Financial Analysis & Balanced Scorecard PDF

Assessing the Internal Environment of the Firm Copyright Anatoli Styf/Shutterstock Learning Objectives 3-1 How value-chain analysis can help managers create value by investigating relationships among activities within the firm and between the firm and its customers and...

Assessing the Internal Environment of the Firm Copyright Anatoli Styf/Shutterstock Learning Objectives 3-1 How value-chain analysis can help managers create value by investigating relationships among activities within the firm and between the firm and its customers and suppliers. 3-2 The primary and support activities of a firm’s value chain. 3-3 The resource-based view of the firm and the different types of tangible and intangible resources, as well as organizational capabilities. 3-4 The four criteria that a firm’s resources must possess to maintain a sustainable advantage and how value created can be appropriated by employees and managers. 3-5 The usefulness of financial ratio analysis, its inherent limitations, and how to make meaningful comparisons of performance across firms. 3-6 The value of the “balanced scorecard” in recognizing how the interests of a variety of stakeholders can be interrelated.  Evaluating Firm Performance Financial Analysis Balanced Scorecard Balance sheet Analysis Income statement Employees Cash Flow Statement Owners Customer satisfaction Financial Ratio Analysis Internal processes Historical comparison Innovation, learning & Comparison with improvement activities industry norms Financial perspectives Comparison with key competitors (strategic group) Market valuation Strategy and Financial Analysis Strategic Management process includes Evaluation and Control Comparison between desired and actual performance Financial analysis helps to… Assess firm performance Do comparisons overtime; with the industry; and with direct competitors (the strategic group) Determine if the firm's strategy is working. Are the profitability goals realistic? Identify problems Evaluate financial trends Prepare financial forecasts and updated goals 4 Financial Ratio Analysis Financial analysis is fundamental for company analysis Financial analysis expertise can be developed with application. Provide basic structure for financial analysis qWhat to look for in the financial statements qHow to do basic ratio analysis qWhat financial forecasting entails qHow to interpret financial statements data strategically 5 Evaluating the Balance Sheet Assets = Liabilities + Equity l Any increase in assets has to be associated with an equal increase in liabilities or equity Skim the Balance Sheet report l Is the firm large or small (Total Assets)? l What are the biggest items? l What items have changed (increased/decreased) significantly? l How large is debt relative to equity? n Significant amounts of debt may indicate financial risk 6 Income Statement or “Profit and Loss Statement” Track sales, expenses and profit/loss of a business during a given period Revenues - COGS (cost of goods sold) Gross Margin - SG&A (Selling, General and Administrative expenses) - R&D -Amortization, Depreciation Operating Income - Taxes +/- Interest +/- Special Charges Net Income/(Loss) (=Profit, Net Profit) 7 Income Statement – cont’d Revenue/Sales/Net Sales qSale of product or service qGross Sales: Without discounts and allowances qNet Sales: With discounts and allowances Gross Margin (Gross Profit) is Revenue minus Cost of goods sold Cost of goods/services sold qDirect costs associated with the production of the goods/services sold § Material costs, direct labor costs § For banks this could be interest expenses § For Software development firms this could be people expenses EBITDA: qEarnings Before Interest, Taxes, Depreciation and Amortization 8 Interpreting Income Statements Strategically Revenues (Top Line) Is sales growth slow or fast? § Compare to: qPrevious/historical growth qindustry average qstrategic group/main competitors § What product line? What market? § Small vs. large company Net Income/Loss (Bottom Line) Are Revenues and Profits changing at the same rate? § if Profits are slower, is this due to a specific product line? Is this due to costs? Is this due to a write-off (one-time expense)? If profits are very high or very low in relation to sales, WHY? § First, what is high and what is low in this industry? qIntensity of competition 9  Income Statement – Home Depot Fiscal Year 2006 2005 2004 2003 2002 Net revenues 90,837 81,511 73,094 64,816 58,247 Cost of sales 61,054 54,191 48,664 44,236 40,139 Gross margin 29,783 27,320 24,430 20,580 18,108 Selling, general & administrative 18,348 16,485 15,256 12,713 11,375 Depreciation and amortization 1,762 1,472 1,248 1,021 903 Operating income 9,673 9,363 7,926 6,846 5,830 Interest and investment income 27 62 56 59 79 Interest expense 392 143 70 62 37 Earnings before taxes 9,308 9,282 7,912 6,843 5,872 Income taxes 3,547 3,444 2,911 2,539 2,208 Net income 5,761 5,838 5,001 4,304 3,664 # of shares 2065 2146 2213 2289 2349 Diluted earnings per share 2.79 2.72 2.26 1.88 1.56 10 Income Statement – Home Depot Percentage Change/ Growth Figure 1 Percentage change income statements Fiscal Year 2006 2005 2004 2003 Net revenues 11.4% 11.5% 12.8% 11.3% Cost of sales 12.7% 11.4% 10.0% 10.2% Gross margin 9.0% 11.8% 18.7% 13.7% Selling, general & administrative 11.3% 8.1% 20.0% 11.8% Depreciation and amortization 19.7% 17.9% 22.2% 13.1% Operating income 3.3% 18.1% 15.8% 17.4% Interest and investment income -56.5% 10.7% -5.1% -25.3% Interest expense 174.1% 104.3% 12.9% 67.6% Earnings before taxes 0.3% 17.3% 15.6% 16.5% Income taxes 3.0% 18.3% 14.7% 15.0% Net income -1.3% 16.7% 16.2% 17.5% Diluted earnings per share 2.6% 20.4% 20.2% 20.5% 11 Business Unit information - Dell Dell’s Revenue by Business Segment Revenue FY03 % Chg FY02 % Chg FY01 Desktop 21.0 12% 18.9 14% 16.5 Laptop 11.4 18% 9.6 9% 8.8 Enterprise Systems 9.0 31% 6.9 19% 5.8 Dell’s Revenue by Geographic Region Americas Business 21.9 13% 19.4 12% 17.3 Consumer 6.7 19% 5.7 26% 4.5 Europe 8.5 23% 6.9 8% 6.4 Asia Pac/Japan 4.3 26% 3.4 16% 3.0 TOTAL 41.4 17% 35.4 14% 31.2 Source: http://www.sec.gov/Archives/edgar/data/826083/000095013404005058/d14085e10vk.htm#007 12  Cash Flow Statement What are the problems associated with too little or too much cash? ¨ Too little of it will cause an immediate problem: cannot pay employees, repay debts, pay suppliers, etc… ¨ Cash as an “inactive asset.” Too much of it represents lost investment opportunities (cash not invested) ¨ Cash is a key factor in countries with poor access to credit 13 Financial Ratio Analysis Five types of financial ratios: 1. Short-term solvency or liquidity 2. Long-term solvency measures 3. Asset management or turnover 4. Profitability 5. Market value Meaningful ratio analysis must include: Analysis of how ratios change over time Comparison with industry norms Comparison with key competitors  Liquidity Ratios: Ability to pay short-term obligations Current Ratio (CR) Current Assets Ability to pay bills short term Current Liabilities Between 1 -2 (rule of thumb as a last resort if there is no benchmark) Quick Ratio (QR) (acid test) Current Assets - Inventory Ability to pay off short-term obligations, except Inventory Current Liabilities Above 1 safer (rule of thumb as a last resort if there is no benchmark) Cash Cash Ratio Current Liabilities 15 Leverage/Solvency Ratios: Ability to meet Long-term obligations Debt to Asset Ratio Total Debt Extent to which borrowed funds are used Total Assets to buy assets 0.5 or less (rule of thumb) Debt to Equity Ratio Compares funds provided by creditors to funds provided by owners Total Debt Whether a lot of debt is being used to Shareholders’ Equity finance increased operations Capital intensity of the industry Automotive (>2) is larger than Personal Computers (5% (rule of thumb as a last resort if Net Sales there is no benchmark) Return on Assets (ROA) Net Profit Rate of return on assets utilized, a measure of Total Assets management efficiency Return on Invested Capital (ROIC) Net Operating Profit after taxes Efficiency in using the capital invested Comparing a company's ROIC with its cost of capital Invested Capital (WACC) reveals whether the firm is creating value Return on Equity (ROE) Net Profit Rate of return on shareholders’ investment Stockholders’ Equity Gross Profit Gross Margin Net Sales 18 Shareholder Ratios Earnings per share Also considered a profitability ratio Net Profit –Preferred Stock Dividend Common shares outstanding Price to Earnings (PE) Ratio Stock price over (current year or prior year) Earning per share (EPS) Share price http://www.investopedia.com/video/play Earning per share /price-to-earnings-ratio/#axzz2JcC43aqB Total Shareholder Return (TSR) Dividends + share price at end of period Dividends + Share price at end of period (adjusted for splits)/share price at the Share price at beginning of period beginning of the period 19 Sources of Financial Information Company web sites Investor Information Corporate Sections Earnings reports Annual reports Financial Websites Yahoo Finance: http://finance.yahoo.com/?u - financial/quotes The Wall Street Journal: www.wsj.com www.fortune.com - Fortune 500 list www.sec.gov/cgi-bin/srch-edgar - Securities & Exchange Commission 10-K (Annual) 10-Q (Quarterly) Databases : Compustat (across countries, years, industries), … https://wrds-web.wharton.upenn.edu/wrds/ 20 The Balanced Scorecard A meaningful integration of many issues that come into evaluating performance Four key perspectives: 1. How do customers see us? (customer perspective) 2. What must we excel at? (internal perspective) 3. Can we continue to improve and create value? (innovation & learning perspective) 4. How do we look to shareholders? (financial perspective) Internal Business Perspective Managers should focus on those critical internal operations that enable them to satisfy customer needs. § Business processes q Cycle time, quality, employee skills, productivity § Decisions § Coordinated actions § Key resources and capabilities Innovation and Learning Perspective Managers must make frequent changes to existing products & services as well as introduce entirely new products with extended capabilities. This requires: Human capital (skills, talent, knowledge) Information capital (information systems, networks) Organization capital (culture, leadership) Financial Perspective Managers must measure how the firm’s strategy, implementation, and execution are indeed contributing to bottom line improvement. Financial goals include: Profitability, growth, shareholder value This should lead to: Improved sales Increased market share Reduced operating expenses Higher asset turnover Limitations of the Balanced Scorecard Not a “quick fix” – needs proper execution Needs a commitment to learning Needs employee involvement in continuous process improvement Needs cultural change Needs a focus on nonfinancial rather than financial measures Needs data on actual performance