ACCT:3100

Financial Statement Analysis

Free Cash Flow

Cash flow available to pay dividends, buy back stock, and pay back debt

Cash Flow from Operations - CapEx (Capital Expenditures)

Bermuda Triangle of Valuation

Bias: you want to buy the company

Complexity: the 10-k is 300 pages of noise

Uncertainty: no one knows the future

Gross margin

(Revenue - COGS) / Revenue

Operating Margin

EBIT margin

Operating income / Revenue

Current Ratio

Current Assets / Current Liabilities

Quick Ratio

Acid test

(Cash + Marketable Securities + Accounts Receivable) / Current Liabilities

Strips Inventory: checks if cash is trapped in unsold inventory

Porters 5 forces

Supplier Power, Buyer Power, Threat of substitutes, barriers to entry, rivalry

High Rivalry

Higher CapEx/ Lower FCF

High barriers to entry

Longer growth duration

High supplier power

Increases input costs, compresses gross margins

Higher buyer power

Lower revenue growth

High threat of substitutes

Increases overall business risk, higher cost of capital(WACC)

Economic Moat

ROIC > WACC

ROE

Return on Equity: Net Income / Equity

ROI + (leverage x spread)

Leverage

Borrowings / equity

Spread

ROI - borrowing cost

Common Sizing

Income Statement: Line item / total revenue

Balance Sheet: line item / assets

Asset Overstatement

Failing to write down rotting inventory: current earnings overstated

Asset Understatement

Expensing R&D immediately: current earnings understated

Liability Overstatement

Stashing away “cookie jar” reserves: current earnings understated

Liability Understatement

Ignoring future pension obligations: current earnings overstated

DuPont identity

ROE = Profit Margin x Asset Turnover x Financial Leverage

Asset Turnover

Sales / Total Assets: measures asset efficiency

Profit Margin

Net Income / Sales: Measures pricing power and cost control

Financial Leverage

Total assets / Total Equity: measures financial engineering (Debt)

Current Ratio

Current Assets / Current Liabilities

Times interest earned

EBIT / Interest expense

Accruals Ratio

[(Net Income - CFO) / Total Assets]

Operating leases

Obligation to pay, therefore debt

Cash flow from operations

Cash that is used in operations

Impairment

Writing down goodwill value on with loss, creating a massive loss

Net Profit Margin

Net Income / Net Sales

Inventory and Cost of Goods Sold

BEGINNING INVENTORY

+PURCHASES_______________________

COST OF GOODS AVAILABLE FOR SALE

-ENDING INVENTORY_________________

COST OF GOODS SOLD

Statement of Cash Flows

Cash Flows from Operations

Cash Flows from Investing and

Cash Flows from Financing Activities

The sum of these activities will be the change in cash for the period

EBITDA Bridge

Earnings (Net Income) before Interest, Taxes, Depreciation, Amortization

Net Loss → Add back Interest → Add back Tax → Add back Depreciation → Add back SBC → Add back "Restructuring."

Operating Margins

Operating Income / Net Sales

EBIT / Revenue

Working Capital

Current Assets- Current Liabilities

Net Debt + Equity

NOPAT

Net Operating Profit After Tax

EBIT x (1 - Tax Rate)

ROIC

Return on Invested Capital

NOPAT / Invested Capital

IC

Invested Capital

Total Debt + Equity – Cash

Operating Assests - Operating Liabilities

Book Value

Assets - Liabilities

Market Capitalization

Stock Price x Shares

Operating Assets

Accounts Receivable, Inventory, PP&E. (Exclude Cash)

Operating Liabilities

Accounts Payable, Accrued Expenses. (Exclude Debt)

Enterprise Value

Market Cap + Debt + Lease Liabilities - Cash

Effective Tax Rate

Income Tax Expense / Pre-Tax Income

Burn Rate / Runway (Months)

Cash / (Annual FCF / 12)

R&D Adjustment

Research and Development

• Move R&D from an “Expense” to “CapEx”

• Create an asset on the balance sheet

• Result: Net Profit increases, Assets increase, Book Value of Equity increases, ROE decreases, Book Value of invested capital increases, ROIC decreases