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Business Finance & Credit Analysis


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These slides were part of an on line lecture presentation for post-graduate finance students studying Business Finance & Credit Analysis.

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Business Finance & Credit Analysis

  1. 1. FIN 216:Business Finance & Credit AnalysisTopic 5: Business Analysis - Steps 6 to 8<br />Trey Zagante F Fin<br />October 2009<br />
  2. 2. Topic Overview<br />Business /Credit Analysis is used to determine the ability of a <br />client to service and repay debt.<br />Step 6 – Financial Statement Analysis<br /><ul><li>Understanding and analysing the financial position, financial performance and cash flows of the business</li></ul>Step 7 – Financial Forecasts<br /><ul><li>Projecting the future free cash flows of the business
  3. 3. Analysing the business’ sensitivity to changes</li></ul>Step 8 – Financial Ratio Analysis<br /><ul><li>Extracting financial data and calculating financial ratios
  4. 4. Comparative analysis and benchmarking</li></li></ul><li>Step 6 – Financial Statement Analysis<br />The 3 financial statements are:<br />Balance Sheet <br />Financial Position<br />Assets & Liabilities<br />Income Statement<br />Financial Performance<br />Profit & Loss<br />Statement of Cash Flows<br />Flow of cash in and out of the business<br />
  5. 5. Financial Data Classifications<br />Information on financial statements fall under 5 classifications:<br />Assets<br />Liabilities<br />Owners Equity<br />Revenue<br />Expenses<br />
  6. 6. Cash Basis vs. Accrual Basis<br />Cash Basis:<br />Revenues recorded when received<br />Expenses recorded when paid<br />Accrual Basis:<br />Revenues are recorded as they are earned<br />Expenses are recorded as they are incurred<br />Matching principle determines the accounting period <br /> when revenues and expenses are recognised<br />
  7. 7. Balance Sheet<br />Financial position of a business at a point in time<br />Assets<br />Liabilities<br />Owners Equity<br />Balance sheet equation: Assets = Liabilities + Owners Equity<br />Current vs. non-current:<br />Current &lt; 12 months<br />Non-current &gt; 12 months<br />Considerations:<br />Liquidity<br />Valuations<br />
  8. 8. Assets<br />An asset is anything that a business owns or controls that has a<br /> monetary value, or a future benefit for the entity.<br />Current assets:<br />Cash <br />Accounts receivable<br />Inventories<br />Non-current assets:<br />PPE (Property, Plant & Equipment)<br />Intangible assets e.g. Good will<br /><ul><li>Valuation methods</li></li></ul><li>Liabilities<br />Money or obligations that a business owes.<br />Current liabilities:<br />Short-term credit <br />Accounts payable<br />Non-current liabilities:<br />Long-term debt<br />
  9. 9. Owners Equity<br />The financial interest that an owner (or owners) has in a business, <br />also known as capital, net worth or proprietorship.<br />Shareholders capital:<br />Issued and paid up capital<br />Different share types (ordinary/preference shares)<br />Retained profit<br />Reserves<br />Dividends<br />
  10. 10. Income Statement<br />Financial performance of a business over a period of time<br />Income statement equation: Profit (Loss) = Revenue - Expenses<br />Revenue – The inflow of funds from the sale of goods and services<br />Expenses – The costs incurred in operating the business<br />Operating revenues:<br />Divisions of the business<br />Product lines<br />Geographical<br />
  11. 11. Income Statement cont’d<br />Significant items<br />Extraordinary items:<br />Not part of normal operations e.g. divestment<br />Measures of profit:<br />Gross profit<br />Net profit before income tax<br />Net profit after tax (NPAT)<br />Earnings before interest and tax (EBIT)<br />Earnings before interest, tax, depreciation and amortisation (EBITDA)<br />
  12. 12. Statement of Cash Flows<br />The flow of cash in and out of a business over a period of time<br />Operating activities:<br />Day to day operations of the business<br />Investing activities:<br />Investment into the future of the business<br />Financing activities:<br />How the business finances its operations <br />Change in cash over the period:<br />Cash at the end of the period will match the cash position on the balance sheet<br />
  13. 13. Analysis of Cash Flows<br />Positive cash flows available for future expansion<br />Liquidity of the business<br />How does the business meet its financial obligations?<br />Trends or patterns of cash flows<br />The need for future debt or reliance on debt<br />Free cash flows: Gross cash flow from operations less Capex<br />
  14. 14. Step 7 – Financial Forecasts<br />A key part of effective management of a business is<br />having forecasts and projections.<br />Projected figures may be generated by different sources<br />Forecasts are based on assumptions and variables which must be stated<br />The term of the funding should be covered by the forecasts<br />Best case, worst case and most likely scenarios<br />3 to 5 years of historical data should be basis of forecasts<br />
  15. 15. Sensitivity Analysis<br />How sensitive is the business to changes in the variables of the forecasts?<br />Key variables:<br />Sales growth<br />Profit margins<br />Operating expenses<br />Inventory control<br />Investment into fixed assets<br />Sensitivity to macroeconomic factors e.g. Global Financial Crisis<br />Determine upper and lower limits of repayment capacity<br />
  16. 16. Step 8 – Financial Ratio Analysis<br />Analyse financial ratios extracted from the data in the financial statements.<br />Comparative analysis of the business’ ratio’s against:<br />Intra-entity<br />Intra/inter-industry<br />Accepted standards<br />Benefits of financial ratio analysis:<br />Determines strength of the business (capital structure, liquidity etc.)<br />Limitations of financial ratio analysis:<br />Doesn’t give the full picture of position/performance of a business<br />Doesn’t take into account other factors<br />Large variations of ratios even within a particular industry<br />
  17. 17. Financial Ratio Analysis cont’d<br />Commonly used ratios in business and credit analysis:<br />Liquidity (current and acid test ratios)<br />Capital structure (net debt/equity ratio)<br />Debt protection (net interest cover)<br />Profitability (EBIT margin)<br />Time series analysis:<br />Analyse a business’ ratio trends over time<br />3 to 5 year minimum trend analysis<br />Good prediction of future trends<br />Industry averages for financial ratios:<br />Industry data is useful for benchmarking<br />Data is available from various sources e.g. D&B, accounting firms<br />
  18. 18. Other Considerations in Business Analysis<br />Understand the business and the context of the <br />environment in which it operates.<br />Use qualitative and quantitative analysis<br />SWOT Analysis of the business<br />PESTLE Analysis<br />Consider management capability:<br />Particularly relevant for SME’s and start ups<br />Experience and capacity of key management<br />Consider business risks:<br />Use other risk models<br />Porter’s Five Forces<br />
  19. 19. Porter’s Five Forces Model<br />