CH.
1: FRAMEWORK
BALANCE SHEET EQUATION
A = L + SE
INCOME STATEMENT EQUATION
REV EXPENSES = NET INCOME
SE STATEMENT
END RE = BEG RE + NET INC DIV
CF STATEMENT
Examples: NOT operating items: financial items (interest exp, interest income, dividend
income, investment gains/losses, income from minority investments, income from disc.
operations
Form: NOPAT = Operating profit x (1- tax rate) *USE EBIT AS PROXY
Form (book): NOPAT= NOPBT[Tax exp + (Pretax net nonop exp x stat. tax rate)
NOA (Net Operating Assets)
Def: Assets used in operating activities
Examples: (A) Receivs, inventories, prepaid exp, PPE (L) accts payable, income tax, pensions
NOT examples: (A) ST/LT invest in market securities, fin. invest (L) bonds pay, bank loans
OCF+ICF+FCF=NET INC. IN CASH
Form: Operating Assets Operating Liabilities
Form: NOA = NNO + SE
FCF = Cash flow from Op Capex
Cash Asset + Noncash Assets = L + Cont. Cap + Earned Cap (R-Exp=Net
Inc)
CH. 3: PROFITABILITY ANALYSIS
ROE
Def: Measures return earned by SH
Net income for common
=
Av . SE
Net incomePref . Stock Dividends
Av . SE
NNO (Net Nonoperating Obligations)
Form: Nonoperating Liabilities Nonoperating Assets
NNE (Net Nonoperating Expenses, Interest Cost)
Def: Diff bw net income and NOPAT; counterpart to ATI
Form: NNE = Net income - NOPAT
RNOA =
Form: ROE =
ROA (Return on Assets)
NNEP (Net Nonoperating Expense cost, Financing Cost)
Def: Measurement of firms cost of debt
NNE
Av . NNO
Form: NNEP =
Def: Performance eval for c (not just EH)
ROA = NOPAT / Av. NOA
DUPONT ANALYSIS (Percentages)
Form: ROA =
Net income+ Interest exp(1Tax Rate )
Av .Total Assets
PRE-TAX ROA
ROA = NOPM x NOAT (Profitability and productivity)
ROA = NOPAT / Av. NOA
Net income+ ATI
NOPAT
=
Sales
Sales
Sales
Revenues
=
Av .Total A
Av . NOA
NOPM =
Form: ROA =
EBIT (Earningsbefore interesttax)
Av . Total Assets
AFTER-TAX ROA
Form: ROA = Pretax ROA x (1-tax rate)
Form: ROA =
( Net income+ NNE)
Av . NOA
EBIT (1Tax rate)
Av .Total Asset s
ATI (After Tax Interest)
Def: Net int. cost after taking into acct income tax ben from deduct int. expense
Form: Interest Expense x (1-Tax rate)
ATIP (Av. Financing Cost, Cost of Debt)
Def: Av. financing cost of company
ATI
Form: ATIP =
=
Average L
Interest exp (1tax rate)
Av . Liabilities
NOAT =
LEVERAGE (Decimals)
FL (Financial Leverage)
Form: FL =
Av .Total A
Av .Total SE
Debt-Equity Ratio
Form:
L
SE
Debt-Total Asset Ratio
Form:
L
A
Cap Structure Leverage
Form:
Total A
SE
RNOA (Return on Net Operating Assets) Percentage
Def: Matching op. income with op. assets (corollary to ROA)
NOPAT
=
Av . NOA
Operating profit ( 1tax rate )
Net Operating ANet Operating L
Form: RNOA =
*USE EBIT AS PROXY FOR OP PROFIT BT
Form: RNOA =
( Net income+ NNE)
Av . NOA
NOPAT (Net Operating Profit After Tax)
Def: Rather than just net income, what net profit would be taking out nonop exp.
RETURN SPREAD
Def: Earnings positive economic profit (EP)
Form: ROA WACC (Weighted av. cost of capital)
Form: EP = Av. Total A x (ROA WACC)
FINANCING SPREAD
Def: Difference between what firm earns on investments and the cost of financing
Form: ATIP (After-tax cost of financing) = ATI / Avg. L
Form: Financing Spread: ROA ATIP
After-tax cost of financing: NNEP = NNE / Av. NNO
Financing Spread = RNOA - NNEP
When ROAT ATIP is positive, ROA greater than ROA and using debt well
TOTAL ACCRUALS (Total Operating accruals)
CH. 4: CREDIT RISK ANALYSIS
Accruals from operating A and L
Examples: Inventory, accts receivable, accts payable, income tax payable, deferred income tax, pension liability
Accruals from investment A
PROFITABILITY RATIOS
Examples: Depreciation, write-off, restructuring charges, gains and losses on asset sale, other changes in
investment
RNOA = NOPM X NOAT = NOPAT / AV. NOA
Form: Total Accruals = Net Income Cash Flow from Operations
COVERAGE RATIOS
TIMES INTEREST EARNED (Interest Cov. Ratio)
M-SCORE MANIPULATION VARIABLES
Earnings before income tax ( EBIT )
Interest Expense
Days Sales in Receivables (DSRI)
Receivables/Sales
Gross Margin Index (GMI)
Gross profit/Sales
Asset Quality Index (AQI)
1-((Current A +PPE)/(Total A)
EBITDA COVERAGE RATIO
Sales Growth Index (SGI)
Sales
Def: Exclusion of dep and amort since not cash
Depreciation Index (DEPI)
Depreciation/(Depreciation+PPE)
SG&A Expenses Index
SG&A Expense/Sales
Leverage Index
(LT Debt+Current L)/Total A
Total Accruals to Total Assets
Current operating accruals/Total A
Form: TIE =
Form: EBITDA Cov =
EBIT + Interest Expense + Dep+ Amort
Interest Expense
FCF to TOTAL DEBT (Free Operating Cash Flow to Total Debt)
Def: Measurements using free cashexcess after capex spending
Form:
Cash
OperationsCapex
Debt +ST Debt
LIQUIDITY RATIOS
Moodys Credit Analysis
EBITA/Av. Assets
EBITA/Interest Expense
EBITA Margin
EBITA/Net Revenue
Operating Margin
Operating Profit/Net Revenue
(FFO+Interest Exp)/Interest Exp (Funds from Ops + Interest Expense) / Interest Expense
CURRENT RATIO
Def: Comparing cash inflow to outflow in short term
Form: CURRENT RATIO =
Current Assets
Current Liabilities
FFO/Debt
Funds from Ops/(ST debt + LT debt)
RCF/Debt
(FFO-PrefDiv-Common Div-Minority Div)/(ST and LT debt)
Debt/EBITDA
Debt/Book Capitalization
Interest + Book Equity)
(ST and LT debt)/(ST and LT debt + Deferred taxes +Minority
QUICK RATIO
CAPEX/Depreciation Exp Capital expenditures/depreciation expense
Def: Focus on quick assets, excluding inventory and prepaid A, ability to meet
current Ls without liquidating
FFO = Net income from continuing operations plus dep, amort, deferred income taxes, other
noncash items
Form: QUICK RATIO =
Cash+ Market Sec+ Acct Receiv
Current Liabilities
Operating Activities
Net Income
Adjustments to reconcile net income to operating cash flow
SOLVENCY RATIOS
LIABILITIES TO EQUITY RATIO
Def: How reliant a c is on creditor financing (v. equity)
Form: L-E RATIO =
CASH FLOW STATEMENT
Total Liabilities
SE
Depreciation
Accts receivable
Prepaid expense
Accts payable
Wages payable
X
X (Added adjustments)
TOTAL DEBT TO EQUITY RATIO
Net cash provided from op activities
Def: Distinguishing operating creditors and debt obligations
Form:
Cash used in Investing Activities
Total Liabilities
SE
Cash from financing activities __
Net change in cash
ALTMAN Z SCORE (5 Variables) 1.8 < x < 3.0
Form: [1.2 x Work cap/total A] + [1.4 x RE/Total A] +[3.3 x EBIT/Total A]
+ [0.6 x Market Val. Equity/BV of Total L] + [0.99 x Sales/Total A]
PIOTROSKI F SCORE (9 Variables) 0-2 < x < 7-9
Net income is positive
Profitable
Operating cash flow is positive
Generates cash
Operating cash flow > net income
Earnings quality good
Return on assets increased
Improving business (Net inc b4 ext.items/begyr t.a. x100%)
Gross margin improved
Improving profitability
(gross profit/sales)x100%
Asset turnover improved
Improving efficiency
(Total sales/beg yr total A)
LT Debt/Total assets decreased
Declining risk (LT debt + Current portion LT debt)/Av. total A)
Current ratio improved
Improving liquidity
No new equity issuance
No equity dilution risk
CH. 5: ACCRUALS AND EARNINGS QUALITY
Cash, beginning year
__
Cash, ending year
INCOME STATEMENT
Revenue
Cost of Revenue
Gross Margin
Operating expenses
SG&A
R&D expense
Total op exp
Interest exp
Income bef. Inc. tax
Income tax exp
Net income
Cash Flows from Operations under Indirect Method
Def: Remove accruals from net income
To Use: Add back expenses and losses that did not use cash, and deduct rev and gains that
did not produce cash
Adjustments to current A and current L in operating:
Accts receivable, inventory, accts payable
o
Add decreases in CA and increases in CL, subtract increases in CA and
decreases in CL
Adjustments related to no-current A and non-current L in operating:
o
Depreciation, gains and losses from sale of assets, changes in deferred tax A&L,
pension L
Prepaid expenses
Cash Flows from Ops Using Direct Method
Cash collected from customers
o
Sales Increase in accts receivable
Cash paid to suppliers and employees
o
COGS (excluding deprec) + Inc. in inventory Increase in accts payable
Increase in wages pay
Interest paid
o
Interest exp Increase in interest payable dec. in bond discount (or + decrease
in bond premium)
Other operating cash paid
o
SG&A exp + Increas in prepaid exp increase in accrued L
Income taxes paid
o
Tax exp=increase in tax payable-increase in deferred tax L (or increase in def. tax
asset)
Equity method investments
Red Flags Analysis
1.
Operations risk
2.
Governance and management control risks
3.
Aggressive accounting and misstatement risks
Examples:
Cash flow from op less than net income
CFO down for year compared to last year but net income up
Large unexplained changes in inventory, receivables, etc.
Large one-time items such as impairment charges, g/l from asset sales
Cash flow from op negative for several quarters but positive for the full year
Capex is greater than cash flow from ops (i.e., FCF is negative)
Dividends and stock repurchases exceed free cash flow
Large non-cash acquisitions
Current liabilities of discontinued operations
OPERATING/NONOPERATING ITEMS IN BALANCE SHEET
Current Assets
Cash and cash equivalents
ST investments
Accts receivable
Inventories
Deferred income tax assets
Other current assets
Current Assets of discontinued operations
LT Assets
LT investments in securities
PPE, net
Caplease
Natural resources
Goodwill and intangible assets
Deferred income tax assets
Other longterm assets
LT assets of discontinued operations
Current Liabilities
ST notes and interest payable
Current maturities of LT debt
Accts payable
Accrued L
Unearned revenue
Deferred income tax liabilities
LT Liabilities
Bonds and notes payable
Cap lease obligations
Pension and other post-employment liabilities
Deferred income tax liabilities
LT liabilities of discontinued operations
SE
All equity accounts
Noncontrolling (minority) interest
FINANCING SPREAD EXAMPLE
Firm has 1000 of equity, and borrows 600 at 10% interest rate (7% after-tax interest rate). It
uses the funds to acquire A yielding 15% pre-tax ROA (10.5% after-tax ROA). (Income tax rate
= 30%).
Av. total A = 1000 equity + 600 liabilities = 1600
Net income = 0.7 (1600x0.15-600x0.10)=126
AT profits from A financed with equity = 1000 x 10.5% = 105
AT Profits from A financed with debt = 600 x (10.5-7%0 = 21
ROA numerator = Net income + aftertax itnerst = 126 + 42 = 168
ROA = 168 / 1600 = 10.5% ROE = 126 / 1000 = 12.6%
ROE > ROA, benefiting from positive financing spread of 3.5%
Note: Using formula ROE = ROA + (Financing spread x L/SE),
ROE = 10.5% + [(10.5-7%)x600/1000]=12.6%
Glamour stocks are defined as stocks with high price to book (P/B) values and Value stocks
as having low price to book ratios.
