. This ratio indicates the amount due to creditors within a year as a percent of the owner’s investment. Companies with high leverage (i.e. have higher Total Liabilities relative to Equity) have a higher risk of defaulting on their obligations to their creditors. Normally, a business starts to have trouble when this relationship exceeds 80%. (Alternatively, this number may take the format of 8x pronounced “Eight Times”….as in Liabilities are eight times tangible net worth).Leverage less than 1x is considered nominal and less than 2x is considered low.

68. Leverage less than 3x is considered moderately low.

69. Leverage from 4x to 7x is considered moderately high.

70. Leverage in excess of 8x is considered extremely high.Balance Sheet: Leverage ContinuedThe leverage ratio should be compared to peer firms within the same industry.Example: If a firm had $500,000 in Total Liabilities, $300,000 in Net Worth, what would its leverage be?Leverage = Total Liabilities / EquityLeverage = $500,000 / $300,000 = 1.6 to 1.00Is this company highly leveraged?

71. Balance Sheet: Contingent Liabilities and Off Balance Sheet FinancingIn the last example we determined that the leverage ratio was 1.6 to 1.0 based on the total liabilities of $500,000 and $300,000 in Net worth.What if the same company also had other off balance sheet commitments? Example: $1.5 million in operating leases. How would the leverage calculation change? Leverage = (Total Liabilities + Off Balance Sheet Commitments)/ EquityLeverage = ($500,000 + $1,500,000) / $300,000 = 6.6 to 1.00Is this company highly leveraged if you consider this off balance sheet commitment? Does your opinion of the company’s financial position change? Are the risks of the company defaulting on its loan agreements greater or smaller?

72. Balance Sheet - LeverageDiscussion item:Why do you think that customers who are highly leveraged tend to default more?Food for thought:Equity in a company is like the down payment on an asset. The more that a person has invested relative to the total worth, the more that they will want to retain that investment.

73. Balance Sheet Balance Sheet Comments:Trade Receivables are categorized as;Normal Trade A/R increased sharply because of PT Thailindo equipment were shipped and invoiced in Aug 2008 which will receive the money in Dec 2008. They also provide hire purchase facility to end customers themselves which the A/R also increased sharply.Total Current Assets also includes Inventory of MTHB 649.72 in 2007 and MTHB 640.84 in 2008.Intangible Assets increased by 45% mainly due to the increase in Hire purchase Receivables (from MTHB 58.20 to MTHB 127.33) and the decrease in Assets for Rent (from MTHB 217.22 to MTHB 171.28).As of Aug 2008, Working Capital utilization rose by 144% due to an increase in bank overdraft and trust receipts for imported products (non-Volvo brand). Facilities comprises of Bank overdraft (MTHB 16.94) and Trust receipt (MTHB 102.02).CPLTD has been increasing since 2006 as ITI started floor plan financing with VFS, Krungthai IBJ and Cathay Lease Plan.Intercompany payable in 2007 and 2008 of MTHB 174.80 (repayable on demand and unsecured) consists of 3 related parties which are Italthai Holding (MTHB 46.80) Sakdi Sin Prasit Co., Ltd (MTHB 10.00) and Director (MTHB 118.00).Long-Term debt dropped by 91% to MTHB 4.10 because the equipment under financing was sold to end customers.Accumulated deficit in Retained Earnings was carried over from 1997 to 2007 due to the financial crisis in 1997. But with profitability generated in the last few years, it managed to recover and reported a positive earnings of MTHB 17.90 in Aug 2008.Trade receivables turnover increased from 51 days in 2007 to 86 days as of Aug 2008 mainly due to PT Thailindo deal which was pending VFS financing, but has already been paid in Dec 2008.For contingent liability for PT Thailindo, ITI has not yet decided how to categorize the guarantee in the financial statement and still waiting for management’s final decision.

74. Understanding Financial StatementsSection #3-1Structure of the Income StatementConfidential

75. Example Income Statement (U.S.)

76. Income StatementDefinition:While the Balance Sheet is a statement of financial condition at one point in time, the Income Statement shows what revenues were earned and what expenses were incurred OVER A PERIOD OF TIME. The primary purpose of the income statement is to report the profitability of the business in relation to revenues; however it can also reveal important insights into how effectively and efficiently management is controlling expenses.

77. Income StatementAs an analyst, you should use the income statement to ask management questions like:Are Revenues growing, shrinking, or staying the same and specifically, “Why?”

78. How are revenues earned?

79. What percentage does each of their customers contribute to total revenues?

80. How long have they had relationships with each of these customers?

81. Are the relationships based on contracts?

82. Can I review the contracts?

83. What lines of business or divisions is the company engaged in…how do they make money? How much does each line of business or division contribute to total revenues? How has this changed year to year? Do they earn money outside of providing transportation services, construction services; etc.?

84. How much revenue does one revenue-generating asset contribute to annual sales? Monthly sales? Based on kilometers driven or hours used, can you calculate what the revenue generated per kilometer.

85. Does this historical revenue generating information tie to what management says the new equipment will produce?Income StatementStructure:Balance Sheets note the “as of” date and an Income Statements note the period of time covered by the statement (1 month, 9 months, 12 months, etc.); otherwise, there is no point of reference to understand the information in the statement.

86. It’s important to note that not all income statements look alike but they necessarily contain much of the same information.

87. An Income Statement has a specific structure. It starts with Revenues for the period (Top Line), lists the expenses of the period, and generally ends with Net Income (Bottom Line)Income StatementTyson Foods Inc.Fiscal Year ended 2005 (Millions of USD)Top LineBottom LineTo understand structure and meaning of every “Element of the Income Statement” we are going to review “Tyson Foods Inc” Income Statement 2005

88. Income StatementSalesSales $ 26 014 This figure is the amount of Revenues a business brought in during the time period covered by the Income Statement. It has nothing to do with profit. Many companies can break sales up into categories to clarify how much was generated by each division. Defined and separate revenue sources can make analyzing an income statement much easier.

89. Income Statementb) The Cost of SalesIt represents the cost of producing the products sold. It can include:Raw materialsLabor forceOverhead associated to production Sometimes Depreciation/Amortization but this account can also be included in the operating expenses (to be analyzed)Service based companies generally do not register cost of sales.

90. Income Statementc) Gross Profit The gross profit is the total revenue subtracted by the cost of generating that revenue.

91. Income Statemente) Operating IncomeThe difference between Gross Margin and Operating Expenses give us the Operating Income, which is a measurement of the money a company generated from its own operations. It can be used to check the health of the core business

92. Income Statementf) All other income or expensesThese will arise when non-recurring items or events occur and are not expected to occur again, examples:Sale of fixed assets such as machinery, transport units, etc.

93. Legal Claims

94. Improvement to facilitiesIncome Statementg) Interest ExpenseSome income statements report interest income and interest expenseseparately, while others report interest expense as “Net”. Net refers to: Net Income-Net ExpenseInterest Income: Companies sometimes keep their cash in short-termdeposit investments, the cash placed in these accounts earn interest for thebusiness, which is recorded on the income statement as interest income. Interest Expense: Cost of BorrowingIt is imperative that we extract Interest Expense in order to understand the Company’s ability to cover its interest costs.

95. Income StatementThe amount of interest a company pays in relation to its revenue andearnings is tremendously important because this task can be the difference between a positive or negative result.

96. Income Statementi) Net IncomeThis is the bottom line, which is the most commonly used indicator of acompany's profitability. Of course, if expenses exceed income, this account will read as a net loss.

97. Understanding Financial StatementsSection #3-2How to analyze an Income StatementConfidential

98. Income Statement AnalysisWhat is important of the information that we are reviewing?Ratios for the Income StatementSales GrowthGross Profit MarginOperating profit marginNet Profit MarginEBITInterest coverage ratio: EBIT ÷ Interest ExpenseEBITDAEBITDA MarginEBITDAROn the following slides, (F) denotes formula and (E) denotes example

99. Income Statement AnalysisSales Growth is one of the key measurements an analyst will review.Sales growth is measured bycomparing sales figures from two periods oftime. Ideally, the sales figures should cover equal amounts oftime,otherwise, the analyst must make an adjustment.(F)Sales (current period) – Sales (prior period) Sales (prior period)(E)26,014 – 26,441 26,441= - 0.016 x 100 = -1.6%An analyst should ask management about any large increases in Sales Growth. He should also ask questions if Sales volume is unchanged from the prior period or if Sales have declined. He should ask about erratic trends.Income Statement AnalysisWith multiple financial statements, you compare many of the ratios to determine what direction your company is headed in. Here are some key ratios over a 3 year time frame for a real private traditional trucking operation from our records. What would you say about the financial trends of this company?

100. Income Statement AnalysisEarnings Before Interest and Income Taxes (“EBIT”)EBIT measures of a firm’s profitability and management’s efficiency at minimizing operating costs. It excludes interest and income tax expenses. You will see EBIT and Operating Profitability used interchangeably.Technically speaking, EBIT and Operating Profitability are only equal if a firm does not have any Non-Operating Income. If a firm has significant sources of non operating income and you use Operating Profitability as a measure of profitability, you will underestimate when looking at the income statement and underestimating their ability to cover interest and amortize debt when looking at interest coverage ratios and Cash Flow.

101. Income Statement AnalysisEarnings Before Interest and Income Taxes (“EBIT”)It can be calculated several ways but the result is the same:Net Sales – COGS – Total Operating Expenses (OPEX) + Non-Operating Income.20438 – 7943 – 9270 + 130 = 3355**************************OR********************************Operating Income + Non-Operating Expenses 3225 + 130 = 3355**************************OR********************************Net Income + Interest Expense + Taxes2183 + 145 + 1027 = 3355

102. Income Statement AnalysisEarnings Before Interest and Income Taxes Depreciation and Amortization (“EBITDA”)EBITDA measures the cash earnings that may be applied to interest and debt retirement. Like EBIT, EBITDA measures how efficiently the company is operated which in turn is an indicator of how profitable it is. It is a good indicator of how much Cash is generated by the company’s operating activities which is why we use it in Cash Flow Analysis.Depreciation and Amortization Expense do not signify a Cash Outlfow. The Cash Outflow occurred when the Fixed Asset or Intangible Asset was acquired. See slide #134. As a lender, we ignore depreciation and amortization because they are non-cash charges and thus do not interfere with a company's ability to repay debt. If you omit them from your financial extraction, you negatively impact our understanding of the company's ability to repay debt. Additionally, such figures are merely a reconciliation of cash-basis accounting to accrual-basis accounting and are subject to a certain degree of flexibility corporate accountants have when setting depreciation and amortization schedules.

103. Income Statement AnalysisEBITDAEBITDAEBITDA Margin = EBITDA Margin = SalesSales$1 billion = = 10% $10 billionEBITDA Margin is a financial metric used to assess a company's profitability by comparing its revenue with earnings. More specifically, since EBITDA is derived from revenue, this metric would indicate the percentage of a revenues remaining after operating expenses.For example, if XYZ Corp's EBITDA is $1 billion and its revenue is $10 billion, then its EBITDA to Sales ratio (EBITDA Margin) is 10%. Ten out of every one hundred dollars of revenues earned is retained and is available to service debt.Generally, a higher EBITDA Margin indicates that the company is able to keep its earnings at a good level via efficient processes that have kept certain expenses low.

104. Income Statement AnalysisEBITDAEBITDA Margin = SalesBecause EBITDA margin is a good measure of how efficient a firm is at keeping expenses low and because it is a relative measurement of efficiency, it can be used in a variety of ways which include:Comparing several periods, you can determine if a firm is becoming more or less profitable (efficient) over time.

105. It is used on the Quick and Dirty Financial Statement Analysis Tool as a way to project EBITDA. This projected EBITDA is used to calculate a firm’s ability to service new and existing debt. (Cash Flow Projection Analysis).

106. It can be used to compare a firm to another firm within one industry. However, when comparing company's EBITDA margin, make sure that the companies are in related industries as different size companies in different industries are bound to have different cost structures, which could make comparisons irrelevant.Income StatementEarnings Before Interest and Income Taxes Depreciation and Amortization and Rental or Restructuring Costs (“EBITDAR”)Depending on the company and the goal of the user, EBITDAR can either include restructuring costs or rent costs, but usually not both. The EBITDAR indicator expands on EBITDA by adding an additional excluded item to give a better indication of financial performance.Rent is included in the measure when evaluating the financial performance of companies, such as trucking companies that have significant rental and lease expenses derived from business operations.By excluding these expenses, it is easier to compare one trucking firm to itself over time which allows an analyst to determine if they are more or less efficient, period-over-period. You can also compare one company to another and get a clearer picture of their operational performance relative to their peers.

107. Income Statement EBITDAR - ContinuedTip: When the company has not had any rental or restructuring costs, you use the EBITDA figure. In fact, EBITDA and EBITDAR are equal when there is either no rental or restructuring costs listed among the operating expenses.

108. Tip: When a company has rental costs (like renting transportation or construction equipment), use EBITDAR as the measurement of profitability and the EBITDAR cash flow model to measure historical and projected ability to service debt.Restructuring is included in the measure when a company has gone through a restructuring plan and has incurred costs from the plan. These costs, which are included on the income statement, are usually seen as nonrecurring and are excluded to give a better idea of the company's ongoing operations.Both EBITDA and EBITDAR ratios and cash flow calculations are included in the Quick and Dirty Financial Statement Analysis Tool.

109. Income Statement –Income Statement Comments:As of Aug 2008, Revenue growth is relative flat at 0.1% based on annualized basis compared to last year. Despite the weak economic conditions, the company is still able to maintain its business volume.Based on annualized basis, Depreciation & Amortization for Aug 2008 and Dec 2007 are remained in the same level at MTHB 122.82.For year 2004 and 2005, no corporate income tax were paid on the profit since the company has been granted income tax privileges from 1999 to 2005.As of Aug 2008, Net Profit shown only MTHB 33.84 due to the exchange rate loss for importing the equipment for PT Thailindo deal. Despite an increase in operating expenses, PT Thailindo deal which was booked during Q4 2008 will increase ITI’s Net Income from 33.84 in Aug 2008 to an expected Net Income of MTHB 45.00 in Dec 2008.The company remains profitable in the past 5 years.

110. Income StatementQuick Discussion:What does it mean when a company has gone through a restructuring? Is that the same thing as our loan restructure?

111. Understanding Cash FlowSection #4-1Cash Flow StatementConfidential

112. Cash Flow Statement Construction and AnalysisIn order to construct a valid cash flow, not to mention analyze the balance sheet and income statement ratios, you must accurately extract all the relevant financial data from your financial statements. DO NOT RESTATE THE FINANCIAL STATEMENT FIGURES THEY PROVIDE IN YOUR EXTRACTION WITHOUT ANALYZING THEM! Recall that throughout this presentation we have emphasized the importance of extracting all the appropriate balance sheet and income statement items. A proper financial statement extraction takes into account many variables, regardless of local accounting standards. In doing so, you standardize the format of the financial statement for our internal needs and allows you to more objectively evaluate the financial condition of the customer.Here is a recap of what we discussed and why it is important to extract these items:

113. Cash Flow Statement Construction and AnalysisExtract Depreciation and Amortization Expense as these are non-Cash expenses. These expenses are normally found among the firm’s operating expenses on the Income Statement but occasionally they are listed among the Cost of Goods Sold. If not found on the Income Statement you should:Unless the firm has fully depreciated all its fixed assets, there should be Depreciation Expense listed in your financial extraction. If you omit Depreciation Expense, you negatively impact our understanding of whether or not the customer generates enough Cash to service historical and projected debt.Look at the Statement of Cash Flows for this information

114. Look at the notes to the financial statements for this information

115. Estimate the number by subtracting Accumulated Depreciation from the Current Period from the Prior Period (See Slide #135…the difference in Accumulated Depreciation between Year 1 and Year 2 is Equal to the Depreciation Expense for the period) or

116. Ask management (See Next Slide)Cash Flow Statement Construction and AnalysisIf you ask management about the location and amount Depreciation and Amortization Expense, pay close attention to the way they answer the question. Your first question should be: “Are Depreciation Expense and Amortization Expense buried among the expenses on the Income Statement or have they been excluded?”“If the answer is “Yes, depreciation and amortization are included in the expenses on the Income Statement” then your follow up question should be “What are the exact amounts of depreciation and amortization?” Companies that don’t know what these figures are demonstrate that they have poor internal accounting controls in place. You should take the information they provide and show it when you extract the financial statements. Extracting depreciation and amortization will not affect Net Income since these figures were previously buried among the existing expenses but will positively affect the calculation of Cash Flow. In your extraction, be sure to reduce other expenses so that Net Income is unchanged.

117. If the answer is, “No, depreciation and amortization are not included on this statement” you should ask “Have your fixed assets have been completely depreciation and have your intangible assets, such as Goodwill, been completely amortized?” If they have been fully depreciated and amortized, then your investigation is complete and you should mention this in your presentation. If not, find out what the numbers are and extract these items. This will reduce Net Income by the amount you input but will not effect Cash Flow.

118. Why?Cash Flow Statement Construction and AnalysisIf expenses have been inflated to reduce profitability you should investigate what expense items were inflated and what the net effect was on profitability.If cash actually flowed out of the business, then these were real, cash expenses so this money is not available to service existing debt or amortize new debt. No adjustments to your extraction are required.

119. If cash did not flow out of the business, then these were non-cash expenses akin to Depreciation and Amortization. Additional adjustments to your extraction are required. I recommend categorizing these types of expenses as Depreciation and Amortization because they are non-Cash expenses. By this, you won’t change Net Income but you will give a clearer picture of the company’s ability to service debt.Cash Flow Statement Construction and AnalysisRentals signify significant off-balance sheet financing. Operating equipment leases are an example of off balance sheet financing. Used in calculation of off balance sheet financing which impacts the calculation of operating leverage.

120. Used in the calculation of EBITDAR which can significantly impact our understanding of their ability to service existing and newly proposed debt.Interest Expense should be extracted as it is an important factor in the calculation of EBIT, EBITDA, EBITDAR as well as calculating interest coverage ratios and EBITDA Margin.Contingent Liabilities such as guarantees of another party’s debt should be noted and leverage recalculated to address these items. You should also address the Company’s ability to service this debt if a lender requires them to do so.You should only include A/R, Inventory, Lines of Credit, CPLTD, LTD, A/P, etc. on line items designated for them in the extraction report. Including other accounts skews the financial statement analysis.

121. Cash Flow Statement Construction and AnalysisA few additional questions you will need to answer to construct your cash flow and projection are:Is the equipment the firm wishes to finance, expanding their existing fleet or replacingequipment in their fleet?

122. If they are expanding, you should treat the annual principal and interest payments as additional debt service in your analysis.

123. If they are replacing equipment…i.e. ending one note and starting another and if the payments are similar, you do not have to consider this as additional debt service.

124. If they are replacing equipment but the equipment being replaced has not had any outstanding notes against it for over a year or more, then this is still additional debt service.Cash Flow Statement Construction and AnalysisOnce you have satisfied yourself that you have extracted the data in the financial statements correctly, that you understand the answers management has provided you, and you know whether or not you are looking at additional debt service or replacement debt service, you are ready to analyze the financial statements and construct a Cash Flow Statement.Luckily, you can use spreadsheets to automate this process so it is unnecessary to do this by hand. I do recommend that at some point, you sit down with a calculator and see if you can recreate the calculations in the spreadsheet.

125. Example of Accountant Prepared Cash Flow Statement (U.S)

126. Cash Flow StatementDefinition:A cash flow statement is a financial report that shows incoming and outgoing cash during a specific period of time. The statement shows how changes in balance sheet and income accounts affected cash and cash equivalents. Why is this Statement important?As an analytical tool the statement of cash flows is useful in determining the short-term viability of a company, particularly its ability to pay bills.

127. Cash Flow StatementMany publicly traded companies provide Cash Flow Statements in addition to the Balance Sheet and Income Statement. This document provides aggregate data regarding all cash inflows a company receives from both its ongoing operations and external investment sources, as well as all cash outflows that pay for business activities and investments during a given period. Recall the example U.S cash flow statement. It is comprised of 3 sections which is one typical format of a Cash Flow Statement*:Cash provided (used) by operating activities

128. Cash provided (used) by Investing activities

129. Cash provided (used for) financing activities*Be aware that there are many Cash Flow formats but we will not cover them in this class.

130. Cash Flow StatementBecause public companies tend to use accrual accounting, the income statements they release may not necessarily reflect changes in their cash positions. For example, if a company lands a major contract, this contract would be recognized as revenue (and therefore income), but the company may not yet actually receive the cash from the contract until a later date.

131. While the company may be earning a profit in the eyes of accountants (and paying income taxes on it), the company may actually end up with less cash than when it started the period.

132. Even profitable companies can fail to adequately manage their cash flow, which is why the cash flow statement is important: it helps lenders see if a company is having trouble with cash.Cash Flow StatementSo, if the accountant prepared cash flow statement provides all this information, the logical question is: “Why do I need to construct another Cash Flow Statement? Isn’t this duplicating their efforts? Why is this necessary?”Cash Flow Statements primarily show the sources (inflow) and uses (outflow) of Cash.

133. Depending on the Cash Flow Format used by the customer, it is not always apparent if, on a historical basis, they generated enough Cash to service debt.

134. Additionally, depending on the Cash Flow Format used by the customer, it may be difficult to take their format and manually project if they can service the new debt being proposed.

135. Because of these difficulties, many lenders use an alternative to the customer’s Cash Flow Statement format to analyze how debt was serviced and if they are capable of generating enough Cash to service the newly proposed debt.Alternative Cash Flow FormatsThere are numerous alternative Cash Flow formats but we will focus on two the simplest to construct: Basic Cash Flow and EBITDA Cash FlowBasic Cash Flow (abbreviated “BCF”)Use this method to make a quick assessment of the customer’s historical ability to service debt. It can be done in your head while sitting in front of the customer.*(pp) means Prior Period.

136. Alternative Cash Flow: Basic Cash Flow The Values in the adjacent chart are in $1,000s of USD.Using CPLTD (pp)What is the basic cash flow coverage for 2003 – 2006?What is the surplus (or deficit) basic cash flow?What trend do you see?Compare the BCF trend to the profit trend. What is the difference?What questions would you ask management?

137. Alternative Cash Flow FormatsBCF compared to CPLTD (pp) is the simplest way to evaluate a firm’s ability to service historical debt. It can be done in your head or with a calculator while visiting a customer. If you see negative trends, you can ask the customer about them immediately.BCF compared to CPLTD from the prior period is the most accurate way to evaluate a firm’s ability to service debt. Recall that CPLTD from the balance sheet represents principal on debt a company must repay within the next 12 months. It makes sense that we use the CPLTD from the prior period because it is due in the current period.Example: CPLTD as of December 31, 2008 must be repaid between January 1, 2009 and December 31, 2009. Therefore, we compare it to BCF generated in 2009.

138. Alternative Cash Flow FormatsOne small problem with using CPLTD (pp) is that you cannot analyze cash flow coverage with only one period of data. Additionally, as an analyst, you may want a more conservative calculation, especially if the company is growing rapidly or during times of economic crisis. In this case, you may want to use CPLTD from the current period (CPLTD (cp)). If a company acquires revenue generating assets on December 31, 2008 on credit, principal and interest payments start and will continue through 2009. The revenues the assets will generate should start in 2009. It would not be accurate to compare the revenues generated in 2008 to the principal and interest payments on these assets but it would be conservative. Why?If you calculate positive cash flow coverage and excess surplus cash flow using this conservative method, you can be fairly certain that on a historical basis, the company’s cash flow is strong.

139. Alternative Cash Flow: Basic Cash FlowUsing CPLTD (pp)Using CPLTD (cp)

140. Alternative Cash Flow: Basic Cash FlowThe Values in the adjacent chart are in $1,000s of USD.Notice that our financial statement covers 12 months of data in each period. This makes our calculations simple. What if the numbers in the last column only represented 9 months of data instead of 12?How would we adjust our BCF formula? Would your opinion of the financials change?

141. Alternative Cash Flow: Basic Cash FlowWe would need to adjust (or ANNUALIZE) our formula so that we are comparing 12-months of basic cash flow to CPLTD that has to be repaid in 12 months.In our example on the previous slide, the accounts in the last column only represent 9 months of data instead of 12. We must annualize this data to construct our cash flow. Recall that the figures are in $1,000s of USD.The firm’s Net Loss for the first 9 months of 2006 was = (782K) Annualize the Net Loss by dividing it by 9 months and multiplying the result by 12 months.(782K) / 9 months = (86,9K). They lost, on average, 86,9 K per month for the first 9 months of 2006.(86,9K) x 12 months = (1042,7K). They are projected to lose 1042,7K during the 12 months ended December 31, 2006.

142. Alternative Cash Flow: Basic Cash FlowRepeat for Depreciating and Amortization. There is no amortization in our example.We must annualize this data to construct our cash flow. Recall that the figures are in $1,000s of USD.The firm’s Depreciation Expense for the 9 months was = 4,618K Annualize Depreciation Expense by dividing it by 9 months and multiplying the result by 12 months.4,618K / 9 months = 513,1K. The firm reported 513,1K in depreciation expense per month during the first 9 months of 2006.513,1K x 12 months = 6157,3K. The firm is projected to report 6157,3K in depreciation expense for the 12 months ended December 31, 2006.

143. Alternative Cash Flow: Basic Cash FlowIt is not necessary to annualize CPLTD. This figure already represents what is to be repaid within the next 12 months. You now have enough information to construct a cash flow based on information from the 9 month interim period.

144. Alternative Cash Flow: Basic Cash Flow ProjectionWhat if this customer wanted to finance (5) 2009 A25E with dumper bodies for 182,000 each. 8.15% interest rate. 60 months., No down payment. The monthly payment (principal and interest) on 1 unit would be about 3703. The annual payment on 5 units would total 222202. The units will be additions to their fleet. If they continued to perform the way they have performed in 2006, for the next 5 years, do you think they could service the debt (principal and interest) they have proposed?