Financial Analysis and

Short-term Planning

Outline

Review Financial Statements

Review the difference between

profits and cash flows

Review some financial ratios

External Funds Needed (EFN)

Accounting Statements

Income Statement

Balance Sheet

Statement of Cash Flows

The Income Statement

A flow statement (each item covers the cumulative

value of that item over a period of time)

Matches revenue and expenses over a particular time

period

Based in most cases on accrual accounting methods:

Revenues are recognized as earned when sales are made.

Expenses are recognized when incurred.

A Basic Income Statement

Income Statement
Company Name
For the time period ending 19XX

Net Sales
- Cost of Goods Sold
= Gross Profit
- Operating Expenses
= Operating Profit
- Interest Expense
= Profit Before Taxes
- Taxes
= Net Income

The Balance Sheet

Basic identity:
ASSETS = LIABILITIES + EQUITY

A stock statement (each item covers

the value of that item as of a specific
point in time)

Constructed based on book values,

not market values

A Simple Balance Sheet

Assets
Cash
Receivables
Inventories
Total Current Assets
Gross Fixed Assets
(less Accum. Deprec)
Net Fixed Assets
Total Assets

Assets

Liabilities and Owners Equity

Notes Payable
Account Payables
Accrued Expenses
Curr. Portion of LTD
Total Current Liabilities

S.T.
Funds

Long term Debt

L.T.
Total Liabilities
Capital
Preferred Stock
Common Stock
Retained Earnings
Total Liabilities and equity

Claims on Assets

The Statement of Cash Flows

Income statement is accrual based

Therefore, profits do NOT equal cash

flows

The statement of cash flows deaccrualizes the income statement

Adds back all non-cash deductions

Subtracts non-cash revenues
Adjusts for changes in balance sheet accounts

Statement of Cash Flow

+Net Income
+Depreciation
+/-Receivables
+/-Payables
+/-Other current
assets
CF from operating
Activities

+/-Fixed assets
CF from Investing
Activities
+/-LTD
+/-Common Stock
-Dividends
CF from Financing
Activities

Statement of Cash Flow

+CF from Operating Activities
+CF from Investing Activities
+CF from Financing Activities
Net CF from all Activities=Change in
Cash

Ratio Analysis

Liquidity Ratios
Efficiency Ratios
Profitability Ratios
Leverage Ratios

Some Liquidity Ratios

current assets
Current ratio =
current liabilities
Cash A/R Mar.Sec.
Quick ratio =
Current liabilities

Some Efficiency Ratios

Average Inventory
Days Inventory =
365
Cost of goods sold
Average Receivables
Avg. Collection Period
365
Sales
Average Payables
Payable Days
365
Cost of goods sold

Some Profitability Ratios

Net Income
Net profit margin =
Sales

Net Income
Return on Assets = ROA
average total assets
Net Income
Return on equity ROE =
average equity

Some Leverage Ratios

Total Debt
Total debt ratio =
Total Assets
EBIT
Times interest earned =
interest payments

The DuPont Analysis

A breakdown of ROE into component ratios

Net Income Assets Sales Net Income

ROE

x
x
Equity
Equity Assets
Sales

Leverage

Profitability
Asset
Efficiency

The Need for Financial

Planning

All assets must be funded (LHS = RHS)

As sales increase, both assets and

financing sources (RHS) grow to some
extent

Mismatches in the extent of automatic

growth in LHS and RHS accounts will
result in future needs for financing

Types of Right Hand Side

Financing

Spontaneous accounts - grow at the same

general rate as sales (e.g. Accounts
payables, accruals)

Retained earnings - growth is a function of:

Profitability

Dividend payout ratio

Financing decision accounts which increase

only when management has made an explicit
decision to seek financing (i.e. NP, LTD or
equity)

External Funds Needed

EFN

Change in Total Assets

Less

Change in Spontaneous Liabilities

+
Change in Retained Earnings

EFN: Percent of Sales Method

Change in Total Assets ( TA 0 ) (g)
Change in Spontaneous Liabilities
Change in RE
EFN

( L 0 ) (g)

[( S 0 + g*S 0 )(NPM)-div payout ]

( TA 0 ) (g) [ ( L 0 ) (g) +
( S 0 + g*S 0 )(NPM)-div payout ]

Weve Calculated EFN

Whats Next?

EFN is the necessary financing

Next step is to determine how to fund or reduce EFN

Decision issues
Debt versus equity (restriction on the debt ratio)
Short term debt (notes payable) vs long term (bonds)
(restriction on the current ratio)
Changes in payables or collections policies
Changes in dividend payout policies
Operational changes outsourcing, etc