chapter 9 analyzing historical performance

Chapter 9 Chapter 9 Analyzing Historical Analyzing Historical

PerformancePerformancePresented by Shan LiPresented by Shan Li

Organization of this chapterOrganization of this chapter

• Reorganizing the accounting statements to gain greater analytical insights and to calculate ROIC and economic profit

• Calculate free cash flow• Breaking down ROIC and Developing an

integrated perspective• Analyzing credit health and liquidity• Dealing with more advanced issues in analyzing

financial performance

Reorganizing The Accounting Reorganizing The Accounting StatementsStatements

• The purpose of reorganization of accounting statements is to calculate Invested Capital, NOPLAT,ROIC and Economic Profit.

• ROIC and Economic Profit reflect more of an economic than accounting view of the company.

For example: distinguish operating from non-operating assets.

Invested CapitalInvested Capital

• Need to reorganize the balance sheet.• It reflect how much of the capital has been

invested in operating activities and other non-operating activities.

• Operating invested capital: the amount invested in the operation of the business.OIC = operating working capital + net property, plant and equipment + net other assets

Invested Capital-9 itemsInvested Capital-9 items

• Operating current assets Comprise all current assets used in or

necessary for the operation of the business. OCA= cash balance + trade accounts

receivables + inventories. Specifically excluded are cash and

marketable securities greater than the operational needs of the business.


• Non-interest-bearing current liabilitiesSuch as accounts payable and accrued expenseNet working capital=Operating current assets

– Non-interest-bearing current liabilities

• Net property, plant and equipmentIs the book value of the company’s fixed

assetsNPPE=Gross PPE – Accumulated depreciation


• Other operating assets, net of other liabilitiesAny other assets or non-interest-bearing liabilities

related to the operation of business

• Non-operating assetsAny assets not included in operating invested capital

should be added when total investor funds.For example: Goodwill, Excess cash and securities,

Non-operating investments.


• Equity Is the sum of all common equity accountsSuch as paid-in capital and retain earnings, preferred

shares, and minority interest in consolidated subsidiaries

• Quasi-equity itemsAccounts recorded as liabilities for accounting

purpose, but should be treated as equity to determine how much capital the shareholder have invested.

For example: deferred income taxes


• Adjusted equityIs the sum of all equity accounts plus all quasi-

equity accounts

• Interest-bearing debtIncludes long-term debt, short-term debt,

current maturities of long-term debt, and capital lease

NOPLATNOPLAT

• NOPLAT-Net Operating Profit Less Adjusted Taxes

• Need to reorganize income statement

• Represents the after-tax operating profits of the company after adjusting the taxes to a cash basis

NOPLAT-4 itemsNOPLAT-4 items

• EBITAEBITA-Earning Before Interest, Taxes and

Amortization of goodwill Is the pretax operating income that a company would

earned if it had no debt and no goodwill amortization Includes all types of operating income, including

most revenues and expensesExcludes interest income and expense, gain or loss

from discontinued items, extraordinary income or loss, investment income from non-operating invests


• Taxes on EBITARepresent the income

taxes that are attributable to EBITA

Are taxes the company would pay if it had no debt, cash above operating needs, or non-operating income or expenses

Total income tax provision from income statement 216

Tax shield on interest expense 33

Tax on interest income 0

Tax on non-operating income (18)

Taxes on EBITA 231


• Change in deferred taxesDeferred taxes are the difference between the

provision for income taxes in the income statement and the actual taxes paid in cash.

Can be made by calculating the change in accumulated deferred income taxes on the company’s balance sheet

For example: accumulated deferred taxes in 1995 was 192, in 1996 was 224. Therefore, change in deferred taxes is 224-192=32.


• Reconciliation to net income

To ensure that nothing is missing in the calculation of NOPLAT

To ensure a complete understanding of the company’s financial statements

Net income 282

Add: Increase in deferred taxes (1)

Add: Goodwill amortization 15

Adjusted net income 296

Add: Interest expense after-tax, net 27

Total income available to investors 323

After-tax non-operating income 0

NOPLAT 323

ROICROIC

• ROIC-Return On Invested Capital• ROIC= Net operating profit less adjusted taxes Invested capital• Invested capital is generally measured at the

beginning of the period or as an average of the beginning and end of the period.

• ROIC is a better analytical tool because it focuses on the true operating performance of the company.

Economic ProfitEconomic Profit

• It measures the dollars of economic value created by a company in a single year.

• Economic profit=Invested capital x (ROIC-WACC) or

• Economic profit=NOPLAT-Capital charge or• Economic profit=NOPLAT-(Invested capital x

WACC)• Economic profit combines spread and size of

company into dollar performance

Free Cash FlowFree Cash Flow

• Free cash flow is a company’s true operating cash flow.

• It is the total after-tax cash flow generated by the company that is available to all providers of the company’s capital, both creditors and shareholders.

• Free cash flow is before financing and therefore not affect by the company’s financial structure.

Free Cash FlowFree Cash Flow

• FCF=NOPALT-Net investment

=[NOPLAT + Depreciation]-[Net investment + Depreciation]

=Gross cash flow-Gross investment

Where net investment is the change in invested capital.

Free Cash Flow-14 itemsFree Cash Flow-14 items

• Depreciation Includes all the noncash charges deducted from

EBITA except goodwill amortization

• Gross cash flowRepresents the total cash flow thrown off by the

company’s operation It is the amount available to reinvest without relying

on additional capitalGCF=NOPLAT + Depreciation


• Change in operating working capitalIs the amount the company invested in

operating working capital during the period.

• Capital expenditureInclude expenditures on new and replacement

property, and equipmentCapital expenditure=increase in net property,

plant and equipment + depreciation expenses


• Increase in other assets, net of liabilitiesEquals the expenditure on all other operating assets

including deferred expense, and net of increases in non-current, non-interest-bearing liabilities

• Gross investment Is the sum of a company’s spending for new capital Includes working capital, capital expenditures, and

other assetsGI=change in working capital + capital expenditure +

change in other assets + foreign currency translation effect


• Investment in goodwillEquals the expenditures to acquire other

companies in excess of the book value of their net assets

IIG=net changes in goodwill + amortization of goodwill


• Non-operating cash flowRepresents the after-tax cash flow from items

not related to operationsIncludes cash flow from discontinued

operations, extraordinary gain or loss, and the cash flow from investments in unrelated subsidiaries

TV=PV of FCF + PV of After Tax Non-Operating CF and Marketable Securities


• Change in excess marketable securities Excess marketable securities are the short-term

investments that the company holds above its target balance to support operation.

The change in excess marketable securities can be treated as non-operating cash flow or as financing cash flows.


• Foreign Currency translation effectIs driven by the changes in translation rates

applies to both assets and debtTreat this gain or loss as non-operating cash

flow

• Total funds available to investor=FCF + all non-operating items


• Change in DebtRepresents the net borrowing or repayment on

all the company’s interest-bearing debtIncludes short-term debt and capital lease

• After-tax interest expense=pretax interest expense x (1-marginal tax

rate)


• DividendsIncludes all cash dividends on common and

preferred shares

• Share issues/repurchasesIncludes both preferred and common shares

and the effects of conversions of debt to equity

Breakdown ROICBreakdown ROIC

• ROIC = NOPLAT Invested Capital

• NOPLAT=EBITA x (1-Cash tax rate)

• ROIC= EBITA x (1-cash tax rate) Invested Capital

Breakdown ROICBreakdown ROIC

EBITA EBITA RevenuesInvested Capital = Revenues x Invested Capital

• Operating Margin (EBITA/Revenues) measures how effectively the company converts revenues into profits.

• Capital turnover ( Revenue/Invested capital) measures how effectively the company employs its invested capital.

Credit Health and LiquidityCredit Health and Liquidity

• Interest CoverageIs the amount of earnings available to pay

interest expenseIt provides a sense of how far operating profits

could fall before the company would have difficulty servicing its debt.

Measures the company’s financial cushionInterest Coverage= EBIT/Interest expense


• Debt/Total Investor FundsMeasures the company’s reliance on debt

capitalExpressed both at book value (creditors often

use) and at market values


• Investment RateIs the ratio of investment to available fundsNet basis : Net investment / NOPLAT Gross basis: Gross investment / Gross cash

flowInvestment rate > 1 : company is consuming

more funds than it is generating


• Dividend Payout Ratio Is total common dividends divided by income

available to common shareholders= Common Dividends / Net Income available

to commonIf a company has investment rate >1 and a

high dividend payout ratio, it must be borrowing money to fund a negative free cash flow to pay interests and dividends.

chapter 9 analyzing historical performance

Documents

operating invested capital

nonoperating assets

operating current assets

pretax operating income

types of operating income

nonoperating activities

assetsinvested capital

operating assetsany