Overview of Corporate Reporting and Analysis

1. Overview of Corporate Reporting and Analysis • BY • HERICK ONDIGO • SCHOOL OF BUSINESS • UNIVERSITY OF NAIROBI

2. Business Analysis Evaluate Risks Evaluate Prospects Business Decision Makers • Equity investors • Creditors • Managers • Merger and Acquisition Analysts • External Auditors • Directors • Regulators • Employees & Unions • Lawyers

3. Quantitative Financial Statements Industry Statistics Economic Indicators Regulatory filings Trade reports Qualitative Management Discussion & Analysis Chairperson’s Letter Vision/Mission Statement Financial Press Press Releases Web sites Information Sources forBusiness Analysis

4. Credit Analysis Equity Analysis Management & Control Labor Negotiations Types of Business Analysis Director Oversight Regulation External Auditing Financial Management Mergers, Acquisitions & Divestitures

5. Trade Creditors Provide goods or services Most short-term Usually implicit interest Bear risk of default Non-trade Creditors Provide major financing Most long-term Usually explicit interest Bear risk of default Credit Analysis Creditors

6. Liquidity Ability to meet short-term obligations Focus: Current Financial conditions Current cash flows Liquidity of assets Solvency Ability to meet long-term obligations Focus: Long-term financial conditions Long-term cash flows Extended profitability Credit Analysis Credit worthiness: Ability to honor credit obligations (downside risk)

7. Intrinsic Value(or Fundamental Value) Value of Company (or stock) without reference to market value (or stock price) Strategy Intrinsic value > Market value Buy Intrinsic value < Market value Sell Intrinsic value = Market value Hold

8. Business Environment & Strategy Analysis Industry Analysis Strategy Analysis Prospective Analysis Accounting Analysis Financial Analysis Analysis of Sources &Uses of Funds Risk Analysis Profitability Analysis Cost of Capital Estimate Intrinsic Value

9. Accounting Analysis Process to evaluate and adjust financial statements to better reflect economic reality Comparability problems — across firms and across time Manager estimation error Distortion problems Earnings management Distortion of business Accounting Risk

10. Financial Analysis Process to evaluate financial position and performance using financial statements Profitability analysis—Evaluate return on investments Risk analysis ——— Evaluate riskiness & creditworthiness Sources and uses —Evaluate source & of funds analysis deployment of funds Common tools Ratio analysis Cash flow analysis

11. Prospective Analysis Process to forecast future payoffs Business Environment & Strategy Analysis Accounting Analysis Financial Analysis Intrinsic Value

12. Dynamics of Business Activities Business Activities Time Beginning of period Financing Investing Planning Operating Investing Financing Planning End of period

13. Business Activities Pricing Competition Market demands Tactics Planning Activities: Goals & Objectives Promotion Distribution Projections Managerial performance Opportunities Obstacles

14. Business Activities Financing activities • Owner (equity) • Nonowner (liabilities) Financing

15. Business Activities Investing activities • Buying resources • Selling resources Investing Financing Investing = Financing

16. Business Activities Planning Activities Financial Activities Investing Activities Operating Activities Revenues and expenses from providing goods and services

17. Investing Activities • Spending the funds obtained effectively and efficiently • involve purchase and sale of • buildings, machinery or other investment instruments such as government bonds, treasury bills • extending loans to other companies • are expected to contribute directly or indirectly to the profit maximization and solvency goals of the business

18. Operating Activities • involve the daily activities of the entities to run the business • include • sales and marketing of the goods sold and services provided • production • purchasing merchandise and inventory items • managing human resources • effective and efficient management of operating activities needed to achieve profitability and liquidity

19. Financing Activities • initially - funds to setup a business • in later periods – funds to run operations and to grow • obtaining such funds either from external or internal sources • Funds obtained: from creditors shareholders • Funds provided to: payment of payment of interest dividends repayment of debts • Cash management

20. Financial Statements Reflect Business Activities Planning Financing Current: • Notes Payable • Accounts Payable • Salaries Payable • Income Tax Payable Noncurrent: • Bonds Payable • Common Stock • Retained Earnings Investing Current: • Cash • Accounts Receivable • Inventories • Marketable Securities Noncurrent: • Land, Buildings, & Equipment • Patents • Investments Operating • Sales • Cost of Goods Sold • Selling Expense • Administrative Expense • Interest Expense • Income Tax Expense Net Income Liabilities & Equity Income statement Assets Cash Flow Financial position ST Statement of Financial Position Statement of Cash Flows Statement of Shareholders’ Equity

21. Financial Statements • Statement of Financial Position • Statement of Income • Statement of changes in shareholders’ Equity • Statement of Cash Flows

22. Additional Information(Beyond Financial Statements) • Management Discussion & Analysis (MD&A) • Management Report • Auditor Report • Notes to Financial Statements • Social Responsibility Report • Corporate Governance Reporting

23. Analysis Preview Yr1 Yr2 Yr3 Comparative Analysis Purpose: Evaluation of consecutive financial statements Output: Direction, speed, & extent of any trend(s) Types:  Year-to-year Change Analysis  Index-Number Trend Analysis

24. Analysis Preview Common-Size Analysis Purpose :  Evaluation of internal makeup of financial statements  Evaluation of financial statement accounts across companies Output: Proportionate size of assets, liabilities, equity, revenues, & expenses

25. Analysis Preview Ratio Analysis Purpose : Evaluate relation between two or more economically important items (one starting point for further analysis) Output: Mathematical expression of relation between two or more items Cautions:  Prior Accounting analysis is important  Interpretation is key -- long vs short term & benchmarking

26. Analysis Preview Valuation Purpose: Estimate intrinsic value of a company (or stock) Basis: Present value theory (time value of money) Valuation - an important goal of many types of business analysis

27. Bt = It +1 + It +2 + It +3 + ... + It +n + F (1+r)1 (1+r)2 (1+r)3 (1+r)n (1+r)n Analysis Preview Debt (Bond) Valuation Bt is the value of the bond at time t It +n is the interest payment in period t+n F is the principal payment (usually the debt’s face value) r is the interest rate (yield to maturity)

28. Vt = E(Dt +1)+ E(Dt +2) + E(Dt +3) + ... + E(Dt +n)+ ... (1+k)1 (1+k)2 (1+k)3 (1+k)n Analysis Preview Equity Valuation Vt is the value of an equity security at time t Dt +n is the dividend in period t+n k is the cost of capital E() refers to expected dividends

29. Vt = E(FCFt +1) + E(FCFt +2) + E(FCFt +3) + ... + E(FCFt +n) + ... (1+k)1 (1+k)2 (1+k)3 (1+k)n Analysis Preview Equity Valuation - Free Cash Flow Model FCFt+n is the free cash flow in the period t + n [often defined as cash flow from operations less capital expenditures] k is the cost of capital E(•) refers to an expectation

30. Vt = BVt + E(RIt +1) + E(RIt +2) + E(RIt +3) + ... + E(RIt +n) + ... (1+k)1 (1+k)2 (1+k)3 (1+k)n Analysis Preview Equity Valuation - Residual Income Model Rit+n is the residual income in period t + n [defined as net income, NI, minus a charge on beginning book value, BV, or RIt = NIt - (k x BVt-1)] k is the cost of capital E(•) refers to an expectation

31. Analysis in an Efficient Market Three assumed forms of market efficiency Weak Form - prices reflect information in past prices Semi-strong Form - prices reflect all public information Strong Form - prices reflect all public and private information

32. Analysis in an Efficient Market Market Efficiency • assumes competent and informed analysis • distinguish aggregate from individual behavior • reflects information (both reliable and unreliable) • cross-country differences in rewards to analysis Financial statement analysis relevant to more than just market analysis, e.g., • credit and lending • auditing • valuation of nonpublicly traded firms • mergers and acquisitions • etc...

33. Course overview Corporate Reporting and Analysis Part II Accounting Analysis Part III Financial Analysis Part I Introduction and Overview Overview of Financial Statement Analysis Financial Reporting and Analysis Analyzing Financial Activities Analyzing Investing Activities Analyzing Investing Activities: Special topic Analyzing Operating Activities Cash Flow Analysis Return on Invested Capital & Profitability Analysis Prospective Analysis Credit Analysis Equity Analysis and Valuation

34. Conclusion Corporate Financial Reporting and analysis is important in many contexts. This importance has been achieved over many centuries as accounting and analysis of corporate Financial statements has assumed a critical role in the commercial world and the allocation of scarce resources in an optimal manner both by individuals, corporate organizations and even Governments

35. THE END • THANK YOU