financial statements and cash flow

McGraw-Hill/Irwin Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved

CHAPTER

2 Financial Statements and

Cash Flow

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved

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Key Concepts and Skills• Understand the information provided by

financial statements• Differentiate between book and market

values• Know the difference between average and

marginal tax rates• Know the difference between accounting

income and cash flow• Calculate a firm’s cash flow


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Chapter Outline2.1 The Balance Sheet

2.2 The Income Statement

2.3 Taxes

2.4 Net Working Capital

2.5 Financial Cash Flow

2.6 The Accounting Statement of Cash Flows


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Balance Sheet Analysis

• When analyzing a balance sheet, the Finance Manager should be aware of three concerns:

1. Liquidity2. Debt versus equity3. Value versus cost


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Liquidity:Composition of assets plays role

• Refers to the ease and quickness with which assets can be converted to cash—without a significant loss in value

• Current assets are the most liquid.• Some fixed assets are intangible.• The more liquid a firm’s assets, the less likely

the firm is to experience problems meeting short-term obligations.

• Liquid assets frequently have lower rates of return than fixed assets.


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Debt versus Equity

• Creditors generally receive the first claim on the firm’s cash flow.

• Shareholder’s equity is the residual difference between assets and liabilities.


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Value versus Cost

• Under Generally Accepted Accounting Principles (GAAP), audited financial statements of firms carry assets at cost.

• Market value is the price at which the assets, liabilities, and equity could actually be bought or sold, which is a completely different concept from historical cost.


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2.2 The Income Statement

• Measures financial performance over a specific period of time

• The accounting definition of income is:Revenue – Expenses ≡ Income


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Income Statement Analysis• There are three things to keep in mind

when analyzing an income statement:1. Generally Accepted Accounting Principles

(GAAP)2. Non-Cash Items3. Time and Costs


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GAAP The matching principal of GAAP dictates

that revenues be matched with expenses. Thus, income is reported when it is

earned, even though no cash flow may have occurred.


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Non-Cash Items Depreciation is the most apparent. No

firm ever writes a check for “depreciation.” Another non-cash item is deferred taxes,

which does not represent a cash flow. Thus, net income is not cash.


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2.4 Net Working Capital

Net Working Capital ≡ Current Assets – Current Liabilities

NWC usually grows with the firm


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U.S.C.C. Balance Sheet

2007 2006 2007 2006Current assets: Current Liabilities: Cash and equivalents $140 $107 Accounts payable $213 $197 Accounts receivable 294 270 Notes payable 50 53 Inventories 269 280 Accrued expenses 223 205 Other 58 50 Total current liabilities $486 $455 Total current assets $761 $707

Long-term liabilities:Fixed assets: Deferred taxes $117 $104 Property, plant, and equipment $1,423 $1,274 Long-term debt 471 458 Less accumulated depreciation (550) (460 Total long-term liabilities $588 $562 Net property, plant, and equipment 873 814 Intangible assets and other 245 221 Stockholder's equity: Total fixed assets $1,118 $1,035 Preferred stock $39 $39

Common stock ($1 par value) 55 32 Capital surplus 347 327 Accumulated retained earnings 390 347 Less treasury stock (26) (20) Total equity $805 $725

Total assets $1,879 $1,742 Total liabilities and stockholder's equity $1,879 $1,742

Here we see NWC grow to $275 million in 2006 from $252 million in 2005. This increase of $23 million is an investment of the firm.

$23 million$275m = $761m- $486m

$252m = $707- $455


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CHAPTER

3Long-Term Financial Planning and Growth


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Chapter Outline

3.1 What is Financial Planning?

3.2 A Financial Planning Model: The Ingredients

3.3 The Percentage Sales Method

3.4 What Determines Growth?

3.5 Some Caveats of Financial Planning Models

3.6 Summary and Conclusions


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3.1 What is Corporate Financial Planning?

• Corporate financial planning formulates the method by which financial goals are to be achieved.

• Scenario Analysis– Each division might be asked to prepare three

different plans for the near term future with regard to the assumptions about the company’s products and the state of economy.

• A Worst Case• A Normal Case• A Best Case


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3.2 The Ingredients of Financial Planning Model:

1. Sales forecast: Depends on • a detailed and dynamic macroeconomic study of

uncertain future• investment opportunity

2. Pro forma statements: income statements, cash flow statements and balance sheet

3. Asset requirements: Prediction of both fixed and working capital requirements

4. Financial requirements including a focus of the dividend policy and debt policy of the firm

5. Plug: Suppose sales grows at one rate and assets grow at different rate then a third variable like dividend policy is plugged in to make them compatible.

6. Economic assumptions


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1. Sales Forecast• All financial plans require a sales forecast. • Perfect foreknowledge is impossible since sales

depend on the uncertain future state of the economy. Forecasts depend on the future of industry structure, strategy of competitors, technological progress, fiscal policies, consumer preferences etc. This makes sales forecast challenging.

• Businesses that specialize in projection of macroeconomics and industry can help in estimating sales.


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2. Pro Forma Statements

• The financial plan will have a forecasted balance sheet, a forecasted income statement, and a forecasted sources-and-uses-of-cash statement.

• These are called pro forma statements or pro formas.


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3. Asset Requirements

• The financial plan will describe projected capital spending.

• In addition it will discuss the proposed uses of net working capital.


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4. Financial Requirements

• The plan will include a section on financing arrangements.

• Dividend policy and capital structure policy should be addressed.

• If new funds are to be raised, the plan should consider what kinds of securities must be sold and what methods of issuance are most appropriate.


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5. Plug

• Compatibility across various growth targets will usually require adjustment in a third variable.

• Suppose a financial planner assumes that sales, costs, and net income will rise at g1. Further, suppose that the planner desires assets and liabilities to grow at a different rate, g2. These two rates may be incompatible unless a third variable is adjusted. For example, compatibility may only be reached if outstanding stock grows at a third rate, g3.


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Effects of Increased SalesIncome Statement Balance Sheet

Sales $1,000 Assets $500 Debt $250

Costs 800 Equity 250

Net Income $200 Total $500 Total $500

Pro forma Income Statement (g=20%)

Pro forma Balance Sheet (g=20%)

Sales $1,200 Assets $600 Debt $300

Costs 960 Equity 300

Net Income $240 Total $600 Total $600Plug Variable: Dividends distribution of $190 . Debt: Equity ratio unchangedWhat if no distribution of dividends? Equity increases to $490 ($250+$240), Debt =$110 ($600-$490). Plug variable is then Debt:Equity ratio.


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6. Economic Assumptions• The plan must explicitly state the

economic environment in which the firm expects to reside over the life of the plan.

• Interest rate forecasts are part of the plan.

• Fiscal Policy like import duty, vat, tax holiday forecast is another.


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Percent of Sales Approach

• Some items vary directly with sales, others do not.• Income Statement

– Costs may vary directly with sales - if this is the case, then the profit margin is constant

– Depreciation and interest expense may not vary directly with sales – if this is the case, then the profit margin is not constant

– Dividends are a management decision and generally do not vary directly with sales – this affects additions to retained earnings


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Percent of Sales Approach (Contd..)

• Balance Sheet– Initially assume all assets, including fixed, vary directly

with sales.– Accounts payable also normally vary directly with sales.– Notes payable, long-term debt, and equity generally do

not vary with sales because they depend on management decisions about capital structure.

– The change in the retained earnings portion of equity will come from the dividend decision.

• External Financing Needed (EFN)– The difference between the forecasted increase in assets

and the forecasted increase in liabilities and equity.


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The Steps in Estimation of Pro Forma Balance Sheet:

1. Express balance-sheet items that vary with sales as a percentage of sales.

2. Multiply the percentages determined in step 1 by projected sales to obtain the amount for the future period.

3. When no percentage applies, simply insert the previous balance-sheet figure into the future period.

4. Compute Projected retained earnings as:Present retained earnings + Projected net incomes- Cash Dividends = Projected retained earnings

5. Add the asset accounts to determine projected assets. Next, add the liabilities and equity accounts to determine the total financing; any difference is the shortfall. This equals the external funds needed.

6. Use the plug to fill External Fund Needed (EFN).


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A Brief Example

The Rosengarten Corporation is thinking of acquiring a new machine. The machine will increase sales from $20 million to $22 million—10% growth.

The firm believes that its assets and liabilities grow directly with its level of sales. Its profit margin on sales is 10%, and its dividend-payout ratio is 50%.

Will the firm be able to finance growth in sales with retained earnings and forecast increases in debt?


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Case 1: Rosengarten CorporationProforma Income Statement

Figures in thousands

Current Pro forma

Sales $ 20,000 $ 22,000

Cost 16,970 18,667

Taxable Income 3,030 3,333

Tax (34%) 1,030 1,133

Net Income 2,000 2,200

Dividend (50%) 1,000 1,100

Addition to retained earnings 1,000 1,100


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A Brief ExampleCurrent Balance Sheet Pro forma Balance Sheet (millions) Explanation

Current assets $6 $6.6 g=10%

Fixed assets $24 $26.4 g=10% Total assets $30 $33 g=10%

Short-term debt $10 $11 g=10%

Long-term debt $6 $6.6 g=10%

Common stock $4 $4 Constant

Retained Earnings $10 $11.1 Net Income

Total financing $30 $32.7

$300,000 Funds needed

(millions)


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The Percentage Sales Method: EFN

• The external funds needed for a 10% growth in sales:

)1(Sales) Projected(ΔSalesSalesDebtSales

SalesAssets dp

p = Net profit margin = 0.10

d = Dividend payout ratio = 0.5

Sales = Projected change in sales = $2 million

5.120$30$

SalesAssets

8.0

20$16$

SalesDebt


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The Percentage Sales Method: EFN

• The external funds needed


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Unilate CorporationBalance Sheets: Assets

CashA/RInventories

Total CAGross FALess: Dep.

Net FATotal Assets

2005$ 15.0 180.0270.0

$ 465.0

680.0

(300.0) 380.0

$845.0

2004$40.0160.0

200.0400.0

600.0

(250.0) 350.0$750.0


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Unilate CorporationBalance sheets: Liabilities and Equity

Accts payableNotes payableAccruals

Total Current LiabilitiesLong-term debtTotal LiabilitiesCommon stockRetained earnings

Total EquityTotal Liabilities & Equity

2005$30.0 40.0

60.0$130.0

300.0$430.0

130.0 285.0$415.0$845.0

200415.035.0

55.0 $105.0

255.0$360.0

130.0260.0

$390.0750.0


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Unilate Corporation Income statements

SalesCOGSOther expenses

EBITDADepr. & Amort.

EBITInterest Exp.EBTTaxes (40%)Net incomeCommon Dividends

2005$1500.0

(1,230.0) (90.0)

180.0 (50.0)$130.0

(40.0)$90.0

(36.0)$ 54.0(29.0)

2004$1435.0

(1,176.7)(85.5)173.3

(40.0)133.3

(35.0)$98.3

(39.3) $59.0(27.0)


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Balance Sheets 2005-2004Assets: Common size (Figures in million dollar)

2005 % 2004 %

Cash 15 1.8 40 5.3

A/R 180 21.3 160 21.3

Inventories 270 32.0 200 26.7

Total Current Assets 465 55.0 400 53.3

Gross Fixed Assets 680 80.5 600 80.0

Less Depreciation -300 -35.5 -250 -33.3

Net Fixed Assets 380 45.0 350 46.7

Total Assets 845 100 750 100


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Balance Sheets 2005-2004Liabilities & Equity: Common size

(Figures in million dollar)

2005 % 2004 %Accounts payable 30 3.6 15 2Notes payable 40 4.7 35 4.7Accruals 60 7.1 55 7.3Total current liabilities 130 15.4 105 14.0Long term debt 300 35.5 255 34.0

Total liabilities 430 50.9 360 48.0Common stock 130 15.4 130 17.3

Retained earnings 285 33.7 260 34.7Total equity 415 49.1 390 52Total liabilities & Equity 845 100 750 100


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Income Statement 2005-2004Figures in million and common size

2005 % 2004 %Sales 1500 100 1435 100Cost of Goods Sold -1230 -82.0 -1177 -82.0Other expenses -90 -6.0 -85 -5.9EBITD 180 12.0 173 12.1Depreciation -50 -3.3 -40 -2.8EBIT 130 8.7 133 9.3Interest -40 -2.7 -35 -2.4EBT 90 6.0 98 6.8Taxes (40%) -36 -2.4 -39 -2.7Net Income 54 3.6 59 4.1Common Dividends -29 -1.9 -27 -1.9


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Other data

Shares outstandingEPSDPSStock price

200525

$2.16$1.16

$24.50

200425

$2.36$1.08

$23.00


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Statement of Retained Earnings (2005)

Balance of retainedearnings, 12/31/04

Add: Net income, 2005

Less: Dividends paidBalance of retained

earnings, 12/31/05

$26054

(29)

$285


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Comment about the financial condition

• The net change in cash flow is negative. The cash position of the firm has deteriorated compared to the last year.

• Huge inventories are piled up. Abnormal increase in inventory in the current year [35%] does not match with sales promotion [4%].

• Accounts payable has increased as well. It seems that the firm procures inventories on credit and makes an unproductive stock.

• Although profit performances go down but the firm makes higher payments of dividends.

• The most important performance indicator is market price of share which has increased. This demonstrates that investors like the firm strategy to pile up inventories. In an inflationary economy that refers to hidden profit.


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Cash Flow statement: Approach 2EBIT 130Add depreciation 50Less tax 36Operating cash flow (Source of cash) 144Capital spending:

Ending net fixed investment 380 Less beginning fixed investment 350 Add depreciation 50Net fixed investment (Use of cash) 80Changes in net working capital:

Ending net working capital 335 Less beginning net working capital 295Changes in net working capital (Use of cash) 40


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Cash Flow statement: Approach 2Free Cash flow from assets Operating cash flow (Source of cash) 144 Net fixed investment (Use of cash) 80 Changes in net working capital (Use of cash) 40Free Cash Flow (Source) 24Cash flow from/to creditors Interest paid (Uses) 40 Less new long term borrowing (Source) 45Cash flow from creditors (Source) 5Cash flow from investors Dividend paid 29 New equity 0Cash flow to investors (Use of cash) 29


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Comments of cash flow statement

• Free cash flow is only 24 million which has gone down due to high investment in inventory

• Cash flow to investor is $29 million that is financed by operating cash flow of $24 million and $5 million from creditors. Seems like dividends paid from borrowing.

• Fixed investment has consumed huge cash


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Ratio AnalysisRatio Formula 2009 2008 Industry

Current Cur. Assets/Current. Liabilities 3.6 3.8 4.1

Quick (Cur. Assets-inventories)/ Current. Liabilities

1.5 1.9 2.1

InventoryTurnover

COGS/ Inventories 4.6x 5.9x 7.4x

DSO Receivables/Daily sales 43.2 40.7 32

Total Assets Turnover

Sales/Total Fixed Assets 1.8x 1.9x 2.0x

Debt Ratio Total Debt/Total Assets 50.9% 48% 45%

TIE EBIT/Interest charges 3.3 x 3.8x 6.5x

P:E Market Price per share/EPS 11.6 9.7 13.0

Comment: Apparently, all the ratios are worse than those of the industry as well as of the last year except the P:E ratio. P:E is not ignorable. Can profitability explain the reason?


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Profitability Analysis: DuPont Method

a. Profit Margin on Sales =Net income/salesx

b. Total Asset Turnover=Sales /Total Asset=

c. Return on Assets (ROA) = Net Income/Total Assetsx

d. Financial Leverage=Total Assets/Common Equity=

e. Return on Equity (ROE) =Net income (available to common stockholders)/Common Equity


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Profitability Ratios

2009 2008 Ind.

Profit Margin(54/1500)

3.6%(59/1435)

4.1%4.7%

Asset Turnover(1500/845)

1.77x(1435/750)

1.9x2

ROA(54/845)

6.4%(59/750)7.87%

9.5%

Financial Leverage

(845/415)2.04

(750/390)1.92

1.8

ROE(54/415)13.0%

(59/390)15.1%

17.2%


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DuPont analysis• A major set back is that ROA has gone down from 7.9% of the last year

to 6.4% of the current year, when industry average is as high as 9.5%. The inefficiency is attributed to the decline in both profit margin and asset turnover ratios.

• While enquiring into the reason behind the decline in profit margin we have seen the growth rate of the cost composition and sales (see following slides). It can be seen that abnormal increase took place in depreciation and interest charges. Increase in depreciation is related to increase in fixed assets. Is the firm holding too much fixed assets? Fixed asset turnover increases from 3.9 to 4.1. This is partially responsible. Increase in interest charges may be due to off-balance sheet financing or higher debt. The growth rate of debt is 16.5% (compared to the growth of interest of 14%) which rules out the role of off-balance sheet financing.

• Asset turnover rate declined because of poor growth in sales (4.5%) and higher growth in assets (12.7%). The asset composition shows that the proportion of current assets to total assets has increased from 53% to 55%. This merits attention to the composition of current assets. The growth of current assets is 16% which by itself is high. Growth of cash is negative 63% and that of accounts receivable is 13%. What is noticeable is the growth of inventories which is as remarkable as 35%. This must have contributed to the inefficiency of asset management.


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DuPont analysis (Contd.)• Increase in financial leverage suggests that growth of total

debt is higher than that of equity. Total debt grew by 19.4% and equity grew by 6.4%. Increased financial leverage is also reflected in higher interest payments (from $35m to $40m). This should have contributed to a promotion of return on equity. However, the firm could not take advantage of non-taxable interest charges as because EBIT could not be promoted. In fact, EBIT has rather gone down from $133m to $130 million. As a result, although tax payment has gone down from $39.3m to $36m but return on equity has also gone down.

• An enquiry into the debt composition shows that the proportion of long term debt into total debt was consistent around 70%. The growth rate short term liability (23%) is higher than that of long term liability (17.6%). Highest growth rate was that of accounts payable which doubled from that of the previous year. It has been noticed earlier that inventory grew by 35%. Now, we see that accounts payable has been doubled. This indicates that the firm is making use of facility of credit purchase and piling up inventory.


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Enquiry into the growth of sales and cost composition

2009 2008 Growth

Sales 1500 1435 0.045

COGS 1230 1176 0.046

Selling & Admin Cost 90 85.5 0.053

Depreciation 50 40 0.250

interest expenses 40 35 0.143

Taxes 36 39.3 -0.084


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Enquiry into the growth of current assets composition

2009 2008 growth

Cash $15.00 $40.00 ($0.63)

A/R 180 160 $0.13

Inventories 270 200 $0.35

Total CA $465.00 400 $0.16


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Enquiry into the growth of debt composition

2009 2008 Growth

Accts payable $30 15 1

Accruals 60 55 0.09

Total Current Liabilities $130 $105 0.24

Long-term debt 300 255 0.176

Total Liabilities $430 $360 0.19


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Enquiry into the growth and composition of debt

2009 2008Proportion

2009Proportion

2008 Growth

Accts payable $30 15 0.07 0.04 1

Notes payable 40 35 0.09 0.1 0.14

Accruals 60 55 0.14 0.15 0.09

Total Current Liabilities $130 $105 0.30 0.29 0.24

Long-term debt 300 255 0.70 0.71 0.176

Total Liabilities $430 $360 1.00 1.00 0.19


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The Sustainable Growth Rate in Sales

)1()1((

)1()1(

EDdpT

EDdp

gs

065.0)

2851303001301(*)

54291(*

150054

1500845

)2851303001301(*)

54291(*

150054

sg

T =Ratio of total assets to salesp =Net profit margin on salesd =dividend payout ratioD/E=Debt Equity Ratio


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Implication of sustainable growth rate and valuation

Projected growth of sales Current

Year 2010gs=6.5%

2011 gs

2012gs

2010optimist

g=20%

2010Pessimist

g=-20%

Sales 1500 1597 1700 1808 1800 1200

Net Income 54.0 57 61 65 65 43

Dividend (Current 29/54) 29 30 33 34 35 23

Addition to retained earnings 25 26 28 30 30 20

Total assets 845 900 958 1019 1014 676

Total Debt 430 458 487 518 516 344

Common stock 130 130 130 130 130 130

Retained earnings 285 312 340 370 315 305

Total Financing 845 900 957 1019 961 779

Funds needed 0 0 0 0 53 -103

Debt:Equity ratio 1.04 1.04 1.04 1.04 1.28 0.55Sustainable Growth Rate 0.0648 0.0648 .0648 .0648 .072 .048

EPS (net Income/25) $2.16 $2.28 $2.44 $2.6 $2.59 $1.73

Price (P:E=25/2.16=11.6) $25 $26.45 $28.3 $30.16 $30.07 $20.04


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Comments on valuation projection

• Despite the odds of cash flow findings the sustainable growth rate of the firm is as sizeable as 6.5%. The other growth rate is g=ROE*Retention rate=.13*.46=.06, which is also satisfactory. Given the sustainable growth rate of sales the firm will not need external financing for next few years and debt: equity ratio would remain constant. The stock price has been forecasted on the basis of P:E ratio of the current year. The firm looks indeed prospective.


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Contextual Forecasting: Since the firm piled up inventories and fixed assets, we suppose, the firm is already prepared to finance higher sales

in the next year. So, we keep these away from growth. Assume: gs=6.5%. Does this explain increase in share price?

Sales 1597

COGS (only 50% of direct cost follows growth) 1462

Taxable income 135

Net Income 81

Dividends 43

Addition to Retained earnings 38

Current assets 495

Fixed assets (Only half of Fixed assets has increased) 392

Total assets 888

Total debt 458

Equity (Common stock +Retained Earnings) 323

Total financing 910

Funds needed (This is negative debt or lending) -23

Debt:Equity 0.96

Growth 0.092


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Increasing the Sustainable Growth Rate

• A firm can do several things to increase its sustainable growth rate:– Sell new shares of stock– Increase its reliance on debt– Reduce its dividend-payout ratio– Increase profit margins– Decrease its asset-requirement ratio


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Prediction of Distress • Models for distress prediction

– Several models to predict distress have been developed over the years. One of the more popular and robust models is the Altman’s Z-score model:

• Bankruptcy prediction when Z is less than 1.2,• Z within the range between 1.2 and 2.9 is gray area.• Z above 3 is safe.


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Calculation of Z score2009 2008

X1 Net working capital/ Total assets

(465-130)/845

=.75 400-105)/750

=0.39

X2 Cumulative retained earnings/Total assets

285/845 =.337 260/750 =0.3367

X3 EBIT/Total Assets 130/845 =.154 133/750 =.177

X4 Market value of equity/ Total liabilities

(25*25)/(845-415)

=1.45 (25*23)/(750-390

=1.6

X5 Sales/Total Assets 1500/845 =1.78 1435/750 =1.91

Z2009=(1.2*0.75)+(1.4*0.337)+(3.3*0.154)+(0.6*1.45)+1.78=4.53

Z2008=(1.2*0.39)+(1.4*0.3367)+(3.3*0.177)+(0.6*1.6)+(1*1.91)=4.39

Comment: The firm is safe. The score increased in 2009 against 2008. This contradicts the ratio and cash flow findings as well.


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Z-score in optimistic/pessimistic case

Next Year: 2010 (optimistic) Next Year: 2010 (pessimistic)

X1 {(465-130)*(1.2)}/1014 0.39645 {(465-130)*(.8)}/676 0.39645

X2 315/1014 0.310651 305/676 0.451183

X3 130*1.2/1014 0.153846 130*.8/676 0.153846

X4 30/((516+53)/25) 1.318102 20/((344-103)/25) 2.074689

X5 1800/1014 1.775148 1200/676 1.775148

Z score 3.98 4.64

Comment: The Optimistic case does not necessarily mean higher Z score. We see Z score in fact is higher in pessimistic case because the firm could adjust all the variables very well with lower sales. This might have contributed to higher share price.


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Case of Midterm 1• Following is the information of income statements, balance sheets, and

different ratios of Tiny Crafts involved in the production of low-cost solar system for the years of 2008 and 2009.

– Make a performance analysis of the firm by the help of cash flow and ratio analysis with particular emphasis on DuPont method. What is the sustainable growth rate and consequential EFN, Debt: Equity ratio and forecasted stock price for next couple of years? What would happen if sales grow at 30% rate in the next year in an optimistic case and decline 20% in the pessimistic case? Compare this with the situation of current sustainable growth.

– In the new budget the government has withdrawn considerable extent of tariffs that would result in the change of current unit price of the commodity from Tk.20,000 to Tk.15,000 in the next year. Of course, sales volume would increase from the current level of 154 to 175 in the next year. COGS is in general consistent with sales but due to excess procurement of inventory in the current year (in anticipation of increased price) around half of COGS is insensitive. Also consider that short term interest rate would increase by 10% as the government is contemplating to introduce the 10% vat on that. Besides, capacity utilization of fixed assets is 70% at present suggesting that no new assets would be needed for the next year. (3 marks)


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Balance Sheet: Assets Figures in thousands

Assets 2009 2008Cash Tk.80 Tk.70Accounts receivable Tk.110 Tk.100Inventory Tk.450 Tk.300Total current assets Tk.640 Tk.470Gross plant and equipment Tk.620 Tk.450Accumulated depreciation Tk.120 Tk.80Net Plant & Equipment Tk.500 Tk.370Total assets Tk.1140 Tk.840


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Balance Sheet : LiabilityLiabilities 2009 2008Accounts payable Tk.140 Tk.70Accruals Tk.61 Tk.55Notes payable Tk.150 Tk.60Total current liability Tk.351 Tk.185Long term bond Tk.74 Tk.60Total liabilities Tk.425 Tk.245Common stock (5,000

shares of Tk.100 each) Tk.500 Tk.500Retained earnings Tk.215 Tk.95Owners' equity Tk.715 Tk.595Total liability & equity Tk.1140 Tk.840


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Income Statements Figures in thousands

SalesCOGS

Tk.3080 Tk.2800

Tk.2360 Tk.2220Gross Profit Tk.720 Tk.580Fixed operating exp. Tk.225 Tk.175Depreciation Tk.40 Tk.30EBIT Tk.455 Tk.375Interest Tk.55 Tk.30EBT Tk.400 Tk.345Tax (40%) Tk.160 Tk.138Net income for common

stockholders Tk.240 Tk.207Common dividends Tk.120 Tk.112Share price (Absolute amount) Tk.167 Tk.180


McGraw-Hill/Irwin

Cash flow statement AmountOperating Activity: Net income 240Add depreciation 40Less increase in current assets: Receivables -10Inventory -1501

decrease in current liabilities: Accounts payable 702

Accruals 6Net cash from operation 1963

Financing activity: Notes payable 904

Bond 14Dividends -1205

Total from financing -16Investment activity: Increase in net fixed assets -1706

net change in cash 10opening balance 70Closing 80


McGraw-Hill/Irwin

Cash Flow Analysis• 1. Inventory was piled up in anticipation of price increases of

raw materials and finished products. But as it turned up, price went down due to withdrawal of tariffs. This represents hidden loss as price gone down

• 2. Credit purchase might be a motivation to pile up inventory.• 3. Operating cash flow is less than net income• 4. Abnormal increase in short term bank loan rather than

long term debt is risky as that holds variable interest. In fact, the same happened as the govt. increased interest rate.

• 5. Loan taken to pay dividends• 6. Abnormal increase in fixed assets consumed cash.


McGraw-Hill/Irwin

Pro forma Income Statements

current Y1 Y2Y1Optimistic

Y1Pessimist

Y1(context)

Growth of sales 20% 20% 30% -20% -14.77%1

Sales 3,080 3,701 4,448 4,004 2,464 2,625Cost 2,680 3,221 3,870 3,484 2,144 2,4782

Taxable Income 400 481 578 520 320 147Tax (40%) 160 192 231 208 128 59Net Income 240 288 347 312 192 88Dividend (50%) 120 144 173 156 96 44Addition toRetained earng. 120 144 173 156 96 44


McGraw-Hill/Irwin

Pro forma Balance sheet & Forecasting Current Y1 Y2

Y1Optimistic

Y1 Pessimistic Y1 (context)

Current assets 640 769 924 832 512 545

Fixed assets 500 601 722 650 400 460

Total assets 1,140 1370 1646 1482 912 1005

Total Debt 425 511 614 553 340 362

Common stock 500 500 500 500 500 500

Addition to Ret earng. 215 359 532 371.0 311.0 259

Total Financing 1,140 1,370 1,646 1,424 1,151 1,121Increase in assets 230 276 342 -228

Funds needed 0.0 0.0 58.5 -239 -116Debt: Equity ratio 0.59 0.59 0.59 0.70 0.12 0.32

growth 0.202 0.20 0.20 0.22 0.13 0.06EPS 48.0 57.7 69.3 62.4 38.4 17.6

P:E 3.5 3.5 3.5 3.5 3.5 3.5

Price 167 201 241 217 134 62


McGraw-Hill/Irwin

Notes of contextual forecast• 1: Expected sales of next year=15*175=Tk.2,625, Current

sales=20*154=Tk.3,080. The rate of change is negative 14.77%.

• 2. Calculation of the cost of Tk.2,478: COGS=(2,360/2)+((2,360/2)*(1-.14.8))=2,186 Fixed operating expenses=225*(1-.148)=192 Depreciation unchanged as no new fixed investment

=40 Interest increases by 10%=(55*1.1)=60


McGraw-Hill/Irwin

3.5 Some Caveats of Financial Planning Models

• Financial planning models do not indicate which financial polices are the best.

• They are often simplifications of reality—and the world can change in unexpected ways.

• Without some sort of plan, the firm may find itself adrift in a sea of change without a rudder for guidance.

financial statements and cash flow

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