FINANCIAL STATEMENT ANALYSIS
Basic Financial Statements
Balance Sheet: financial statement that provides a snapshot of a venture’s financial position as of a specific date
Income Statement: financial statement that reports the revenues generated & expenses incurred over an accounting period
Statement of Cash Flows: shows how cash, reflected in accrual accounting, flowed into & out of a firm during a specific period of operation
Operating Breakeven Analysis
Variable Expenses: costs or expenses that vary directly with revenues
Fixed Expenses: costs that are expected to remain constant over a range of revenues for a specific time period
EBITDA: earnings before interest, taxes, & depreciation & amortization
EBDAT: earnings before depreciation, amortization, & taxes
EBDAT Breakeven: amount of revenues (survival) needed to cover cash operating expenses
Cash Flow Breakeven: cash flow at zero for a specific period (EBDAT = 0)
Survival Breakeven Analysis
Basic Equation:
EBDAT = Revenues (R) - Variable Costs (VC) – Cash Fixed Costs (CFC)
Where: CFC includes both fixed operating (e.g., general & administrative, & possibly marketing expenses) & fixed financing (interest) costs
When EBDAT is Zero: R = VC + CFC
Breakeven Level of Survival Revenue
Starting Point:
Ratio of variable costs (VC) to revenues (R) is a constant (VC/R) & is called the Variable Cost Revenue Ratio (VCRR)
Survival Revenues (SR) = VC + CFC
Rewriting, CFC = SR – VC
By substitution, CFC = SR[1 – (VCRR)]
Solving for SR, SR = [CFC/(1 – VCRR)]
NOPAT Breakeven Analysis
Economic Value Added (EVA): measure of a firm’s economic profit over a specified time period
NOPAT: net operating profit after taxes or EBIT times one minus the firm’s tax rate
NOPAT Breakeven Revenues (NR): amount of revenues needed to cover a venture’s total operating costs
Basic Equation: NR = TOFC/(1 – VCRR)
Where: TOFC is the total operating fixed costs which consist of cash operating fixed costs (excluding interest expenses) plus noncash fixed costs (e.g., depreciation)
Breakeven Drivers
1. Contribution Profit Margin = 1 – VCRR
higher contribution profit margins mean lower levels of survival revenues are needed to break even (EBDAT = 0)
2. Amount of Cash Fixed Costs
lower cash fixed costs result in lower levels of survival revenues needed to breakeven (EBDAT = 0)
Financial Ratios and Analysis
Financial Ratios: show the relationship between two or more financial variables
Trend Analysis: used to examine a venture’s performance over time
Cross-sectional Analysis: used to compare a venture’s performance against another firm at the same point in time
Industry Comparable Analysis: used to compare a venture’s performance against the average performance in the same industry
Financial Forecasting Process
The Financial Forecasting Process contains the following steps:
Sales forecast
Identify spontaneous assets & liabilities
Project Balance Sheet
Reconcile Balance Sheet to Income Statement
Project Income Statement
Simulation
Decision made
That is we:
1. We forecast sales over the period. Note it is the sales forecast that drives the analysis. The better the forecast, the better your analysis.
2. We identify the spontaneous assets and liabilities. Spontaneous assets and liabilities increase as sales increase. In our first cut, we assume that they go up the same percentage as sales. Quasi-spontaneous assets go up with sales, but are “lumpy.” They do not go up as a percentage of sales, but as whole units (see below – you can not buy half a piece of equipment – you must buy a whole piece). Quasi-spontaneous equity is retained earnings. Retained earnings will probably go up with sales, but not as a percentage.
3. We project the Pro-Forma Balance Sheet by increasing spontaneous assets and liabilities by the