Corporate Finance

Financial Statements

Philipp Krüger
Why financial statements?
• The corporate organizational structure greatly facilitates the
firm’s access to investment capital.
• Anyone with money to invest is a potential investor.
diverse shareholders

• As a result, corporations are often widely held, with

individuals who hold several shares to institutional investors
who own millions of shares.
• Share ownership is most investors’ sole tie to the company.
• How do investors learn enough about a company to know
whether or not they should invest in?
difficult to get the relevant info for investors: provide investors with the relevant info to decide to invest or divest

2
Disclosure of information
• Financial statements are accounting reports issued by a firm
periodically (quarterly or annually) that present past
information and a snapshot of the firm’s financial position.
published publicly by a firm, always annually (depend on the size of the company): if you are in bourse, you have to present at least one past info only

• Public companies around the world are required to file their

financial statements with the relevant listing authorities.
stock market regulation

• An annual report with financial statements must be sent to

shareholders. less standardize, has to include financial statement

• Reports about a company’s performance must be

understandable and accurate.
– IFRS or GAAP rules, standards that tell the company how their financial statement has to be prepared

– A neutral third party (auditor) checks the annual financial statements.

complies with IFRS and GAAP

3
Types of financial statements
• Balance Sheet reflecting a « stock » (different from action, here it is a quantity) : point in time

– A snapshot in time of the firm’s financial position

– Cumulated investments and their financing
• Income Statement represent flows (of revenues, cash flow during a period of time, usually the last period)

– Lists the firm’s revenues and expenses over time

– Meaningful cash movements
• Statement of Cash Flows represent flows: most relevant from the perspective of the value of a company

– Informative about the firm’s cash movements

• We will focus on the big picture!

4
Balance sheet Assets, liabilities, stockholders equity

• The balance sheet identity:

D
A

Assets = Liabilities + Stockholders’ Equity

E

• Assets
– What the company owns

• Liabilities Passif
How the assets are finance

– What the company owes (or how the assets are financed)

• Stockholders’ equity
– The difference between the value of the firm’s assets and liabilities

5
 Balance sheet

suppose to be converted into cash into less than a year

decreasing liquidity (how

easily the asset can be funds own to the firm
converted into cash)
raw materials unfinished product: airplaines 70% complete

Or non current assets tangible benefit over a period of time that are above one year

machinery

by using machine (worn out), they use value: capture to this Negative figure ()

Texte

6
 Balance sheet
debt of the firm that result from the firm due in that period
having product or services havent paid yet:
recu la marchandise mais doit payer en
retour
due during the fiscal period

10, 15, 100 years of debt: due in the fiscal period

Non current liabilities: not due in the fiscal period

debt of the company due to the goverment

7
 Balance sheet
• Stockholders’ equity A=D+E

E=A-D
– Book value of equity = book value of assets – book value of liabilities
if the firm has more debt than assets before looking

• Could possibly be negative

• Many of the firm’s valuable assets may not be captured on the balance
sheet employees: human capital not include in the balance sheet but has a value, reputation, costumers..
not precise, not necessary good representation of the true value of the company because lot of assets are bought in historical cost

• Market value versus book value

– Market value of equity (market capitalization) = Market price per
share x Number of shares outstanding determined by what the shareholders things
the company worth
In the stock market we can see the market value: get more accurate value of the company

• Cannot be negativeWhy? because of limited liabilities: negative price of the company not possible
• Often differs substantially from book value
forwards looking: what they expect the company will produce in term of assets

8
Balance sheet
• The market-to-book ratio is defined as:

Market Value of Equity

Market-to-Book Ratio
Book Value of Equity

• Value stocks: Low M/B ratios

Walmart, electricity company: stable business but not a lot of growth potential, the market price of equity will be close to book value, lower market price for the stabilization of growth

• Growth stocks: High M/B ratios

lot of value are not included in the balance sheet: technology company: you pay a higher price today because of the anticipation of growth in the future

9
Balance sheet

3.6m * $14 : $50.4m

MTB (2012): 50.4/22.2 = 2.27 (time the book value): real value of the company

10
Balance sheet

11
 difference between the book value of debt and the market value of debt is small.

Balance sheet A=D+E

E=A-D

• A firm’s market capitalization measures the market value of

the firm’s equity, or the value that remains after the firm has
paid its debts.
• But what is the value of the business itself?
• The enterprise value (or firm value) assesses the value of the
underlying business assets, separate from any cash and
marketable securities. = debt intrument that are very liquid (transform into cash easily): short term swiss government debt, transform into cash
easily, very liquid market

• Enterprise value = Market value of equity + debt – cash

cost of taking over the business: what would it cost if a wanted to buy the whole business ?

12
Income statement Texte

• While the balance sheet shows the firm’s assets and liabilities
at a given point in time, the income statement shows the flow
of revenues and expenses generated by those assets and
liabilities between two dates.
• The last or “bottom” line of the income statement shows the
firm’s net income (or net profit).
what’s potentially available for the shareholders

• The income statement is sometimes called a profit and loss, or

“P&L” account, and the net income is also referred to as the
firm’s earnings.

13
Income statement
• Earnings are the difference between revenues and charges,
leading to a change in net worth during a given period.
equity’s between assets and liabilities

• The EBIT is the Earnings before Interest and Taxes, and

represents the profit generated by the industrial and
commercial activities of a business.
• The EBITDA is the Earnings Before Interest, Depreciation, and taxes

Amortization, and shows the profit generated by the firms’

operations.

14
Income statement

amount of sales genereted during the financial time

direct cost that would occur (produce the sales: raw materials) to these specific
sales
Total sales - Cost of sales

not directly attribute to sales

(marketing…)
operate expensives
result of the use of machinaries

doesnt result from the commercial activities of the company

debt holders lend money to the company

the company pays debt holders (out of EBIT) before the government (taxes) and before the shareholders.

RQ: residual claimant: shareholders: after everybody else have been paid
if the company is a net lender, the interest income would be positive

15
Statement of cash flows
how much cash the company has must used and paid or
distributed

• The net income typically does NOT equal the amount of cash
the firm has earned.
some expensive are non cash exepnses

– Non-cash expenses: depreciation and amortization

– Uses of cash not on the income statement: investment in property,

plant, and equipment

• The statement of cash flows uses the information from the

income statement and the balance sheet to determine how
much cash the firm has generated, and how that cash has
been allocated, during a set period.
• Three sections: operating activities, investment activities, and
financing activities.

16
Statement of cash flows
• Operating activities
– Adjusts net income by all non-cash items related to operating activities
and changes in net working capital
• Accounts receivable company sells good or services book it as a sell but no cash movement yet
• Accounts payable buys raw materials but hasnt paid the cash for these raw material yet
• Inventories

• Investing activities
– Capital expenditures investment in physical assets: buying lands, building…

– Buying or selling marketable securities when the company buy or sell bonds

• Financing activities cash movements resulting from financial statement: when a company pay dividend, it needs cash

– Payment of dividends (retained earnings = net income – dividends)

– Changes in borrowings
17
Statement of cash flows

18
Statement of cash flows

19
Statement of cash flows

20
Other financial statements
• The Statement of Stockholders’ Equity provides a
reconciliation of the opening and closing equity positions. As
such, it provides details of the movements in share capital and
reserves.
• The management discussion and analysis (MD&A) or
business and operating review is a preface to the financial
statements in which the company’s management discusses
the recent year’s performance, significant events etc.
• Notes to the financial statements.

21
Financial statement analysis
• Investors often use accounting statements to evaluate a firm
in one or two ways:
– Compare the firm with itself by analyzing how the firm has changed
over time.
– Compare the firm to other similar firms using a common set of
financial ratios.

• Financial analysis is a tool used by existing and potential

shareholders of a company, as well as lenders or rating
agencies.
– Shareholders want to know whether the firm creates value.
– Lenders want to know whether the firm is solvent and liquid.
• The purpose of a financial analysis is to provide a global
assessment of the firm’s current and future position.
22
Financial statement analysis
• Financial analysis is NOT accounting
– Accounting from a finance perspective:
• I do not want to be as precise and exhaustive as an accountant
• I want to focus on the big picture

• Using financial statements for financial analysis

– Focus on the large contributions to profit
– Forget about the small accounting items
– Focus on what matters in finance:
• Cash flow (for valuation)
• Debt and leverage (for risk analysis)
• Profitability

23
Financial statement analysis
• Profitability ratios:
Gross Profit
1. Gross Margin=
Sales

Operating Income
2. Operating Margin=
Sales

EBIT
3. EBIT Margin =
Sales

Net Income
4. Net Profit Margin
Total Sales

24
Financial statement analysis
• Liquidity ratios:
– Current ratio = Current assets / Current liabilities

– Quick ratio = (Cash + short-term investments + A/R) / Current liabilities

– Cash ratio = Cash / Current liabilities

25
Financial statement analysis

26
Financial statement analysis
• Working capital ratios:
Accounts Receivable
1. Accounts Receivable Days
Average Daily Sales

Accounts Payable
2. Accounts Payable Days
Average Daily Cost of Sales

Inventory
3. Inventory Days
Average Daily Cost of Sales

27
Financial statement analysis
• Interest coverage ratios:
– EBIT / Interest

– EBITDA / Interest
• EBITDA = EBIT + Depreciation and Amortization

28
Financial statement analysis

29
Financial statement analysis
• Leverage ratios:
Total Debt
1. Debt-Equity Ratio
Total Equity

Total Debt
2. Debt-to-Capital Ratio
Total Equity + Total Debt

Net Debt
3. Debt-to-Enterprise Value Ratio
Market Value of Equity + Net Debt

4. Net debt = Total debt – Cash & short term investments

30
Financial statement analysis
• Valuation ratios:
Market Capitalization Share Price
1. P / E Ratio
Net Income Earnings per Share

Market Value of Equity + Debt - Cash

2. Enterprise Value to EBIT=
EBIT

Market Value of Equity + Debt - Cash

3. Enterprise Value toSales=
Sales

31
Financial statement analysis

32
Financial statement analysis

33
Financial statement analysis
• Operating returns:
Net Income
1. Return on Equity
Book Value of Equity

Net Income + Interest Expense

2. Return on Assets
Total Assets

EBIT ( 1 - Tax Rate)

3. Return on Invested Capital
Book Value of Equity + Net Debt

The Return on Invested Capital (ROIC) is sometimes also called Return

on Capital Employed (ROCE)

34
Financial statement analysis

35
Financial statement analysis

36
Wrap up
• Use financial statements to understand the dynamics of
– Sales,
– assets (in particular working capital),
– cash flows,
– and profits

• Use market prices to understand market expectations of

future profits.

37