ANALYSIS, USING AND UNDERSTANDING FINANCIAL STATEMENTS OF THE FIRM

ANALYSIS, USING AND UNDERSTANDING FINANCIAL STATEMENTS OF THE FIRM

ANALYSIS, USING AND UNDERSTANDING FINANCIAL STATEMENTS OF THE FIRM • E-mail: erasmus.MICHALSKI@gmail.com • www: HTTP://MICHALSKIG.UE.WROC.PL/ • Mobile: +48503452860 • 5 lectures + 1 exam (individual homework sent via email + test) • Next lecture: .... • Michalski G., Prediction cooperator future condition using financial statements (In Polish: Ocenakontrahenta na podstawie sprawozdań finansowych), ODDK, Gdańsk, 2008. • D.R.Harrington, B.D. Wilson, Corporate Financial Analysis, Irwin.

Basic financial aim of the firm • Firm value maximization: Where: FCFn = free cash flows, CC = cost of capital financing the firm (WACC) n = period in which FCFn will be generated

Wilcox-Gambler Model • Wilcox's Gambler's-Ruin Formula: This model can be used to estimate the liquidation value of a company. It's likely to be significantly less than the book value because of the "fire sale" nature. Most current assets are valued at 70% of their balance sheet values; fixed and other assets at 50% of book value. Real estate should generally be valued separately. Cash plus marketable securities at market value + Inventory, accounts receivable, prepaid expenses, at 70% of book value + Fixed and other assets at 50% of book value - Current liabilities - Long-term liabilities = Liquidation Value

Example:Firm has assets with the following book values: • Cash on hand = $26,000 Accounts receivable = $80,000 Inventory = $20,000 Prepaid insurance = $5,000 Equipment, office furniture, and trucks = $150,000 Accounts payable and accrued expenses = $40,000 Long-term liabilites = $60,000 • Here's the computation: • Cash $26,000 • Accounts receivable $80,000 x .7 • Inventory $20,000 x .7 • Prepaid insurance $5,000 x .7 • Equipment, etc. $150,000 X .5 • Accounts payable and accruals -40,000 • Long-term liabilities -60,000 • Liquidation Value = ?

Example:calculate Wilcox-Gambler liquidation value for Chemical and for Tobbaco company

If kd = 5% for Chemical and kd = 7% for Tobbaco Calculate ROA for them and compare with kd and sector/branch ROA = (NI+INT)/(Total_Assets) NI = net income, INT = interests (financial costs of debt)

Basic financial aim of the firm • Firm value maximization: Where: FCFn = free cash flows, CC = cost of capital financing the firm (WACC) n = period in which FCFn will be generated

FCF – how to calculate? CC – cost of capital (cost of money), how to value?

The return on assets (ROA) • The return on assets (ROA) percentage shows how profitable a company's assets are in generating revenue. • ROA can be computed as: • This number tells you what the firm can do with what it has, i.e. how many dollars of earnings they derive from each dollar of assets they control. Its a useful number for comparing competing companies in the same industry. The number will vary widely across different industries. • It is better when ROA > kd

Ex. ROA: • Calculate ROA if you know that in the firm SARKA in 200(X-1) & 200(X), NI200(X-1)= 1318, NI200X= 5556, INT200(X-1)= 5053, INT200X= 6225, TA200(X-1)=103528, TA200X=119057, kd,200(X-1)= 7%, kd,200X= 8%. • Typical results for firms from SARKA branch are on fig.:

The return on equity (ROE) • The return on equity (ROE) percentage shows how profitable is a company's equity in generating revenue. • ROE can be computed as: • This number tells you what the firm can do with what it has, i.e. how many euros of earnings they derive from each euro of equity they invest. Its a useful number for comparing competing companies in the same industry. The number will vary widely across different industries. • It is better when ROE > ke

Ex. ROE: • Calculate ROE if you know that in the firm SARKA in 200(X-1) & 200(X), NI200(X-1)= 1318, NI200X= 5556, E200(X-1)=E200X=61000, D200(X-1)= 41528, D200X= 54057, βu200(X-1)=βu200(X) = 0,63. • Typical results for firms from SARKA branch are on fig.:

Liquidity indicators • Current ratio (current ratio) is the ratio of current assets and current liabilities: • Current ratio is an indication of a firm's market liquidity and ability to meet creditor's demands. • Acceptable current ratios vary from industry to industry. • Some types of businesses usually operate with a current ratio less than one. For example, if inventory turns over much more rapidly than the accounts payable become due, then the current ratio will be less than one (this is true for FastFoods). This can allow a firm to operate with a low current ratio.

Ex. CurRat: • Calculate CurRat if you know that in the firm SARKA in 200(X-1) & 200(X), CA200(X-1)= 28845, CA200X= 24174, CL200(X-1)= 2528, CL200X= 8057. • Typical results for firms from SARKA branch are on fig.:

ANALYSIS, USING AND UNDERSTANDING FINANCIAL STATEMENTS OF THE FIRM • E-mail: GRZEGORZ.MICHALSKI@GMAIL.COM • www: HTTP://MICHALSKIG.UE.WROC.PL/ • Mobile: +48503452860 • 5 lectures + 1 exam (individual homework sent via email + test) • Next lecture: .... • Michalski G., Prediction cooperator future condition using financial statements (In Polish: Ocenakontrahenta na podstawie sprawozdań finansowych), ODDK, Gdańsk, 2008. • D.R.Harrington, B.D. Wilson, Corporate Financial Analysis, Irwin.

The return on equity (ROE) • The return on equity (ROE) percentage shows how profitable is a company's equity in generating revenue. • ROE can be computed as: • This number tells you what the firm can do with what it has, i.e. how many euros of earnings they derive from each euro of equity they invest. Its a useful number for comparing competing companies in the same industry. The number will vary widely across different industries. • It is better when ROE > ke

Ex. ROE: • Calculate ROE if you know that in the firm SARKA in 200(X-1) & 200(X), NI200(X-1)= 1318, NI200X= 5556, E200(X-1)=E200X=61000, D200(X-1)= 41528, D200X= 54057, βu200(X-1)=βu200(X) = 0,63. • Typical results for firms from SARKA branch are on fig.:

Liquidity indicators • Current ratio (current ratio) is the ratio of current assets and current liabilities: • Current ratio is an indication of a firm's market liquidity and ability to meet creditor's demands. • Acceptable current ratios vary from industry to industry. • Some types of businesses usually operate with a current ratio less than one. For example, if inventory turns over much more rapidly than the accounts payable become due, then the current ratio will be less than one (this is true for FastFoods). This can allow a firm to operate with a low current ratio.

Ex. CurRat: • Calculate CurRat if you know that in the firm SARKA in 200(X-1) & 200(X), CA200(X-1)= 28845, CA200X= 24174, CL200(X-1)= 2528, CL200X= 8057. • Typical results for firms from SARKA branch are on fig.:

ANALYSIS, USING AND UNDERSTANDING FINANCIAL STATEMENTS OF THE FIRM