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ASB 3208: Financial Statement Analysis 2011/12 Semester 2

Lecture 2: Analysing profitability

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Session contents

The cash flows of a business Reformulating the financial statements Analysing profitability

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Business Activities: All Cash Flows

The firm Capital markets

Net Operating Assets (NOA)

Net Financial Assets (NFA)

Operating Activities

Financing Activities

Sh ar eh ol de rs

D eb or tho is de lde s u b rs er t s

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The Cash Conservation Equation

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A fundamental accounting identity: C = Net cash from operations I = Net cash outflow for investing C - I = Free cash flow d = Net dividends (common dividends + share repurchases share issues) F = Net cash outflow to debtholders and debt issuers = Net borrowing principal payments + net

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The treasurers rule

If own debt If lending

: :

lend or buy down borrow or reduce

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Reformulating the financial statements

Statement of Cash Flows Statement of Financial Position Statement of Comprehensive Income

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Statement of Cash Flows: Typical Layout Cash flows from operating activities Cash generated from operations Interest paid Corporation tax paid Net cash from operating activities Cash flows from investing activities (x) (x) x x

Purchase of property, plant and equipment and other assets Purchase of intangible assets (x)

(x)

Proceeds from disposal of property, plant and equipment and other assets x Investment in financial assets Interest/Dividends received Net cash from investing activities Cash flows from financing activities Proceeds from issuance of ordinary shares x x x (x)

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Morrisons: Consolidated cash flow statement 52 weeks ended 31 January 2010 2010 2009 m m Cash flows from operating activities Cash generated from operations 1,004 964 Interest paid (60) (70) Taxation paid (209) (104) Net cash inflow from operating activities 735 790 Cash flows from investing activities Interest received 8 29 Proceeds from sale of property, plant and equipment 7 22 Purchase of property, plant and equipment and investment property (906) (678) Net cash outflow from investing activities (891) (627) Cash flows from financing activities Proceeds from issue of ordinary shares 34 3 Shares repurchased for cancellation (146) Finance lease principal payments (2) New borrowings 200 250 Repayment of borrowings (1) (2) Decrease in long term cash on deposit 74 Dividends paid to equity shareholders (159) (131) Net cash inflow from financing activities 74 46 Net (decrease)/increase in cash and cash equivalents (82) 209 Cash and cash equivalents at start of period 327 118

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Reformulated Statement of Cash Flows

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Morrisons: Reformulated consolidated cash flow statement - 52 weeks ended 31 January 2010 2010 Cash flows from operations m Cash generated from operations 1,004 Taxation paid (209) Net (decrease)/increase in cash and cash equivalents 82 Net cash flow from operations 877 Cash investment in operations Proceeds from sale of property, plant and equipment 7 Purchase of property, plant and equipment and investment property (906) Net cash investment in operations (899) Free Cash Flow (22) Equity financing flows Dividends paid to equity shareholders Proceeds from issue of ordinary shares Net equity financing cash flow Debt financing flows New borrowings Interest received Interest paid Repayment of borrowings Net debt financing cash flow Total financing flows 159 (34) 125 (200) (8) 60 1 (147) (22)

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Applying the Treasurers Rule

2010 m Net cash flow from operations Net cash investment in operations Free Cash Flow Net interest cash flow Interest received Interest paid (60) 8 (52) (74) (22) 877 (899) m

Cash available for shareholders Net dividend Dividends paid to equity shareholders Proceeds from issue of ordinary shares Sale of financial assets (159) 34

(125) (199)

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Statement of Financial Position: typical layout

Non-current assets: Current assets: Current liabilities: Non-current liabilities: Net Assets Equity Capital and reserves X X X (X) (X) X

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Morrisons: Consolidated balance sheet - 31 January 2010 2010 m Non-current assets Property, plant and equipment Lease prepayments Investment property Other financial assets Current assets Stocks Debtors Other financial assets Cash and cash equivalents Current liabilities Creditors (1,845) (1,915) 577 201 71 245 1,094 494 245 327 1,066 7,180 257 229 7,666 6,587 250 242 81 7,160 m m m 2009

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Morrisons: Consolidated balance sheet - 31 January 2010 2010 m Net assets 4,949 m 4,520 2009

Shareholders equity Called-up share capital Share premium Capital redemption reserve Merger reserve 2,578 92 6 2,578 2,008 1,613 4,949 4,520 265 60 6 263

Retained earnings and hedging reserve

Total equity attributable to the owners of the Company

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The Reformulated Balance Sheet

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Balance Sheet Restated

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Reformulated Balance Sheet: Morrisons 2010

Assets Financial assets

m 8,432 328 (257 + 71) m

Operating assets 8,760

Liabilities and Equity

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Balance Sheet Restated: Morrisons 2010

Operating assets Operating assets Operating liabilities Net operating assets

m 8,432 (2,571) 5,861

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Financial obligations & owners

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Income Statement: Typical layout

Turnover Cost of sales Gross profit Expenses Operating profit Interest income (x) x x x (x) x

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Morrisons - Consolidated statement of comprehensive income 52 weeks ended 31 January 2010 2010 m Turnover Cost of sales (13,615) 2009 m 14,528 (14,348)

15,410

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Reformulated Income Statement

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Reformulated Income Statement: Morrisons 2010 m m Operating income Operating revenue Operating expense 15,479 (14,572)

Operating income before tax 907 Tax on operating income (Av rate =
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Business Activities and the Financial Statements

Income Statement
NIt = OIt - NFEt

Balance Sheet Net Operating Assets

NOAt = NOAt-1 + OIt (Ct - It)

Net Financial Obligations

NFOt = NFOt-1 + NFEt - (Ct - It) + dt

CSEt = CSE t-1 + OIt NFEt - dt

Cash Flow Statement

(Ct It) = dt + Ft

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Analyzing Financial Statements

Ratio analysis The process of examining various financial statement items with the objective of assessing the success of past and current performance and, perhaps more importantly, of projecting future performance and financial condition. Analysis Approach: Inter-firm comparison cross-sectional analysis Intra-firm Comparison - Trend and time-series analysis Industry Averages

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The Analysis of Profitability

The objective of profitability relates to a companys ability to earn a satisfactory profit so that the investors and shareholders will continue to provide capital to it. Measure the return to common shareholders Assess a firms operating performance

ROCE
ROCE = equity ROCE = Comprehensive earnings Average common shareholders (CSE) OI NFE NOA NFO

Reminder key:- OI = Operating income NOA = Net operating assets NFE = Net financial expense 4/2/12 NFO = Net financial obligations

Stocks & Flows Ratios: Business Profitability

Separating operating and financing activities in the income statement identifies profit flows of these flows with their balance sheet base yields the corresponding rates of return: Return on Net Operating Assets Return on Net Financial Assets
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Comparison

Analyzing ROCE: The Scheme

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First-Level Breakdown: Analysis of Effects of Financial Leverage (FLEV)

So, ROCE is a weighted return to operating activities and financing activities: or,
Spread

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Second-Level Breakdown of ROCE: Drivers of Operating Profitability

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Operating profit margin: Asset turnover: The ability to generate sales for a given asset base

1.

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Third-Level Breakdown of ROCE: Profit Margin Drivers

PM = Sales PM + Other operating income PM
by product or line of business

GM = Sales Cost of Sales

benefit or expense ??

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Third-Level Breakdown of ROCE: Asset Turnover Drivers

Some times other measures are used: Days in Acc. Receivable = Acc. Receivable/ Avg. Sales per day Inventory Turnover = Cost of Sales / Avg. Inventories
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Solutions

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