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Federico Beltrame and Alex Sclip

Analysing, Planning and Valuing Private

Firms
New Approaches to Corporate Finance
Federico Beltrame
Department of Economics and Statistics, University of Udine, Udine,
Italy

Alex Sclip
Department of Management, University of Verona, Verona, Italy

ISBN 978-3-031-38088-4 e-ISBN 978-3-031-38089-1

https://doi.org/10.1007/978-3-031-38089-1

© The Editor(s) (if applicable) and The Author(s), under exclusive

license to Springer Nature Switzerland AG 2023

This work is subject to copyright. All rights are solely and exclusively
licensed by the Publisher, whether the whole or part of the material is
concerned, specifically the rights of translation, reprinting, reuse of
illustrations, recitation, broadcasting, reproduction on microfilms or in
any other physical way, and transmission or information storage and
retrieval, electronic adaptation, computer software, or by similar or
dissimilar methodology now known or hereafter developed.

The use of general descriptive names, registered names, trademarks,

service marks, etc. in this publication does not imply, even in the
absence of a specific statement, that such names are exempt from the
relevant protective laws and regulations and therefore free for general
use.

The publisher, the authors, and the editors are safe to assume that the
advice and information in this book are believed to be true and accurate
at the date of publication. Neither the publisher nor the authors or the
editors give a warranty, expressed or implied, with respect to the
material contained herein or for any errors or omissions that may have
been made. The publisher remains neutral with regard to jurisdictional
claims in published maps and institutional affiliations.

Cover illustration: © Melisa Hasan

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company Springer Nature Switzerland AG
The registered company address is: Gewerbestrasse 11, 6330 Cham,
Switzerland
Introduction
Every asset and firm has a value. One of the goals of corporate finance is
to analyze and value companies and their assets. Corporate finance
textbooks usually focus on the valuation of firms and assets traded in
public markets. However, over the past decade, the number of private
companies and the amount of private investments have risen, while the
number of public listed firms has been falling since 1997 (Gupta and
Van Nieuwerburgh, 2021). As the fraction of wealth in the form of
private investments is growing, the importance of developing and
applying appropriate valuation techniques is increasing. This book aims
to provide a framework for the valuation of private corporations.
Starting from the analysis of financial statements to understand where
value comes from, to the application of valuation methods, this book
tries to provide a list of tools and techniques to solve practical
application drawbacks. Regarding the financial statement analysis,
despite the consolidated use of financial ratios and scores, sometimes it
is difficult to provide a complete picture of the company’s economic,
financial, and strategic dynamics. The process of valuing private
companies is not different from the process of valuing public
companies. The present value is computed by discounting future cash
flows with a proper rate that reflects the riskiness of the cash flows.
However, when applying valuation techniques to private companies,
there are two standard problems to overcome: the financial statements
for private firms are likely to go back fewer years and have less detail;
there is no market value for either debt or equity. In this book, we try to
overcome these two criticalities by proposing some approaches to (1)
forecast revenues, margins, and cash flows; (2) estimate the cost of
capital for private corporations. Then we also provide a framework on
how to use relative valuation techniques (multiple) that despite their
simplicity hide some pitfalls in the application.
The structure of the book is as follows. The first chapter is devoted
to financial analysis through ratios and cash flows. The key to
successfully investing and managing a business lies in understanding
the sources of value. Financial analysis is the key to this aim. We focus
our attention on how to organize financial statements, and how to
analyze a company’s economic, financial, and strategic situation. In
doing so, we provide a different configuration of the monetary cycle
which is better able to catch the financial needs dynamics. We also
provide a way to organize and conduct ratio and cash flow analysis
properly.
The estimation of future cash flows is one of the key ingredients in
the valuation process. The second chapter is related to forecasting
techniques. More in detail, we provide a different way to plan future
firm/investment projects operating revenues by exploiting the concept
of the financial break-even. The second key input in any valuation
process is the cost of capital. The estimation of this input is difficult in
the case of private companies. In the third chapter, we present a novel
way to estimate the cost of capital of private corporations, which is
based on some practical steps and on credit scoring systems.
Relative valuation techniques allow us to avoid some shortcomings
in the application of traditional valuation methods on private
companies. For this reason, the private equity industry and many
practitioners largely use this approach. While a multiple approach is a
convenient valuation method, it has many common pitfalls. In chapter
four, we explore the mechanics of multiples, when and how to use
different types of multiples, and we present a way on how to adjust the
comparable firm value to properly adapt the risk-return profile of
comparable companies to the firm under valuation.
The last chapter wraps up the notions provided in the four main
chapters of the book by providing an application of the methods in the
context of start-up valuation.
We believe that the tools provided in this book can be useful for
practitioners and for stimulating the debate among academics on the
topic.

Reference
Gupta, A., & Van Nieuwerburgh, S. (2021). Valuing private equity
investments strip by strip. The Journal of Finance, 76(6), 3255–3307.
Contents
1 Corporate Financial Analysis
1.​1 Introduction
1.​2 The Reclassification​of the Balance Sheet
1.​2.​1 The Reorganization of the Balance Sheet According to
Asset Liquidity and Liability Maturity
1.​2.​2 The Reorganization of the Balance Sheet by-Function
1.​2.​3 In-Depth Analysis of NOWC Monitoring and
Management
1.​3 The Income Statement Reorganization
1.​3.​1 The Reorganization of the Income Statement as Value-
Added
1.​3.​2 The Reorganization of the Income Statement by the
Contribution Margin
1.​4 Ratio Analysis
1.​5 Cash Flow Statement Analysis
Appendix—A Comprehensive Financial Analysis Method
References
2 The Financial and Economic Forecast
2.​1 Introduction
2.​2 Qualitative Analysis
2.​3 The Traditional Economic and Financial Forecast:​From
Assumptions to Estimation Procedures
2.​3.​1 Assumptions
2.​3.​2 The Estimation Process to Obtain a Forecast Budget
2.​4 A Different Method to Estimate Forecast Operating
Revenues
2.​5 Conclusions
 Appendix—Drafting a Forecast Budget:​Combining New and
Classic Approaches
Step 1:​Determining the Break-Even Revenues
Economic Assumptions
Trade Assumptions
Investment Assumptions
Financing Assumptions
Step 2:​Forecasting the Budget Balance (“Classic” Method)
Reference
3 The Cost of Capital for Private Businesses
3.​1 Introduction
3.​2 Private Business Evaluation:​General Points
3.​3 The Critical Issues in Calculating the Cost of Capital for
Private-Owned Companies
3.​3.​1 First Issue:​“No Market Reference for Equity and Debt”
3.​3.​2 Second Issue:​“Considering Specific Risks in the
Evaluation Process”
3.​4 An Alternative Model to Estimate the Cost of Capital of
Private Corporations
3.​4.​1 The Model Basics
3.​4.​2 Estimating the Unlevered Cost of Capital Through a
Risk-Neutral Approach
3.​4.​3 The Default Probabilities for the Model
3.​4.​4 The Loss Given Default (LGD) to Be Used in the Model
3.​5 Conclusions
Appendix 1—Steady-State and Steady-Growth Evaluations
Appendix 2—Evaluation of an Investment Project
References
4 Business Valuation Through Market Multiples
4.​1 Introduction
4.​2 The Key Multiples
4.​3 The Evaluation Process
4.​4 The Critical Issues with Comparability in the Use of
Multiples
4.​4.​1 A Conceptual Outline
4.​4.​2 Adjustments by Growth Profile
4.​4.​3 Adjustments by Debt Level
4.​4.​4 Adjustments by Growth Rate and Debt Level
4.​5 The Issues Relating to the Calculation of the Single Multiple
4.​6 Specific Features of Stock-Market Multiples
4.​7 Using the Multiples Approach:​Final Considerations
Appendix:​The Unlevered Value Maps:​An Empirical Evaluation
References
5 Conclusions—Putting All Together for Valuing a Start-Up
5.​1 Introduction
5.​2 Start-Up Capital Structure, Expected Cash Flows, and Cost of
Capital
5.​3 Start-Up Valuation Process
5.​4 Focusing of the Venture Capital Method
5.​5 Conclusions
References
References
Index
List of Figures
Fig. 2.1 Qualitative analysis chart (Source Data processed by the
authors)

Fig. 4.1 APP—Company belonging to the sector of design and

production of sun awnings, pergolas, and outdoor structures (APPAREL
and HOMEBUILDING) (Source Data processed by the authors)

Fig. 4.2 APP—Company belonging to the sector of household appliances

and kitchen components (FURNISHING) (Source Data processed by the
authors)

Fig. 4.3 APP—Company working in the frozen-food industry (RETAIL

GROCERY and FOOD) (Source Data processed by the authors)

Fig. 4.4 APP—Company belonging to the business consulting sector

(SERVICES) (Source Data processed by the authors)

Fig. 4.5 APP—Company working in the kitchen construction industry

(BUILDING MATERIALS) (Source Data processed by the authors)

Fig. 4.6 APP—Company belonging to the engineering and construction

sector (ENGINEERING/CONSTRUCTION) (Source Data processed by the
authors)

Fig. 4.7 APP—Company belonging to the real-estate sector (REAL

ESTATE) (Source Data processed by the authors)
Fig. 4.8 APP—Company belonging to the window manufacturing sector
(CONSTRUCTION SUPPLIES) (Source Data processed by the authors)

Fig. 4.9 APP—Company belonging to the foodservice sector

(RESTAURANT) (Source Data processed by the authors)
List of Tables
Table 1.​1 Balance sheet outline, reorganized according to indicators of
asset liquidity and liability maturity

Table 1.​2 Balance sheet outline, reorganized according to the by-

function method

Table 1.​3 Value-added reorganization of the income statement

Table 1.​4 Reorganization of the income statement according to

contribution margins

Table 1.5 Cash flow statement outline (Step 1)

Table 1.6 Financial statement outline (Step 2)

Table 1.7 Cash flow statement outline (Step 3)

Table 1.​8 APP—Balance sheet outline, reorganized through the by-

function method

Table 1.​9 APP—Income statement reorganized through value-added

method

Table 1.​10 APP—Overview for company financial assessments

Table 1.​11 APP—Outline of the cash flow statement (Step 2)

Table 2.​1 Main items grouped by areas

Table 2.​2 Forecasting parameters

Table 2.​3 Forecast parameters T + 3

Table 2.​4 Partial balance sheet and income statement T + 3

Table 2.​5 Final balance sheet and income statement T + 3

Table 3.​1 Example evaluation of two restaurants

Table 3.​2 Comparison between the expected default frequencies of EM

score, standard and poor rating, and KMV

Table 3.​3 Comparison between the expected default frequencies of EM

Score and KMV (interpolation)

Table 3.​4 APP—Cost of capital and evaluation of the two example

restaurants

Table 3.​5 APP—IS, BS, and CF statement

Table 4.​1 Key stock-market multiples

Table 4.​2 Unlevered multiples

Table 5.1 Cash flow statement outline (step 2)

Table 5.​2 Expected income statement

Table 5.​3 Balance sheet

Table 5.​4 Cash flow statement

Table 5.​5 TLA cost of capital calculation

© The Author(s), under exclusive license to Springer Nature Switzerland AG 2023
F. Beltrame, A. Sclip, Analysing, Planning and Valuing Private Firms
https://doi.org/10.1007/978-3-031-38089-1_1

1. Corporate Financial Analysis

Federico Beltrame1 and Alex Sclip2
(1) Department of Economics and Statistics, University of Udine,
Udine, Italy
(2) Department of Management, University of Verona, Verona, Italy

Federico Beltrame (Corresponding author)

Email: federico.beltrame@uniud.it

Alex Sclip
Email: alex.sclip@univr.it

Abstract
This chapter is devoted to financial analysis through financial ratios and
cash flows. The first part of the chapter reports the reorganization of
the balance sheet and the income statement, which represents key
preparatory steps to perform a proper financial ratio and cash flow
analysis. In the second part of the chapter, we propose a novel
methodology for monitoring the monetary cycle and an organized
assessment of financial ratio analysis. Finally, in the last part of the
chapter, we focus on how to calculate cash flow and how to interpret
them for different purposes: valuation and debt sustainability analysis.

Keywords Balance sheet – Income statement – Cash flow statement –

Monetary cycle

1.1 Introduction
Aim of financial statement analysis. Financial statements—the
income statement, balance sheet, and statement of cash flows—do not
promote easy insights into firm operating performance and value. The
balance sheet mixes together operating and nonoperating assets and
different sources of financing. In a similar way, the income statement
combines operating profits, nonoperating profits, amortization and
depreciation of fixed assets, and interest expenses. The first step for
analyzing the economic and financial dynamics of a corporate business
is to reorganize financial data properly. In this chapter, we present
financial statements organizing techniques and financial ratios useful
for company analysis from different perspectives: credit rating, self-
assessment tools, and company valuation.
Chapter aims and analyses. This chapter illustrates the two main
balance sheet reorganizing techniques (asset liquidity/liability
maturity and by-function balance sheet) and income statement
schemes (value-added and contribution margin methods)—Then the
chapter moves on to the analysis of the economic-financial dynamics
through the main financial statement ratios and cash flows. Alongside
the traditional analyses using main ratios—such as ROE or leverage—
the chapter emphasizes the existing link between the working capital
and the monetary cycle. The monetary cycle is calculated in a different
way, considering not only the commercial component but also the other
operating debts within the debt-payment deadlines. In this way, the
analyst can carry out a more complete examination of corporate debt
and overcome the critical issues that come from reading the
commercial monetary cycle. The chapter ends with the analysis of
financial flows, placing emphasis not only on the preparation of the
financial statement but also on how cash was generated and used.

1.2 The Reclassification of the Balance Sheet

1.2.1 The Reorganization of the Balance Sheet
According to Asset Liquidity and Liability Maturity
The reorganization schemes. The reorganization of the balance sheet
according to indicators of asset liquidity and liability maturity aims to
analyze the matching between the expiry of assets and the maturity of
liabilities. For this purpose, asset and liability items are grouped
according to a defined maturity period (generally 12 months).
 More specifically, the reorganization identifies:
Short-Term (ST) or current assets, i.e., all company assets that will
potentially turn into cash within 12 months and—to a residual extent
—fixed assets.
Short-Term (ST) or current liabilities, i.e., those liabilities that will
become payable within 12 months—identified as separate from
medium/long-term liabilities and equity, as they are both payable
over a longer period.
Table 1.1 shows the most relevant balance sheet items to be
considered in the various aggregates.

Table 1.1 Balance sheet outline, reorganized according to indicators of asset

liquidity and liability maturity

Assets Liabilities
Short-Term (ST) assets Short-Term (ST) liabilities
Cash and cash equivalents • ST financial debt to banks
• Cash
• Cash equivalents: financial assets • ST marketable securities
Current non-cash assets • ST payables owed to financing
partners
• Trade receivables expiring within the FY • Trade payables
• Tax receivables expiring within the FY • ST deposits
• Financial receivables expiring within the • Tax liabilities expiring within the
FY FY
• Other receivables (remaining items) • Other liabilities expiring within the
expiring within the FY FY
• Accruals and prepayments • Accrued expenses and deferred
income
• Inventory • ST payables owed to parent
companies
• ST payables owed to social security
institutions
Fixed assets
Assets Liabilities
• Tangible fixed assets Medium/Long-Term (M/LT)
liabilities
• Intangible fixed assets • M/LT payables owed to banks
• Equity investments • M/LT marketable securities
• Financial receivables expiring beyond the • M/LT payables owed to financing
FY partners
• Trade receivables expiring beyond the FY • M/LT payables owed to parent
companies
• Tax receivables expiring beyond the FY • Trade payables expiring beyond the
FY
• Other receivables (remaining items) • Deposits beyond the FY
expiring beyond the FY
• Pension accumulated benefits
obligation
• Other M/LT payables
• Provisions for future risks and
charges
Equity capital
• Shareholders capital
• Reserves
• Retained earnings and earnings for
the FY
Total assets Total liabilities

Source Data processed by the authors

Asset items. The assets are divided into ST assets and fixed assets.
The ST assets are then further divided into two main categories:
Cash and cash equivalents, consisting of liquid assets and financial
assets that can be readily made cashable, such as deposit accounts
and government bonds.
Current non-cash assets, i.e., assets that will presumably turn into
cash assets within the Fiscal Year (FY), such as various types of
 receivables and inventory.
Fixed assets, on the other hand, are made up of intangible, tangible,
and financial assets (equity investments, financial receivables, and
other Medium-Long-term financial assets), as well as Medium/Long-
Term (MLT) receivables and inventory items that may not be included
in ST assets.
Liability items. Three macro-aggregates can be identified for
liabilities, depending on the decreasing order of expiration. The first
item, namely, ST liabilities include all items that presumably will be
payable within the FY, independently of their nature (financial or
commercial liabilities). The most relevant items in terms of size—
within this macro-category—are trade payables and ST financial debt.
Medium- and long-term liabilities and equity capital constitute the
two remaining macro-categories of liabilities. The former includes
financial debts and liabilities that presumably will not result in cash
outflows within the FY; whereas the latter includes items relating to the
equity capital, reserves, and earnings.
Analysis of asset liquidity and liability maturity. The
reorganization of the balance sheet using the asset liquidity/liability
maturity rule aims to analyze the degree of ST company liquidity, i.e.,
the ability to meet ST obligations (paying suppliers and repaying short-
term loans) through the cash liquidity produced or that can be
produced in the next 12 months (credit collection, sale of inventory
goods). From a practitioner perspective, the analysis can be done by
calculating two ratios. The first—commonly known as the current ratio
—is obtained by dividing ST assets with ST liabilities. If this ratio is
equal to or greater than zero, it indicates a situation in which the
company can meet its ST obligations with the cash liquidity it either has
already produced or will produce. The second ratio—quick ratio—can
be calculated by dividing ST assets net of inventory (ST assets −
Inventory) to ST liabilities. If this ratio is equal to or greater than zero,
it suggests that more liquid assets can repay ST liabilities. The
reorganization of the balance sheet with the distinction between assets
and liabilities based on a predetermined maturity rule does not provide
a tool to understand the underlying financial dynamics of a company. As
a matter of fact, operating and nonoperating assets and liabilities are
not reorganized by-function. The analysis of asset liquidity and liability
maturity is more appropriate in the case of a valuation of a ceasing
business in which the analyst has to recognize the liquidation time of
assets and maturity of liabilities.

1.2.2 The Reorganization of the Balance Sheet by-

Function
The reorganization scheme. The by-function reorganization of assets
and liabilities allows to identify specific areas of the company business.
This reorganization scheme is particularly suited for financial
forecasting and planning, as it highlights the economic use of the
financial investments and the origin of the funding resources. In this
way, balance sheet items are organized into three areas: operation
items, nonoperating items, and sources of financing. This often requires
searching through the notes to separate accounts that aggregate
operating and nonoperating items. Although this task seems tedious, it
is crucial to provide a more accurate picture of the company statement
and serve as a valuable base to: analyze the operating efficiency and
performance, cash flow analysis, and forecast techniques for valuation
methods.
The reorganization process starts with the identification of
operating and nonoperating items, then proceeds with the distinction
between fixed and current items.1 Fixed assets are linked to capital
expenditures and refer to the operational structure of a company, i.e.,
property plant and equipment. Current assets refer to investments
related to the production cycle (purchase, transformation, and sale)
that generate costs and revenues whose monetary consequences have
yet to take place. They are represented by the net operating working
capital (inventories plus receivables minus payables). On the liability
side, the reorganization identifies the origin of funding: equity capital,
medium-long-term financial debt, and short-term financial debt.
Financial debts are classified based on their maturity, because revolving
facilities (short-term debt) usually serve to finance networking capital
expenditures, whereas medium-long-term liabilities usually serve as a
financing instrument for fixed capital expenditures. A more detailed
description of the areas that can be identified through the
reorganization of the balance sheet is provided in the following lines.
 Surplus assets. This area includes all investments in nonoperating
assets (not related to the core business of a company), such as, for
example: residential real estate, equity investments, and liquidity in
excess. The purpose of surplus asset investments differs from those
related to the operating company business and, therefore, they are not
necessary to carry out the production process. This area includes the
purchase choice of real estate for lease or residential use (if the
company is not in the construction industry); the purchase and
management choice of financial assets like government bonds, short-
term deposits, and investments in funds; and purchase choices related
to the high cash balance. In this last case, many analysts prefer to offset
cash and cash equivalents from financial debt by quantifying the so-
called net financial position (short-term and long-term financial debt
minus cash and equivalents). Equity investments that are not defined as
“strategic” also fall within this area, as they relate to companies
operating in sectors that differ from those of the examined company.
Fixed capital investments. To undertake its production cycle, each
company requires an operating structure resulting from the initial
acquisition of the tangible, intangible, and financial assets necessary to
carry out the production process. From a financial point of view,
investments in fixed capital require financial resources. Therefore, we
define “fixed capital” as the set of financial resources necessary to
establish, expand, or improve the company’s production cycle. Since
fixed capital is of long-term nature, it should be financed through
liabilities of a similar maturity: equity capital and M/LT financial
liabilities.
Fixed capital is the sum of:
Intangible fixed assets: these include expenses that have yet to be
recovered for the purchase of industrial patent rights, concession
rights, operating licenses for technologies, as well as expansion costs
and R&D expenses.
Tangible fixed assets: include land and buildings, industrial and
commercial equipment, other properties, fixed assets under
construction, and advance payments. In the local gaap system:
tangible fixed assets are recorded at the historical cost2 net of
depreciation and amortization costs; whereas for the international
standards, tangible fixed assets are recorded at fair value.
 Financial fixed assets: these include net equity investments (equity
investments in parent companies, subsidiaries, related companies,
and other companies) and other financial assets (M/LT security
deposits or loans arising under financing from companies belonging
to the group, like financial receivables from parent companies,
subsidiaries, and related companies).
Current assets. The production cycle of a company consists of a
repetition of three main phases: (1) purchase, (2) transformation, and
(3) sale. The production cycle generates a continuous cash-out flows
from costs and cash-in flows from revenues. If on average, cash-out
flows take place before cash-in flows, the production cycle requires an
injection of capital (typical case of a manufacturing company). On the
contrary, if cash-in flows take place before cash-out flows the
production cycle generates a liquidity surplus (typical case of a
supermarket). The capital needs related to the cash-out and cash-in
cycle are usually called Net Operating Working Capital (NOWC).
Within the NOWC, it is possible to identify three main items:
Inventory: includes the inventory of raw materials, semi-finished
products, contracts in progress, finished products, and advance
delivery of material and services to suppliers.
Receivables: include all exposures to customers and subsidiaries for
commercial transactions. The stock of receivables is linked to: the
amount of revenues and the company policy on customer credit. This
asset item also includes tax receivables, accruals, and prepayments in
general.
Payables: includes trade credit received from suppliers, advance
payments from customers, sundry payables, other ST operating
liabilities, provisions for future charges and expenses, accrued
expenses, and deferred income.
Financing. The financing area is formed by the equity capital and by
the short and M/LT financial liabilities. It corresponds to the sources of
funds deployed by the company to finance invested capital. Here, it is
important to identify how much of the invested capital is financed
through equity capital and how much is financed through financial debt
(marketable securities, payables owed to banks, payables owed to
financing partners, etc.).
 This area includes:
The Equity Capital: all items that contribute to forming the
company’s net worth (subscribed and paid-up capital stock, sundry
reserves, active and past profits and losses). The main feature of
equity items is that they permanently remain in the company with no
obligation to refund. Equity capital is the most suitable form of
financing to establish and expand fixed assets. In fact, since it has no
refund obligations, it guarantees coverage of this requirement up
until the company’s liquidation. M/LT financial payables should
therefore perform a complementary role to equity capital. This form
of financing can only be used if the company is able to guarantee
repayment capacity.
M/LT Financial debt: includes bonds, M/LT obligations to financing
partners, term loans, and other M/LT financial liabilities. This
includes bonds; M/LT payables owed to financing partners; term
loans3; and other M/LT sundry payables. Banks should issue term
loans to companies able to generate future cash flows to repay their
obligations.
ST Net Financial Debt: this includes all payables of a financial nature
(due within the year) that should help cover the financial
requirements related to daily company operations—net of cash and
cash equivalents. Items relating to ST financial debt are ST debt to
banks and other sundry ST financial liabilities. While items relating
to cash and cash equivalents include: available liquid assets and
financial assets that are not fixed. In the event of high liquidity, the
analyst can opt to add the surplus assets, as mentioned above.
Table 1.2 presents a detailed scheme of the specific asset and
liability items. For simplicity the scheme does not report surplus assets.

Table 1.2 Balance sheet outline, reorganized according to the by-function method

Assets Liabilities
Fixed capital Equity capital
• Tangible assets • Shareholder’s equity Capital
• Intangible assets • Reserves
Assets
• Financial assets
Inventory
Receivables
• Trade receivables
• Tax receivables
• Other receivables (remaining
items)
• Accruals and prepayments
TOTAL ASSETS LESS CASH AND
EQUIVALENTS
Liabilities
• Retained earnings
M/LT financial debt:
• Marketable securities beyond the FY
• Financial debt owed to financing partners for
financing beyond the FY
• Financial debt owed to banks beyond the FY
• Financial debt represented by debt securities
beyond the FY
• Financial debt owed to financing partners
beyond the FY
ST Financial debt:
• ST financial debt owed to banks
• Financial debt owed to financing partners
within the FY
• Financial debt owed to financing partners
within the FY
• (Cash and cash equivalents)
Payables
• Provisions for future risks and charges
• Pension accumulated benefits obligation
• Advances from clients
• Trade payables
• Tax payables
• Other payables
• Accrued expenses and deferred income
• Payables owed to parent companies and
subsidiaries
TOTAL LIABILITIES LESS CASH AND
EQUIVALENTS
Source Data processed by the authors
The configuration of total investments. By reclassifying the
balance sheet according to the by-function model, it is possible to
identify three configurations of total investments. The first is equivalent
to the sum of all assets. The second—Net Capital Employed—is the
capital spent to cover the company’s needs, which result from the
company’s assets net of working payables. This second configuration is
formed by surplus asset investments, investments in fixed capital, net
operating work capital and cash and equivalents. The third—Net
Operating Capital Employed (NOCE) or Invested capital (IC)—is the
capital spent to finance the company’s core operations. This third
configuration is formed by the sum of all investments in fixed capital
and the net operating work capital.

1.2.3 In-Depth Analysis of NOWC Monitoring and

Management
NOWC analysis. Monitoring the evolution of the NOWC is important for
two main reasons: to determine the working capital needs and to check
the exposure to the banking system.
The financial needs that are linked to the NOWC are closely
influenced by the sector and by the operational strategy. The first is
difficult to amend as they are strongly dependent on the company’s
core business. For example, companies in the trade industry (ex:
supermarkets and retailing stores) receive the proceeds of their sales
before paying their production costs, so their working capital is
negative. Put in another way, their production cycle generates cash to
deploy in capital expenditures. On the contrary, firms carrying out basic
transformation processes, usually purchase raw materials from
international markets with no or very short payment delays, leading to
higher NOWC needs.
As for operating strategies, these are closely linked to:
a. The management policies regarding the supply of raw materials,
and linked to production and sales policies that will influence the
average stock of finished and semi-finished products.
b. The management of customer relations regarding billing
procedures and the commercial strength resulting from the
management of relations.

c. The management of relations and payment terms that the company

can contract with its suppliers. These terms are already partly
established in the employment and supply contracts of some of the
services that are necessary to carry out the company’s operational
tasks.

The operating management choices regarding inventory, sales, and

supply directly influence the monetary cycle, i.e., the period of time
(expressed in number of days) that elapses between the cash
disbursement to support management costs and the cash inflow from
the sale of finished products. The longer the monetary cycle, the greater
amount of investments necessary to finance the NOWC.
NOWC determinants. The NOWC is influenced by two factors:
revenues (higher sales lead to higher receivables, greater inventory, and
higher costs, consequently generating higher NOWC needs) and the
monetary cycle (time between cash-out and cash-in). Stock policies—
both in trade (purchase of productive assets) and in product sales—are
therefore determinants of the financial requirements connected to the
production cycle. The quantification of the NOWC is obtained from the
sum of inventory and receivables (resources employed in the
production cycle) net of payables. Therefore, part of the investments
that are connected to o current/ordinary operations—receivables and
inventory—are offset by the deferral of expenses connected to the
production cycle—payables. The trend in sales and the change in the
monetary cycle result in the flexibility of the capital requirements
connected to the production cycle. In a rapidly developing company, the
NOWC will increase in proportion to the increase in sales. However, this
change will be further expanded by the trend of the monetary cycle.

1.3 The Income Statement Reorganization

1.3.1 The Reorganization of the Income Statement
as Value-Added
The reorganization scheme. In line with the reorganization of the
balance sheet by-function, we present a reorganization of the income
statement that takes into consideration the connection between the
values and the areas in which management operations are allocated. In
this case, we propose the “value-added” reorganization method.
The by-function reorganization of the balance sheet allows to
identify investments related to the company’s core business—fixed
capital and NOWC—as separate from investments not related to the
core business—surplus assets. Similarly, the reorganization of the
income statement aims to separate revenues and costs connected to the
core business—operating revenues and costs—from those that are
generated outside of the core business—extraordinary revenues and
costs. Therefore, through a scalar-form reclassification of the items, this
method makes it possible to identify first the income resulting from
ordinary company operations (which has the function to repay the
financial sources of funds, operating taxes, and financing partners) and
then the income and cost components do not relate to the core
business.
The starting point of the process is related to the identification of
the net operating revenues and the costs of materials and services to
calculate the value-added. This value is remarkably important since it
identifies the value of the business carried out by the company, i.e., the
income created by the transformation of raw material into finished
products gross of costs associated with company personnel, productive
assets, and financial debt expenses. The added value varies depending
on the company sector and the degree of vertical integration.
Companies in the industrial sector have a higher value added than
those operating in the commercial sector. While, as regard to the degree
of vertical integration, companies that independently carry out all
phases of the production cycle have a higher value added than similar
companies that outsource part of the production process.
Once the added value is identified, the reclassification scheme
highlights the other operating costs (labor costs and
depreciation/amortization) and the relative margins that are generated
by the operational tasks, before moving on to the cost components
related to financial debt (interest charges), extra-ordinary income
components, taxes, and net income. Table 1.3 shows the reorganization
scheme briefly described here above.
Table 1.3 Value-added reorganization of the income statement

+ Operating revenues
+ Other current operating revenues
= Revenues total
+ Costs of raw materials and consumables
+ Changes in raw-material inventory
− (Changes in work-in-progress inventory)
− (Capitalized costs)
= Cost of goods sold
+ Costs of services
+ Lease payments
+ Risk provisioning
= Cost of services
Value added (Revenues total – Cost of goods sold – Cost of services)
= Cost of labor
Earnings before interest, taxes, depreciation, and amortization: EBITDA
(Value added – Cost of labor)
+ Depreciation/amortization of tangible fixed assets
+ Depreciation/amortization of intangible fixed assets
= Depreciation and amortization
Earnings before interest and taxes EBIT (EBITDA −
Depreciation/amortization)
+ Interest income
− Interest expense
= Net financial charges
Operating profit (EBIT − Net financial charges)
+ Other non-recurring revenues
− Impairment of fixed assets
− Impairment of receivables
− Balance of value adjustments of financial assets and liabilities
± Other extra-ordinary revenues/charges
= Extra-ordinary items
Gross income (Operating profit + Extra-ordinary items)
− Income taxes
Net income (Gross total – Income taxes)

Source Data processed by the authors

Below is a short review of the main items included in the aggregates
that are identified by the value-added income statement
reorganization.
Revenues total. This income measures the company’s turnover and
is calculated as the sum of revenues and other operating positive items.
Within the net operating income, we can identify revenues from sales
and services, sundry operating revenues, the recovery of costs and
charges, and revenue from equity investments. It is necessary to point
out that all revenues deriving from the company’s operating business
are grouped within this form of income. And it is important to note that
financial revenues—if related to equity investments included in fixed
assets—should be included in this aggregate rather than within the net
financial charges. Similarly, foreign exchange income—if related to
foreign exchange transactions—should also be placed in this aggregate.
Cost of Goods Sold. The cost of goods sold is given by the sum of
four items: cost of raw materials and consumables, change in raw
material inventory, changes in work-in-progress inventory, and
capitalized costs. This value—is a proxy of the use and consumption of
materials—should be adjusted to the value of any capitalization of costs
and day-work assets. Foreign exchange charges for sales transactions
should be listed in this aggregate, rather than being considered within
net financial charges.
Cost of Services. The main items that constitute the cost of services
are cost of services (e.g., transport, shipping, maintenance and
assistance, general and administrative costs), risk provision, and
operating leasing fees.
Cost of Labor. This includes the cost of employee wages, salaries,
and other personnel fees, as well as payroll taxes, and other costs and
provisions to the indemnity fund.
Earnings before interest, taxes, depreciation, and amortization
(EBITDA). This includes the income that is generated by the company’s
operating management, given that it is gross of the non-monetary costs
associated with company investments.
Depreciation/Amortization. These are the non-monetary
expenses relating to the multiannual cost ratio paid for the purchase of
fixed assets (tangible, intangible, and financial).
Earnings before interest and taxes (EBIT). This refers to the
income that is generated by the company’s operating activity
(company’s ordinary operations + company investments), which is
calculated as the difference between total revenues and total operating
costs (cost of goods sold, cost of services, cost of labor, and depreciation
and amortization costs). The EBIT indicates the company’s ability to
generate income through the company’s ordinary operations and
therefore is not influenced by activities that are performed outside of
the core business. The EBIT is used for the remuneration capital: both
equity and financial.
Net financial charges. Includes commissions and charges for
financial services, interest expenses, and other financial charges or
financial liabilities owed to financial institutions, financing partners,
and shareholders. This aggregate also includes all financial revenues. If
these are not a high amount—or if they accrue on the liquidity
subtracted from the ST financial debt—they must be deducted from
bank interest expenses. If instead the financial revenues are related to
items that are classified as surplus assets, they should be regrouped
together with extra-ordinary revenues and charges. However, financial
revenues and charges accrued on exchange rates should be excluded
from this aggregate if they are related to foreign exchange transactions.
Extra-ordinary items. Includes other non-recurring revenues,
impairment of fixed assets and receivables, adjustments of the value of
financial assets and liabilities, and other extra-ordinary revenues and
charges.
 Income Taxes. This includes the income taxes produced during the
fiscal year.
Net income. By subtracting taxes from the gross profit you obtain
the net profit for the fiscal year.

1.3.2 The Reorganization of the Income Statement

by the Contribution Margin
The reclassification of the income statement as value-added is typically
used by external analysts who do not have access to information on the
company’s cost structure. When, instead, analysts have access to
internal company information on the structure of fixed and variable
costs, they can opt for a reorganization according to the contribution
margin. This method highlights the company’s degree of operating
leverage by pointing out a division between fixed and variable costs, as
the following table shows. In this framework, taxes have been broken
down into tax shields on financial charges and operating taxes. In
formula:
(1.1)
In which tax shields are nothing more than financial charges
multiplied by the tax rate ( ). Therefore,
according to (1.1), we can also state that
(1.2)
Following a logic that separates operating implications from
financial ones, we find that operating taxes must be placed to form the
operating margin, while tax shields must be grouped within financial
charges (Table 1.4).
Table 1.4 Reorganization of the income statement according to contribution
margins

+ Operating revenues
+ Other current operating revenues
= Revenues total
− Cost of goods sold
− Variable costs for services
− Variable labor costs
= Contribution margin
− Fixed service costs
− Fixed labor costs
EBITDA
+ Depreciation/amortization of tangible fixed assets
+ Depreciation/amortization of intangible fixed assets
= Depreciation/amortization
EBIT (EBITDA − Depreciation/amortization)
− Operating taxes
NOPAT (Net Operating Profit After Taxes)
+ Financial revenues
− Financial charges
+ Tax shields on financial charges
= Net financial charges
Gross earnings before extra-ordinary items
+ Other non-recurring revenues
− Impairment of fixed assets
− Impairment of receivables
− Balance of value adjustments of financial assets and liabilities
± Other extra-ordinary revenues/charges
= Extra-ordinary items
Net income

Source Data processed by the authors

The reclassification of the income statement according to
contribution margins allows for drawing a more precise estimate of the
forecast operating costs, which can be used as an input for forecasting.
1.4 Ratio Analysis
An in-depth financial analysis should highlight four fundamental
features: efficiency in the use of the capital deployed; the correct use of
funding sources; the correct mix between equity and debt; and the
achievement of a profitability level to properly remunerate financial
investors.
In more detail, the company should seek:
1. Operating efficiency, measured through the turnover ratio, which
proxy for the ability to renew the net capital employed.

2. Asset balance, that correlates assets (investments of capital) and

liabilities (funding sources). Maintaining a balance between the
various forms of sources and the various forms of investment is
necessary. Consider, for example, an investment like the acquisition
of an industrial warehouse, which will inevitably involve a
significant cash disbursement at the time of purchase but which
will also generate profitability over some time. In this case, the
investment must be covered by long-lasting funding sources like
equity capital and M/LT financial payables.

3. Financial balance, ensuring the right mix of equity capital and

financial debt.

4. Economic balance, ensuring that the revenues from the company’s

core business adequately cover the costs deriving from the
acquisition of productive assets. Economic balance is crucial as it
represents the circumstance under which the company business
generates adequate profit margins.

Operating efficiency. The operating efficiency of a company can be

measured through the Turnover ratio, which measures the number of
times in a year the capital employed in the business is transformed into
revenues. In general, the recovery is faster for NOWC in comparison to
the fixed capital. In the first case, the recovery is higher given the fact
that the NOWC is restored continuously by the sequence of cash out-
flows and cash in-flows related to the production cycle. In the second
case, the time required to recover the fixed capital depends on the
ability of a firm to create adequate margins. In practical terms, turnover
is the ratio of revenues over net operating capital employed. It
measures the average revenue per unit of invested capital. In other
words, the turnover ratio is a proxy for the ability of a company to
recover the investments through cash inflows from revenues. In
formula:

(1.3)

Under the same conditions of invested capital, a company that

manages to produce higher levels of turnover has a higher turnover
rate and, therefore, also greater operating efficiency. This ratio is
influenced by three factors: sales prices, sales volume, and the number
of resources that are invested to carry out business. The turnover rate
measures the operating efficiency of the company. However, the analyst
can evaluate the turnover of the NOWC using other specific turnover
ratios.
The traditional analysis of trade monetary cycles. Financial
analysts use so-called turnover ratios to measure companies’ ability to
recover financial requirements through their ordinary business. The
main indicators in this sense are those aimed at quantifying inventory
shelf life (time of sale of inventory − dd inventory), the duration of
trade receivables (DSO “daily sales outstanding” – dd trade receivables),
and the duration of trade payables (DPO – “daily payable outstanding” –
dd trade payables). It is possible to quantify these ratios through actual
proportions.
For example, in the case of dd inventory, we find that:
(1.4)
And, therefore, also that:

This indicator conveys the days (dd) between the purchase of

materials and their sale. In practice, in order to make the denominator
of the ratio consistent with the numerator (inventory), analysts prefer
to replace the total revenues with the cost of the goods sold at the
denominator. However, since the comparison of two business fiscal
years is more relevant than having accurate data, it is possible to use
total revenues. Regardless of how the calculation is made, an increase
in the indicator represents a deterioration in operating management in
terms of an inventory slowdown during a phase of expansion (growth
in inventory greater than growth in sales – slight loss) or in terms of
actual unsold inventory during a phase of recession (inventory growth
or endurance in response to a decline in sales – considerable loss). On
the other hand, a decrease in the ratio represents an improvement in
operating management, which consequently shows a faster recovery of
inventory through revenues. In this second case, pairing this analysis
with a study of the financial margins could be important, as it would
allow us to highlight how prompt sales policies can come with lower
prices and sacrifices in terms of cost.
As for the dd trade receivables, and assuming that revenues are a
close approximation of the company’s cash in-flow, the following
proportion applies:
(1.5)
And, therefore, also:

This indicator conveys the time between sale and cash-in. An

increase in the ratio would express a slight difficulty in cash-in or a
considerable difficulty in cash-in. On the contrary, with a decrease in
the ratio, we find a company’s ability to cash-in in a shorter amount of
time—from one fiscal year to the next—and, therefore, also improve its
operating management.
Finally, moving on to the dd trade payables, and assuming that the
cost of materials and services is a close approximation of the company’s
cash-out, the following proportion applies:
(1.6)
And, therefore, also:
 This indicator conveys the time between acquisition and cash-out.
Compared to the two previous ratios, interpreting the dd trade
payables is a more complicated matter. In fact, an increase could
represent both a positive and negative sign: positive if suppliers
voluntarily extend trade credit to their customers (the firm), and
negative if a customer is not able to pay his suppliers because of
liquidity shortfalls. Even a decrease could represent both a positive and
negative sign: if the company disposes of contractual strength, it means
that it is losing it and therefore it is a negative sign; if instead it has
poor contractual strength, a decrease often signals the ability to finally
pay past debts, resulting in less financial strain. This indicator must
therefore be considered along with its size and the contractual strength
with suppliers.
Putting these three ratios together, analysts are often able to
quantify the so-called monetary cycle:

(1.7)

A different analysis of the monetary cycle. The monetary cycle

data (1.7) is usually considered to convey the time between cash-out
flows and cash-in flows. However, in the opinion of the authors, this
amount does not necessarily represent the existing time gap between
company cash-out and cash-in. The following example helps explain
and support this claim. Let’s assume that a company is able to sell its
inventory in 30 days, cash in its receivables in 60 days, and settle its
trade payables in 90 days. In this case, its monetary cycle would be
equal to zero:

This would indicate that cash-outs coincide with cash-ins. However,

we know that not all company cash-outs are made in 90 days (consider,
for example, monthly salaries or other payables that are cashed out
instantly). In other words, the average number of cash-outs could be
made well under 90 days, thus leaving a positive monetary cycle. The
dd trade payables, therefore, do not represent the average time of
payment of all working payables, since they must be recalculated if the
goal is that of determining a monetary cycle that appropriately
measures the company’s entire cash flow. Likewise, the dd trade
receivables should also be replaced by the working receivables.
Therefore, the monetary cycle of the overall company cash flow is:
(1.8)
where:

(1.9)

(1.10)

Since the net income should be considered as a source of financing

cost component of the firm (similarly to interests expenses), we should
add it to the total costs, having once again the total revenues at the
denominator:

(1.11)

Therefore, sales are a correct assessment base both for inventory

and for working receivables/payables. This way, by replacing (1.9),
(1.10), and (1.5) in (1.8) we can see that the monetary cycle is nothing
more than the duration of the NOWC:

(1.12)

A very important point emerges from all this: the dd inventory, dd

trade receivables, and dd trade payables are sensible indicators if they
are employed separately (especially since they represent key
elements that the company can operate), but not if they are used to
determine the monetary cycle, given that they do not convey the time
between cash-outs and cash-ins. In this second case, you should prefer
“overall” versions including all working receivables and working
payables. This is the only way in which it is possible to reach a more
correct summary of company cash flow cycle.
Asset balance. Balance sheets highlight the correct use of capital
sources in covering financial requirements. A company can be
considered balanced in its assets if its slow-turnover investments (fixed
capital) are financed by long-term funding sources (equity capital and
M/LT financial debt). On the other hand, fast-turnover investments
(NOWC) should be financed through short-term financial debt. If fixed
assets are not financed through long-term funding sources (equity and
M/LT financial debt) there will be short-term payables that exceed the
NOWC, which would result in a heavier debt burden given the worst
recovery of revolving credit line facilities (Muscettola & Gallo, 2010).
The relation between long-term investments and stable funding
sources can be assessed through the fixed capital coverage ratio:

(1.13)

A company can be considered balanced in its assets if the coverage

ratio is equal to or greater than 100%. In this case, slow-turnover
funding resources cover fixed capital requirements. On the contrary, an
indicator with values below 100% suggests a situation of financial
imbalance.4 The ratio does not only indicate the probability of incurring
short-term solvency issues but it also shows how much room for
investment the company has and, consequently, also its potential for
future growth and development.
The correct use of funding resources can also be analyzed by simply
comparing the net operating working capital (NOWC) and the short-
term net financial debt.
(1.14)
Asset balance occurs with a NOWC greater than or equal to the
short-term financial debt. However, the analysis of the asset balance
cannot overlook the field of reference. For example, in the retail sector
(e.g., supermarkets), the asset balance situation is unimportant since
cash surplus could “physiologically” finance fixed capital requirements
through liquidity generated by cash-ins preceding cash-outs.
 Financial balance. The financial equilibrium measures the relation
between financial debt and equity. The higher the ratio, the greater the
risk, given that an excessive debt obviously makes the company more
vulnerable in situations of economic crisis. The financial balance can be
measured through the debt-to-equity ratio, more commonly referred to
as leverage5:

(1.15)

This ratio highlights the fragility of the company in terms of

capitalization; therefore, a company with high leverage shows greater
financial risk and a higher probability of insolvency.
In any case, the ratio should remain at low values, especially if the
company’s operational risk (which is dependent on the sector) is high.
In other words, the greater the volatility of revenues and margins, the
lower the financial debt, for a mere matter of compensation.
Conversely, the lower the volatility of revenues, the more the company
can afford financial debt.
Economic balance. The company’s cost-effectiveness can be
inferred from comparing the return rate of capital employed and the
cost rate of funding resources. This comparison highlights the
company’s ability to generate enough earnings to compensate for the
capital that was employed in the business.
The return rate results from the relation between the net operating
margin and the capital invested in the company. This ratio commonly
referred to as ROIC (Return On Invested Capital), measures the return
percentage of the company’s operating management, not including the
cost of the company’s financial structure. The invested capital (net
operating capital employed, the terms are used interchangeably) can be
calculated as NOWC plus Fixed Capital

(1.16)

The second indicator, called ROD (Return On Debts), measures the

average cost of debt6:
 (1.17)

where Net financial charges are Interest expenses less Interest

revenues. The condition of economic balance depends on the creation
of operating margins that are greater than the cost of the borrowed
capital.
(1.18)
A positive spread ( ) between the return on invested
capital and the cost of funding ensures that, for each borrowed euro,
the company is able to make the capital profit more than it cost.
However, this condition is not enough to ensure an additional level of
remuneration that is appropriate for shareholders (based on the level
of risk they bear). In fact, it is necessary to point out that—in order to
create value—the ROIC must be greater than the average return on
capital (see Chapter 3). Conversely, a negative spread ( )
between the return on invested equity and the cost of funding suggests
that the return on invested equity is lower than the cost of debt. This
condition indicates an uneconomic situation (poor cost-effectiveness),
given that the return on invested capital is not enough to repay the cost
of borrowed capital.7
The relation between financial and economic balance (ROE
determinants). It is important to note that the condition of economic
balance is followed regardless of the company’s leverage ratio. In any
case, the economic balance is connected to the degree of leverage,
because the economic balances/imbalances spread as many times as
the value of the company’s debt. If the ROIC is higher than the cost of
outside financing sources (ROD), the debt-to-equity ratio (Leverage)
works in a multiplicative way, increasing the profitability of risk capital
(ROE, understood as a return percentage in terms of profit for every
euro of equity capital—Profit/Equity). Conversely, if the ROIC is lower
than the cost of outside funding sources (ROD), the debt-to-equity ratio
(Leverage) always functions in a multiplicative way, but it decreases the
profitability of risk capital. This phenomenon is more commonly
referred to as the leverage effect. The volatility of the ROIC structure
should lead analysts to carefully assess those companies that—despite
having a good economic balance mark a high debt-to-equity ratio.
These concepts can be summarized in the financial leverage formula
(without taxes)8:

(1.19)

ROIC determinants. Just like the ROE, also the ROIC can be broken
down into its determinants. The variables that affect the ROIC can be
summarized as follows:
a. The size and structure of the company business, i.e., the
size/structure combination of economic operations;

b. The conditions of internal (productivity) and external

(competition) efficiency, i.e., the acquisition of productive factors,
actual production, and product sales;

c. The company’s structural elasticity, i.e., the elasticity of

management strategies and policies in response to the volatility of
the conditions of the market and environment.

In other words, the ROIC depends on four main factors:

Total revenues
Operating costs
The NOWC
And the fixed capital.
In order to better understand its dynamics, the ROIC can be broken
down into two ratios (DuPont formula):
1. Return on sales (ROS);

2. Turnover of invested capital (Turnover).

In formula:
(1.20)
 The ROS is a structural ratio. Resulting from the relation between
EBIT and total revenues, it expresses the EBIT per unit of net revenue
(margin for each euro of revenue). In other words, it indicates the
portion of income that is still available after covering all operating
costs. ROS > 0 claims the portion of net revenue that is still available
following the costs of the company’s ordinary operations; whereas a
negative ratio signals the inability of operating income to cover all costs
related to the company’s ordinary operations (as well as remaining
costs and charges).
This ratio is clearly influenced by the company sector and by the
cost structure. For example, manufacturing companies usually have
higher ROS ratios than companies in the trade sector. Therefore,
analysts should consider comparing the company ROS with that of
other companies in the same (or similar) sector.
As for the cost structure—for companies in the same sector—an
increase in the turnover of companies with greater operating leverage
results in a more than proportional increase in the indicator. The
turnover, as described above, measures the efficiency in the
management of capital employed. All this is to say that it is not enough
to compare the cost/revenue ratio, but it is also necessary to consider
the factors that were employed to achieve the volume of business.
Therefore, the company’s cost-effectiveness results from a profitability
ratio and a turnover ratio that jointly express the conditions of the
company’s internal, external, and operating efficiency. Finally, it seems
necessary to specify that the relevance of the two ratios is closely
related to the type of business that is carried out by the company. In
this sense, companies in the trade sector have high turnover rates given
by their high sales volume and low sales margins (ROS). Conversely, in
some manufacturing sectors, companies have high sales margins and
low sales turnover rates.

1.5 Cash Flow Statement Analysis

Cash flow and ratios: a comparison. The balance sheet ratios capture
and reflect the traditional dichotomy between the business and asset
profile of company management. Instead, the cash flows reproduce the
financial vision of operational issues. The analysis is usually carried out
in the time of one year and can be implemented both through a
historical and forecasting lens. Cash flow analysis allows to quantify the
number of monetary resources generated or absorbed during a
reference period of analysis. Cash flows can be positive or negative: in
the first case, they result from an increase in funding resources and a
decrease in investments; in the second, they are a result of an increase
in investments and a decrease in funding sources. From a financial
point of view, assets are defined as investments of capital, while
liabilities and capital are their sources.
The cash flow statement. The cash flow statement is a tool to
analyze the amount of cash-in and cash-out flows over a defined period.
It can be divided into areas depending on the origin of the cash
resources:
a. Current operations;

b. Investments;

c. Extra-management;

d. Financing.

Cash flows from current operations. Current operations include

revenues and expenditures resulting from the operating cycle: purchase
and sales. This cash flow is called operating cash flow (OCF) and it
measures the number of resources that are either generated (if
positive) or absorbed (if negative) by current operations. Therefore, it
represents a summary of ordinary operating revenues, net of ordinary
expenses, and changes in NOWC. How much does a company cash-in in
one year from its current operations? To answer this question, it is
necessary to use information from both the income statement and
balance sheet. Revenues and costs do not necessarily represent the
company’s cash-in and cash-out flows, since the company accounts for
corporate events following a principle of accrual and not cash.
Therefore, balance sheet items related to the NOWC serve to adjust the
components to reach the true monetary dimension of the current
operations. For example, since receivables are trade credit provided to
customers, the cash-in from receivables within a year should be equal
to the sum of receivables of the previous year plus revenues and minus
receivables of the year (payments not yet received from customers).
Similar reasoning should be done with costs and inventories. Since
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from costs within a year should be equal to the sum of payables and
costs minus payables of the year (payments delayed to next year).
Inventories enter both cases depending on their type. Inventories of
final goods represent goods not yet sold in the market, thus reducing
the cash inflows, while inventories of raw materials represent materials
not yet used in the production cycle. In the following table, we place
inventories in full as a cost component, thereby an increase represents
a lower cash-out flow.

Cash flows from current operations EBITDA

− ΔNOWC [NOWC (t) – NOWC (t−1)]
Gross Operating Cash Flow (gross OCF)

− Taxes9
Net Current Operating Cash Flow (OCF)

Current operating cash flow (OCF). The starting point to

determine the current OCF is therefore the EBITDA, which represents
the potential cash flow generated by the current operations in the case
of no delays in payment outflows and invoice inflows and without
inventory changes. Since this situation is not realistic. It is necessary to
address the changes in NOWC, which summarizes revenues yet to be
cashed in (receivables), inventories not yet transformed into cash
income, and costs not yet paid (payables). The difference between
EBITDA and the change in NOWX is the current Operating Cash Flow
(gross OCF), which represents the cash flows generated or absorbed
before paying operating taxes. Current OCF minus taxes are Net Current
Operating Cash Flows (OCF), which refer to the amount of cash flows
generated through the current operations (the production cycle).
CAPEX—Capital Expenditure. Investments in tangible, intangible,
and financial fixed assets form an increase in capital and, therefore, a
disburse of funds. On the contrary, divestitures result in an entry of
monetary resources (positive cash flow). To quantify capital
expenditures, it is necessary to calculate the difference between the
stock of fixed assets of the current year and those of the previous year
and adding depreciation/amortization costs. Depreciation and
amortization are added because they do not lead to cash outflows;
therefore, one should sterilize their accounting effect.

Financing cash ± Cash-in (cash-out) for operating investments (disinvestments)

flow [Fixed capital(t) – Fixed capital(t−1) +
Depreciation/Amortization(t)]10

Nonoperating cash flow. Investments in nonoperating assets

constitute use of resources, resulting in cash outflows. On the contrary,
divestiture of this type of asset results in an incoming cash flow.
This area also includes the balance of extra-ordinary income and
expenses that represent, respectively, the cash inflows and outflows
associated with capital investments in extra-management.

Extra-management cash ± Cash-in (cash-out) for extra-management investments

flow (disinvestments)
[Extra Investments(t) – Extra Investments(t−1)]
± Balance of extra-ordinary income and expenses

Financing cash flow. The cash flow of the financing area is positive
when there is an injection of resources from investors and negative
when there is a repayment of financing sources. According to this
interpretation, an increase in equity capital causes an incoming flow of
resources and, conversely, the payment of a dividend causes a cash
Another random document with
no related content on Scribd:
 Tel est le militaire.
Avec le journal susnommé de Lisbonne qui reproduit en résumé les notes
biographiques du «Panthéon Fluminense», du «Novo-Mundo» de New-
York et du «Dictionnaire biographique brésilien», voyons maintenant les
traits principaux qui caractérisent dans le baron de Teffé l’homme
technique, le savant hydrographe et l’astronome distingué:

«On sait déjà que dans son traité d’hydrographie, Hoonholtz avait révélé
une aptitude rare pour la science hydrographique, jusque-là assez en retard
dans les écoles brésiliennes. Le gouvernement impérial utilisant le talent
manifeste de Hoonholtz, le chargea dès le début de sa carrière militaire, de
la direction d’une Commission qui devait relever la côte et l’île de Sainte-
Catherine. Le travail fut exécuté dans des conditions irréprochables; le
gouvernement en approuva le résultat et lui accorda les plus vifs éloges.
«Après la fin de la guerre du Paraguay, Hoonholtz fut nommé chef de la
Commission de démarcation des limites de l’Empire, au Nord. L’exposé qui
précède a montré comment il sut s’acquitter de cette difficile et pénible
mission. C’est à la suite de son glorieux succès qu’il fut créé baron de
Teffé.....
«Quand fut mise en vigueur la loi du 24 septembre 1873, qui accordait
une garantie d’intérêts au chemin de fer de Paranagua, dans la province du
Parana, de graves difficultés surgirent au sujet de celui des deux ports,
Antonina ou Paranagua, qui offrait les meilleures conditions techniques et
financières comme entrepôt maritime de la province. Hoonholtz fut encore
appelé pour cette difficulté, et avec la bonne volonté qu’il apportait toujours
au service de son pays, il accepta l’invitation du ministre de l’agriculture;
après des études sérieuses et des observations prolongées, il démontra que
le port de Antonina était celui qui réunissait les conditions requises. Le 5
novembre 1878, à l’Institut Polytechnique Brésilien, un distingué ingénieur,
M. André Rebouças, parlait ainsi à cet égard:

«Le rapport du baron de Teffé, publié en 1877 par l’Imprimerie

nationale, constitue aujourd’hui le plus savant et le plus irréfutable
document sur les ports et les lignes ferrées du Parana. On ne peut le nier: en
hydrographie, notre illustre collègue, auteur de l’unique compendium en
langue nationale sur la matière, n’a pas son supérieur dans l’Empire. Dans
tout autre pays, son avis serait décisif, aucun gouvernement ne saurait aller
à l’encontre. L’Institut a entendu et dûment apprécié ses irréfutables
arguments, techniques et économiques; il a admiré l’autorité et la sagacité
avec lesquelles notre illustre collègue a étudié ce problème complexe.
Comme tous les nobles cœurs, Hoonholtz se passionne pour la vérité; c’est
aujourd’hui un des défenseurs les plus convaincus de Antonina et des
véritables intérêts du Parana. Cette belle province, elle aussi, n’oubliera
jamais son nom; déjà elle l’a attaché à la route qui relie à Antonina la
colonie de Assunguy; son dernier discours, disent les lettres que je reçois du
Parana, court déjà imprimé à travers les Sertoès de Guarapuava,
popularisant là même un nom si cher à la patrie par ses actions glorieuses
dans la guerre et dans la paix».

Depuis, la question a été tranchée en sens contraire, mais le baron de

Teffé a été vengé par les événements, et aujourd’hui la Compagnie et le
gouvernement s’efforcent de construire le tronçon qui refera d’Antonina la
tête de ligne.

«Quand il s’est agi du litige entre le gouvernement et la Compagnie

Nord-Américaine de navigation à vapeur, litige qui reposait sur les bonnes
ou mauvaises conditions du port de Maranhao, c’est encore au baron de
Teffé que recourut le gouvernement. Celui-ci était alors occupé à la
désobstruction de la barre à Cabo Frio; il partit pour le Maranhao à la tête
d’une commission. Après une analyse minutieuse, il présenta son rapport
démontrant la possibilité de l’entrée des grands vapeurs dans la baie de S.
Marcos et dans les mouillages de Eira, Itaqui et de l’Ilha do Medo. Son
opinion fut admise et les paquebots se résignèrent à l’escale indiquée dans
son rapport.
«L’assainissement de la lagune Rodrigo de Freitas dans la banlieue de
Rio-de-Janeiro ayant été reconnu d’une urgente nécessité, le baron de Teffé,
sur la demande du gouvernement, présenta un projet qui, mis en parallèle
devant la Société (Club) des ingénieurs avec d’autres rapports, entre autres
celui du distingué ingénieur Milnor Roberts, obtint sur tous la préférence.
«En 1876, il parvint à résoudre une grave question suscitée par les
avaries qu’une roche sous-marine, non mentionnée sur les cartes, avait
causées à l’entrée de Santos, aux vapeurs français et allemands. Sous sa
direction cette roche fut détruite, en employant les plongeurs de l’Arsenal
de marine auxquels était encore inconnu l’usage de la dynamite et du
scaphandre.
«Récemment, un autre fait a attesté de façon éloquente la grande
capacité du baron de Teffé. Nous voulons parler des observations
astronomiques exécutées à l’occasion du passage de Vénus sur le disque du
soleil, observation qui fut faite aux Antilles, où il alla représenter le corps
savant du Brésil. En récompense de cette mission remplie avec tant de
distinction, le baron de Teffé a été élevé à la dignité de Grand de l’Empire.
«Le baron de Teffé est, en outre, un littérateur apprécié. Outre ses écrits
disséminés dans une foule de journaux et de revues, il est l’auteur d’un
drame maritime intitulé: la Justice de Dieu, et d’un roman, la Corvette
Diana, publié en feuilleton par la Patria de Montevideo, par le Diario de
Pernambuco, et par le Despertador de Sainte-Catherine. La Corvette Diana
a été publiée ensuite séparément par l’auteur qui l’a gracieusement
distribuée à ses amis.
«Nous avons eu occasion de lire les appréciations portées sur ce livre
dans le Diario de Pernambuco, le Diario de Bahia et le Pedro II, du Ceara.
Tous ces journaux sont unanimes à considérer l’œuvre du délicat littérateur,
comme une véritable primeur de littérature agréable, où l’imagination
s’allie à un langage choisi, sans jamais s’écarter du plan général de
l’ouvrage. La Reforma, de Rio-de-Janeiro, du 7 juin 1873, consacrait à ce
livre les paroles suivantes:

«La Corvette Diana est le titre d’un roman charmant, dû à la plume de

M. le capitaine de frégate Antonio Luiz von Hoonholtz, officier distingué
de notre marine. C’est un roman maritime, où l’auteur vous fait apprécier
de beaux et variés tableaux de la nature brésilienne. Les épisodes y sont
racontés avec vérité et les caractères des personnages bien dessinés. Le livre
est écrit avec élégance et agrément.»

«Comme écrivain, le baron de Teffé est d’une rare fécondité, puisqu’en

outre du compendium hydrographique et des livres précités, il a publié en
feuilletons divers mémoires, discours, etc.; il a encore inédits plusieurs
autres travaux, comme la traduction et l’organisation alphabétique du code
international des signaux maritimes; un mémoire sur l’invention de
l’ingénieur allemand Wilhelm Bauer pour retirer les navires du fond de la
mer; un livre où il décrit ses impressions durant le voyage qu’il fit aux ports
d’Europe sur la corvette Bahiana, et deux volumes décrivant son voyage
d’exploration sur l’Amazone et ses affluents.
«Parmi ses remarquables travaux scientifiques, il faut mettre à part ses
conférences sur l’Amérique préhistorique, faites aux applaudissements d’un
auditoire choisi, où se montraient à côté des hommes les plus distingués du
Brésil, S. M. l’Empereur Don Pedro II et S. A. le comte d’Eu.»

La Folha do Commercio énumère à la suite les titres et honneurs

accordés au baron de Teffé.
Il est Grand de l’Empire, officier général de la flotte (contre-amiral),
officier des Ordres Impériaux du Cruzeiro et de la Rose, commandeur de S.
Bento de Aviz, de l’Ordre Royal Américain de Isabelle la Catholique;
décoré des médailles de la bataille navale de Riachuelo; de la campagne
générale du Paraguay; de celle conférée par la République Argentine aux
vainqueurs de Corrientes et du Mérite militaire; membre titulaire de
l’Institut historique et géographique du Brésil; vice-président de l’Institut
polytechnique; membre des Sociétés de Géographie commerciale de Paris
et de Lisbonne, et vice-président de la Société de Géographie de Rio de
Janeiro; membre du conseil directeur de la Société centrale d’Immigration,
et directeur général du service hydrographique de l’Empire; chambellan de
S. M. l’Impératrice.
Dernièrement il a été nommé membre correspondant de l’Académie des
Sciences de Paris et de l’Académie des Sciences de Madrid.
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