FSA Chapter 3 PDF

Chapter 3 Balance sheet: Liabilities and Equity  3 Chapter Overview Overview  What is the distinction between liabilities and equity?  Analysis of debt structure of firm: What different liabilities can you find on...

Chapter 3 Balance sheet: Liabilities and Equity  3 Chapter Overview Overview  What is the distinction between liabilities and equity?  Analysis of debt structure of firm: What different liabilities can you find on the balance sheet?  Analysis of equity structure of firm: What can you find on the equity side of the balance sheet? Prof. Alexander Liss Financial statement analysis 112  3 Overview of Balance Sheet Repetition: Balance sheet basics  The balance sheet has three sections:  Assets  Liabilities  Shareholders’ equity Asset = liabilities + shareholder’s equity  The balance sheet reports the assets, liabilities, and equity at a point in time.  Balance sheet accounts are permanent accounts because their balance carries over from period to period. Prof. Alexander Liss Financial statement analysis 113  3 Definition: Debt or Equity? Classification: Debt or equity?  Definition: a present obligation of the reporting enterprise arising from past events, the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits  Accounting standards provide detailed definitions of financial liabilities (IAS 32,36): YES Does the instrument require the issuer to pay Classify as cash? NO debt YES Does the instrument require the issuer to transfer other financial assets? NO Classify as equity Prof. Alexander Liss Financial statement analysis 114  3 Classification Liabilities: Classification  According to maturity:  Current liabilities  Non-current or long term liabilities  Differentiate between short term financing (working capital cycle) and long term financing  Different maturity levels relevant for both shareholders and creditors of the firm Prof. Alexander Liss Financial statement analysis 115  3 Liabilities from Adidas SE Source: Adidas SE, 2023, p.190. Prof. Alexander Liss Financial statement analysis 116  3 Liabilities from Colruyt Group Source: Colruyt Group annual report, 2023, p.209. Prof. Alexander Liss Financial statement analysis 117  3 Different liabilities Current Liabilities  Accounts payable (or accrued expenses) – amounts owed to suppliers for goods and services purchased on credit  Accrued liabilities (or deferred revenues) – obligations for expenses that have been incurred but not yet paid (such as wages earned by employees but not yet paid)  Unearned revenues (or current portion) – cash received from a customer in advance for goods or services to be delivered later  Short-term debt – short-term loans owing to banks or other lenders  Current maturities of long-term debt – principal portion of long-term debt that is due to be paid within one year Prof. Alexander Liss Financial statement analysis 118  3 Analyzing accounts payable  Accounts payable (or accrued expenses) – amounts owed to suppliers for goods and services purchased on credit (also called trade credit)  Substantial position for firms with supply chains  Example: Colruyt Group (2023) Source: Colruyt Group annual report, 2023, p.209. Prof. Alexander Liss Financial statement analysis 119  3 Analyzing accounts payable Accounts payable turnover and days payable outstanding (DPO)  Accounts payable turnover measures the number of payment cycles per period (year) 𝑆𝑎𝑙𝑒𝑠𝑡 𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑃𝑎𝑦𝑎𝑏𝑙𝑒 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟 = (𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑃𝑎𝑦𝑎𝑏𝑙𝑒𝑡 + 𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑃𝑎𝑦𝑎𝑏𝑙𝑒𝑡−1 )/2 1 (𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑃𝑎𝑦𝑎𝑏𝑙𝑒𝑡 + 𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑃𝑎𝑦𝑎𝑏𝑙𝑒𝑡−1 )/2 = 𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑃𝑎𝑦𝑎𝑏𝑙𝑒 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟 𝑆𝑎𝑙𝑒𝑠𝑡  Days payable outstanding (DPO) is the average length of time that payables are deferred 365 𝐷𝑎𝑦𝑠 𝑝𝑎𝑦𝑎𝑏𝑙𝑒 𝑜𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔 = 𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑃𝑎𝑦𝑎𝑏𝑙𝑒 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟 Prof. Alexander Liss Financial statement analysis 120  3 Analyzing accounts payable Analyzing DPO for Südzucker AG (2023) Source: Südzucker AG annual report, 2023, p.165. 𝑆𝑎𝑙𝑒𝑠𝑡 𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑃𝑎𝑦𝑎𝑏𝑙𝑒 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟 = (𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑃𝑎𝑦𝑎𝑏𝑙𝑒𝑡 + 𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑃𝑎𝑦𝑎𝑏𝑙𝑒𝑡−1 )/2 10289 = = 5.75 (1970 + 1609)/2 365 365 𝐷𝑎𝑦𝑠 𝑝𝑎𝑦𝑎𝑏𝑙𝑒 𝑜𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔 = = = 63.48 𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑃𝑎𝑦𝑎𝑏𝑙𝑒 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟 5.75 Prof. Alexander Liss Financial statement analysis 121  3 Analyzing accounts payable Analyzing DPO for Südzucker AG (2023) Source: Südzucker AG annual report, 2023, p.165.  Südzucker’s DPO of 63.5 days is longer than a typical 30 days payment term  Delaying payment to suppliers allows the purchasing company to increase its available cash  However, excessive delays (informally called “leaning on the trade”) can damage supplier relationships Prof. Alexander Liss Financial statement analysis 122  3 Analyzing the cash conversion cycle Cash conversion cycle (CCC)  Each time a company completes one cash conversion cycle, it has purchased and sold inventory (realizing sales and gross profit), and paid accounts payable and collected accounts receivables 𝐶𝑎𝑠ℎ 𝑐𝑜𝑛𝑣𝑒𝑟𝑠𝑖𝑜𝑛 𝑐𝑦𝑐𝑙𝑒(𝐶𝐶𝐶) = 𝑑𝑎𝑦𝑠 𝑠𝑎𝑙𝑒𝑠 𝑜𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔(𝐷𝑆𝑂) + 𝐷𝑎𝑦𝑠 𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝑜𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔(𝐷𝐼𝑂) − 𝐷𝑎𝑦𝑠 𝑝𝑎𝑦𝑎𝑏𝑙𝑒 𝑜𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔(𝐷𝑃𝑂)  The CCC allows to analyze potential increases/decreases of cash flow (unless sales are unprofitable)  The higher the CCC, the longer it takes to convert a firm’s products into operating cash flow Prof. Alexander Liss Financial statement analysis 123  3 Analyzing accrued liabilities Accrued liabilities  Accrued liabilities are adjustments made to the balance sheet:  After all transactions have been recorded  Prior to the issuance of the financial statements  So that the financial statements fairly present the financial condition of the company  These adjustments recognize liabilities (and the related expense on the income statement) that are not the result of external transactions  Accrued liabilities are incurred in the current period and, therefore, must be recognized in the current period Prof. Alexander Liss Financial statement analysis 124  3 Analyzing accrued liabilities Types of accrued liabilities  Two broad categories of accruals: 1. Routine contractual liabilities  Wages to employees for work performed, but not yet paid  Unpaid interest that is due in the current period  Income taxes owed, but not yet paid, on profit earned in the period  Other expense items like rent and utilities, incurred but not yet paid 2. Contingent liabilities – depend on the occurrence of a future uncertain event in order to determine whether a liability exists and in what amount  Litigation brought against the company―the outcome and amount depend upon adjudication  Warranty liabilities for products sold―the amount depends on future claims for product repair or replacement Prof. Alexander Liss Financial statement analysis 125  3 Analyzing accrued liabilities Accrued for contractual liabilities– Deferred revenue  Deferred revenue (or unearned revenue) represents deposits or other prepayments from customers that the company has not yet earned  Deferred revenue is an accrued liability until the company provides the goods or performs the service according to the contract  Once the company satisfies the performance obligations, the liability is reduced and (earned) revenue is recognized Prof. Alexander Liss Financial statement analysis 126  3 Analyzing accrued liabilities Accruals for contingent liabilities  Some liabilities are less certain because the ultimate settlement of the liability is contingent on the outcome of a future event  Examples include  Guarantees on the debt of another entity  Lawsuits  Product warranties and recalls  Environmental disasters and remediation  Companies record a contingent liability when two conditions are met: 1. It is probable that one or more future events will confirm that a liability existed at the financial statement date 2. The amount required to settle the liability in the future can be reasonably determined at the financial statement date Prof. Alexander Liss Financial statement analysis 127  3 Analyzing accrued liabilities Accruals for contingent liabilities example – warranties  Warranty liabilities are commitments that manufacturers make to repair or replace defective products within a specified period of time  If the obligation is probable and the amount estimable with reasonable certainty, IFRS requires that companies:  Record the expected cost of warranties as a liability  Record the related expected warranty expense in the income statement in the same period that the sales revenue is reported  When the defective product is later replaced (or repaired), the liability is reduced and the company records the cost of necessary to satisfy the claim Prof. Alexander Liss Financial statement analysis 128  3 Analyzing accrued liabilities Ferrari’s (2023) accrued liability disclosures Source: Ferrari Group annual report, 2023, p.367. Prof. Alexander Liss Financial statement analysis 129  3 Analyzing net working capital Net working capital  Net working capital: 𝑁𝑒𝑡 𝑤𝑜𝑟𝑘𝑖𝑛𝑔 𝑐𝑎𝑝𝑖𝑡𝑎𝑙 = 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑎𝑠𝑠𝑒𝑡𝑠 − 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠  The net working capital required to conduct business depends on the company’s operating cycle, which is the time between paying cash for goods and receiving cash from customers  Current ratio also measures liquidity of a firm (more in chapter 6): 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑎𝑠𝑠𝑒𝑡𝑠 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑟𝑎𝑡𝑖𝑜 = 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 Prof. Alexander Liss Financial statement analysis 130  3 Analyzing net working capital Net working capital of Renault SA (2023)  Net working capital: Source: Renault SA consolidated financial statements, 2023, p.5. Prof. Alexander Liss Financial statement analysis 131  3 Analyzing net working capital Net working capital of Renault SA (2023)  Net working capital: 𝑁𝑒𝑡 𝑤𝑜𝑟𝑘𝑖𝑛𝑔 𝑐𝑎𝑝𝑖𝑡𝑎𝑙 2023 = 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑎𝑠𝑠𝑒𝑡𝑠 − 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 = 86333 − 77933 = 8400 𝑁𝑒𝑡 𝑤𝑜𝑟𝑘𝑖𝑛𝑔 𝑐𝑎𝑝𝑖𝑡𝑎𝑙 2022 = 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑎𝑠𝑠𝑒𝑡𝑠 − 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 = 81760 − 73045 = 8715  Current ratio: 86333 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑟𝑎𝑡𝑖𝑜 2023 = = 1.11 77933 81760 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑟𝑎𝑡𝑖𝑜 2022 = = 1.12 73045 Prof. Alexander Liss Financial statement analysis 132  3 Different liabilities Non-current liabilities  Non-current liabilities – obligations due after one year  Long-term debt – principal loan amounts that are scheduled to be repaid more than one year hence long-term debt includes bonds, notes, debentures, mortgages, and other long-term loans  Other long-term liabilities – such as pension liabilities and long-term tax liabilities, that will be settled a year or more into the future Prof. Alexander Liss Financial statement analysis 133  3 Analyzing different (private) credit forms Supply of credit – bank loans  Revolving credit line (also called revolver or line of credit)  Cash available on demand, balance fluctuates  Floating interest rate  Letters of credit  Bank is interposed between the company and its supplier  Bank provides a guaranty of payment  Term loans  A set loan amount (principal) with specified periodic payments  Interest rates are either fixed or floating for duration of the loan  Mortgage loans―term loan based on collateral, typically real estate Prof. Alexander Liss Financial statement analysis 134  3 Analyzing different (private) credit forms Supply of credit – other forms of financing  Nonbank private financing  Used when bank financing is limited or unavailable  Provided by private lenders that have experience in industry  Lender creatively structures loan repayment and may act as a management consultant  Lease financing  Typically used for PPE acquisitions  Leasing firm considers credit risk of the lessee and collateral Prof. Alexander Liss Financial statement analysis 135  3 Analyzing corporate bonds Long-term (public) debt  When companies require a large amount of financing, the issuing bonds in capital markets is a cost- efficient way to raise funds  Bonds are structured like any other borrowing:  The borrower receives cash and agrees to pay it back with interest  Generally, the entire face amount (principal) of the bond is repaid at maturity (at the end of the bond’s life)  Interest payments are made in the interim (semiannually or annually)  Companies that raise funds in the bond market normally work with an underwriter (large investment banks like Goldman Sachs or even KBC) to set the terms of the bond issue Prof. Alexander Liss Financial statement analysis 136  3 Analyzing corporate bonds Interest rates and bond prices  Issued bonds can trade in the secondary market just like stocks  Bond prices fluctuate even though the company’s obligation to repay principal and interest remains fixed throughout the life of the bond  The bond’s fixed rate of interest can be higher or lower than the interest rates offered on other securities of similar risk  Because bonds compete with other possible investments, bond prices are set relative to the prices of other investments  Just like in any competitive market – the laws of supply and demand will cause bond prices to rise and fall Prof. Alexander Liss Financial statement analysis 137  3 Analyzing corporate bonds Cash flows to bondholders  Bondholders normally expect to receive two types of cash flow 1. Periodic interest payments (usually semiannual) during the bond’s life  Interest payments are called an annuity because they are equal in amount and made at regular intervals 2. Single payment of the face (principal) amount of the bond at maturity  Repayment of principal is called a lump-sum because it occurs only once  The bond price equals the present value of the annuity payments plus the present value of the lump- sum payment Prof. Alexander Liss Financial statement analysis 138  3 Analyzing debt structures Different maturities of debt  Example: Ackermans & Van Haaren NV (2023) Source: Ackermans & Van Haaren NV annual report, 2023, p.195.  Allows to analyze when certain debt is due (and needs to be refinanced) and (potential) liquidity constraints of firms Prof. Alexander Liss Financial statement analysis 139  3 Analyzing debt repayment availability Times Interest Earned ratio  Investors (especially debt investors) are interested in the ability of firms to pay their interest expenses 𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑏𝑒𝑓𝑜𝑟𝑒 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑎𝑛𝑑 𝑡𝑎𝑥 (𝐸𝐵𝐼𝑇)𝑡 𝑇𝑖𝑚𝑒𝑠 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑒𝑎𝑟𝑛𝑒𝑑 = 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑒𝑥𝑝𝑒𝑛𝑠𝑒 (𝑔𝑟𝑜𝑠𝑠)𝑡  Reflects the operating income available to pay interest expense  Limitation: Ratio assumes that only the interest component must be paid back because the principal will be refinanced Prof. Alexander Liss Financial statement analysis 140  3 Analyzing debt repayment availability Debt analysis based on cash flows  Cash from operations to total debt measures the ability to generate additional cash to cover debt payments as they come due 𝐶𝑎𝑠ℎ 𝑓𝑟𝑜𝑚 𝑜𝑝𝑒𝑟𝑎𝑡𝑖𝑜𝑛𝑠𝑡 𝐶𝑎𝑠ℎ 𝑓𝑟𝑜𝑚 𝑜𝑝𝑒𝑟𝑎𝑡𝑖𝑜𝑛𝑠 𝑡𝑜 𝑡𝑜𝑡𝑎𝑙 𝑑𝑒𝑏𝑡 = 𝑆ℎ𝑜𝑟𝑡 𝑡𝑒𝑟𝑚 𝑑𝑒𝑏𝑡𝑡 + 𝐿𝑜𝑛𝑔 𝑡𝑒𝑟𝑚 𝑑𝑒𝑏𝑡𝑡  adjusted operating cash flow to total debt considers excess operating cash flow after cash is spent on capital expenditures 𝐶𝑎𝑠ℎ 𝑓𝑟𝑜𝑚 𝑜𝑝𝑒𝑟𝑎𝑡𝑖𝑜𝑛𝑠𝑡 − 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝐸𝑥𝑝𝑒𝑛𝑑𝑖𝑡𝑢𝑟𝑒𝑠𝑡 𝑎𝑑𝑗𝑢𝑠𝑡𝑒𝑑 𝑐𝑎𝑠ℎ 𝑓𝑟𝑜𝑚 𝑜𝑝𝑒𝑟𝑎𝑡𝑖𝑜𝑛𝑠 𝑡𝑜 𝑡𝑜𝑡𝑎𝑙 𝑑𝑒𝑏𝑡 = 𝑆ℎ𝑜𝑟𝑡 𝑡𝑒𝑟𝑚 𝑑𝑒𝑏𝑡𝑡 + 𝐿𝑜𝑛𝑔 𝑡𝑒𝑟𝑚 𝑑𝑒𝑏𝑡𝑡 Prof. Alexander Liss Financial statement analysis 141  3 Definition of Equity Shareholders’ equity – contributed capital  Common stock – par value received from the original sale of common stock to investors  Example: Siemens AG (2023) Source: Siemens AG consolidated report, 2023, p.4. Prof. Alexander Liss Financial statement analysis 142  3 Analyzing Equity Shareholders’ equity – contributed capital  Common stock – par value received from the original sale of common stock to investors  Additional paid-in capital (or capital reserves) – amounts received from the original sale of stock to investors in excess of the par value of stock  Treasury stock – amount the company paid to reacquire its common stock from shareholders. Treasury shares are “held” by the company for potential resale on the open market  Preferred stock – value received from the original sale of preferred stock to investors Prof. Alexander Liss Financial statement analysis 143  3 Analyzing Equity Preferred stock  Preferred stock is a multi-use security with a number of desirable features  Preferred stock many common features:  Dividend  Preferred stock receives dividends before common shareholders  Liquidation  Preferred stock may receive bankruptcy proceeds before common shareholders in case of financial distress  Yield  Preferred stock can be structured to provide investors with a dividend yield similar to an interest rate on a bond.  Conversion privileges  Preferred stock often includes a feature that allows investors to convert their preferred shares into common shares at a pre-determined number of common shares per preferred share Prof. Alexander Liss Financial statement analysis 144  3 Analyzing Equity Non-controlling interest  Non-controlling (minority) interest arises when the company controls a subsidiary but does not own all of the subsidiary’s stock  Minority shareholders have no execution power in the firm  Example: Vodafone plc (2023) Source: Vodafone plc annual report, 2023, p.124. Prof. Alexander Liss Financial statement analysis 145  3 Analyzing Equity Shareholder’s equity – earned capital  Retained earnings – cumulative net income that has not been distributed to shareholders via dividends or share repurchases 𝑅𝑒𝑡𝑎𝑖𝑛𝑒𝑑 𝑒𝑎𝑟𝑛𝑖𝑛𝑔𝑠𝑡 = 𝑅𝑒𝑡𝑎𝑖𝑛𝑒𝑑 𝑒𝑎𝑟𝑛𝑖𝑛𝑔𝑠𝑡−1 + 𝑁𝑒𝑡 𝑖𝑛𝑐𝑜𝑚𝑒𝑡 − 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑𝑠𝑡 − 𝑆𝑡𝑜𝑐𝑘 𝑟𝑒𝑝𝑢𝑟𝑐ℎ𝑎𝑠𝑒𝑡  Accumulated other comprehensive income or loss (or dirty surplus items) – cumulative changes in asset and liability fair values that are not reported in the income statement Prof. Alexander Liss Financial statement analysis 146  3 Analyzing Equity Shareholder’s equity statement  Example: Colruyt (2023) Source: Colruyt Group annual report, 2023, p.211. Prof. Alexander Liss Financial statement analysis 147  3 Analyzing Equity Shareholder’s equity statement  Example: Colruyt (2023) Source: Colruyt Group annual report, 2023, p.211.  Total comprehensive income= Net income + other comprehensive income Prof. Alexander Liss Financial statement analysis 148  3 Analyzing Equity Shareholder’s equity statement  Example: Colruyt (2023) Source: Colruyt Group annual report, 2023, p.211.  Distributions to shareholders= Dividends + Share repurchases - Stock issues Prof. Alexander Liss Financial statement analysis 149  3 Analyzing Equity Dividend payout and yield  Dividend Payout – measures the proportion of the company’s earnings paid out as dividends 𝐶𝑜𝑚𝑚𝑜𝑛 𝑠𝑡𝑜𝑐𝑘 𝑑𝑖𝑣𝑖𝑑𝑒𝑛𝑑𝑠 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒𝑡 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑝𝑎𝑦𝑜𝑢𝑡 = 𝐵𝑎𝑠𝑖𝑐 𝑒𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 (𝐸𝑃𝑆)𝑡  Dividend Yield – measures the relation between dividends and current market value of the company’s stock 𝐶𝑜𝑚𝑚𝑜𝑛 𝑠𝑡𝑜𝑐𝑘 𝑑𝑖𝑣𝑖𝑑𝑒𝑛𝑑𝑠 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒𝑡 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑦𝑖𝑒𝑙𝑑 = 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑠ℎ𝑎𝑟𝑒 𝑝𝑟𝑖𝑐𝑒𝑡 Prof. Alexander Liss Financial statement analysis 150  3 Analyzing Equity Book value per share  A measure commonly used by analysts and the financial press is book value per share  This is the equity (net book value) of the company that is available to common shareholders and is defined as: 𝑆ℎ𝑎𝑟𝑒ℎ𝑜𝑙𝑑𝑒𝑟 𝑒𝑞𝑢𝑖𝑡𝑦𝑡 − 𝑃𝑟𝑒𝑓𝑒𝑟𝑟𝑒𝑑 𝑠𝑡𝑜𝑐𝑘𝑡 𝐵𝑉 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 = 𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑠ℎ𝑎𝑟𝑒𝑠 𝑜𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔𝑡  Shares outstanding: Issued shares subtracted by shares in treasury  Shares outstanding is found in the notes section of the annual report Prof. Alexander Liss Financial statement analysis 151  3 Discrepancies to Market Value Book Value vs. Market Value  Shareholders’ Equity – the “equity value” of the company in each annual IFRS statement  Market value = Number of common shares outstanding × Company’s stock price  Book value ≠ Market value  IFRS reports many assets and liabilities at historical costs, whereas the market attempts to estimate fair values  IFRS excludes assets that cannot be reliably measured (mostly internally generated intangible assets)  Market value adjusts for companies’ market characteristics  IFRS does not consider expected future performance  Approximation of difference will be investigated in second part of the lecture Prof. Alexander Liss Financial statement analysis 152  3 Discrepancies to Market Value Effects of “Missing” Assets Prof. Alexander Liss Financial statement analysis 153  3 The Continuing Case: Bekaert SA Questions: 1. Calculate net working capital, current ratio, and the cash conversion cycle of Bekaert SA. Interpret your results. 2. Analyze the debt structure of Bekaert SA. Interpret your results. 3. Analyze the payout structure of Bekaert SA. Calculate dividend payout and dividend yield (use the stock price of 35€). Interpret your results. Prof. Alexander Liss Financial statement analysis 154  3 The Continuing Case: Bekaert SA Asset side of Bekaert SA: Prof. Alexander Liss Financial statement analysis 155  3 The Continuing Case: Bekaert SA Liability side of Bekaert SA: Prof. Alexander Liss Financial statement analysis 156  3 The Continuing Case: Bekaert SA Financing cash flow of Bekaert SA: Prof. Alexander Liss Financial statement analysis 157  3 The Continuing Case: Bekaert SA Information on earnings per share and shares outstanding for Bekaert SA: Prof. Alexander Liss Financial statement analysis 158  3 The Continuing Case: Bekaert SA Solution: 1. Calculate net working capital, current ratio, cash conversion cycle of Bekaert SA. Interpret your results. 𝑁𝑒𝑡 𝑤𝑜𝑟𝑘𝑖𝑛𝑔 𝑐𝑎𝑝𝑖𝑡𝑎𝑙(2023) = 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑎𝑠𝑠𝑒𝑡𝑠 − 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 = 2195 − 1148 = 1047 𝑁𝑒𝑡 𝑤𝑜𝑟𝑘𝑖𝑛𝑔 𝑐𝑎𝑝𝑖𝑡𝑎𝑙(2022) = 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑎𝑠𝑠𝑒𝑡𝑠 − 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 = 2854 − 1724 = 1130 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑎𝑠𝑠𝑒𝑡𝑠 2195 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑟𝑎𝑡𝑖𝑜(2023) = = = 1.91 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 1148 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑎𝑠𝑠𝑒𝑡𝑠 2854 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑟𝑎𝑡𝑖𝑜(2022) = = = 1.66 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 1724  Interpretation: Bekaert has positive net working capital and the current ratio over 1 indicates that Bekaert is not liquidity constrained. In fact, current ratio improved from 2022 to 2023, indicating improved liquidity. Prof. Alexander Liss Financial statement analysis 159  3 The Continuing Case: Bekaert SA Solution: 1. Calculate net working capital, current ratio, cash conversion cycle of Bekaert SA. Interpret your results. 𝐶𝑎𝑠ℎ 𝑐𝑜𝑛𝑣𝑒𝑟𝑠𝑖𝑜𝑛 𝑐𝑦𝑐𝑙𝑒(𝐶𝐶𝐶) = 𝑑𝑎𝑦𝑠 𝑠𝑎𝑙𝑒𝑠 𝑜𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔(𝐷𝑆𝑂) + 𝐷𝑎𝑦𝑠 𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝑜𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔(𝐷𝐼𝑂) − 𝐷𝑎𝑦𝑠 𝑝𝑎𝑦𝑎𝑏𝑙𝑒 𝑜𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔(𝐷𝑃𝑂) 𝑆𝑎𝑙𝑒𝑠 4327.9  𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑟𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒 𝑡𝑢𝑟𝑛𝑜𝑣𝑒𝑟 = (𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒 +𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑡 𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒 = = 6.74 𝑡 𝑡−1 )/2 (553+730.8)/2 365 365  𝐷𝑎𝑦𝑠 𝑠𝑎𝑙𝑒𝑠 𝑜𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔 = 𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑟𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒 𝑡𝑢𝑟𝑛𝑜𝑣𝑒𝑟 = 6.74 = 54.15 𝐶𝑜𝑠𝑡𝑠 𝑜𝑓 𝐺𝑜𝑜𝑑𝑠 𝑠𝑜𝑙𝑑 3623.3  𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟 = (𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 +𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝑡 = = 3.75 𝑡 𝑡−1 )/2 (788.5+1143.1)/2 365 365  𝐷𝑎𝑦𝑠 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝑂𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔 = 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟 = 3.75 = 97.33 Prof. Alexander Liss Financial statement analysis 160  3 The Continuing Case: Bekaert SA Solution: 1. Calculate net working capital, current ratio, cash conversion cycle of Bekaert SA. Interpret your results. 𝑆𝑎𝑙𝑒𝑠 4327.9  𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑃𝑎𝑦𝑎𝑏𝑙𝑒 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟 = (𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑃𝑎𝑦𝑎𝑏𝑙𝑒 +𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑡 𝑃𝑎𝑦𝑎𝑏𝑙𝑒 = = 5.57 𝑡 𝑡−1 )/2 (633+921.1)/2 365 365  𝐷𝑎𝑦𝑠 𝑝𝑎𝑦𝑎𝑏𝑙𝑒 𝑜𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔 = 𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑃𝑎𝑦𝑎𝑏𝑙𝑒 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟 = 5.57 = 65.53 𝐶𝑎𝑠ℎ 𝑐𝑜𝑛𝑣𝑒𝑟𝑠𝑖𝑜𝑛 𝑐𝑦𝑐𝑙𝑒 2023 = 54.15 + 97.33 − 65.53 = 85.95  Interpretation: Bekaert has a long cash conversion cycle, which is costly. Bekaert, in particular, carries large inventory on their balance sheet, which takes time to convert into cash flow. Prof. Alexander Liss Financial statement analysis 161  3 The Continuing Case: Bekaert SA Solution: 2. Analyze the debt structure of Bekaert SA. Interpret your results.  Common metrics to analyze the debt structure and the debt payment ability of Bekaert:  Times Interest Earned: 𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑏𝑒𝑓𝑜𝑟𝑒 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑎𝑛𝑑 𝑡𝑎𝑥 𝐸𝐵𝐼𝑇 𝑡 334.4 𝑇𝑖𝑚𝑒𝑠 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑒𝑎𝑟𝑛𝑒𝑑 2023 = = = 9.47 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑒𝑥𝑝𝑒𝑛𝑠𝑒 𝑔𝑟𝑜𝑠𝑠 𝑡 35.3 𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑏𝑒𝑓𝑜𝑟𝑒 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑎𝑛𝑑 𝑡𝑎𝑥 𝐸𝐵𝐼𝑇 𝑡 317.1 𝑇𝑖𝑚𝑒𝑠 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑒𝑎𝑟𝑛𝑒𝑑 2022 = = = 8.48 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑒𝑥𝑝𝑒𝑛𝑠𝑒 𝑔𝑟𝑜𝑠𝑠 𝑡 37.4  Interpretation: Bekaert has about 8-9 times of operating income available to pay their interest expense. Yet, this ratio does not include principal repayment (which Bekaert did in 2023; see financing cash flow) Prof. Alexander Liss Financial statement analysis 162  3 The Continuing Case: Bekaert SA Solution: 2. Analyze the debt structure of Bekaert SA. Interpret your results.  Cash from operations to total debt: 𝐶𝑎𝑠ℎ 𝑓𝑟𝑜𝑚 𝑜𝑝𝑒𝑟𝑎𝑡𝑖𝑜𝑛𝑠𝑡 439.8 𝐶𝑎𝑠ℎ 𝑓𝑟𝑜𝑚 𝑜𝑝𝑒𝑟𝑎𝑡𝑖𝑜𝑛𝑠 𝑡𝑜 𝑡𝑜𝑡𝑎𝑙 𝑑𝑒𝑏𝑡 2023 = = = 0.23 𝑆ℎ𝑜𝑟𝑡 𝑡𝑒𝑟𝑚 𝑑𝑒𝑏𝑡𝑡 + 𝐿𝑜𝑛𝑔 𝑡𝑒𝑟𝑚 𝑑𝑒𝑏𝑡𝑡 1148.2 + 767.0 𝐶𝑎𝑠ℎ 𝑓𝑟𝑜𝑚 𝑜𝑝𝑒𝑟𝑎𝑡𝑖𝑜𝑛𝑠𝑡 340.3 𝐶𝑎𝑠ℎ 𝑓𝑟𝑜𝑚 𝑜𝑝𝑒𝑟𝑎𝑡𝑖𝑜𝑛𝑠 𝑡𝑜 𝑡𝑜𝑡𝑎𝑙 𝑑𝑒𝑏𝑡 2022 = = = 0.13 𝑆ℎ𝑜𝑟𝑡 𝑡𝑒𝑟𝑚 𝑑𝑒𝑏𝑡𝑡 + 𝐿𝑜𝑛𝑔 𝑡𝑒𝑟𝑚 𝑑𝑒𝑏𝑡𝑡 1724.2 + 875.5  Interpretation: Bekaert has about 13 to 23 percent coverage of their debt from their operating cash flow. In particular, the ratio improved from 2022 to 2023. Prof. Alexander Liss Financial statement analysis 163  3 The Continuing Case: Bekaert SA Solution: 2. Analyze the debt structure of Bekaert SA. Interpret your results.  Adjusted cash from operations to total debt: 𝐶𝑎𝑠ℎ 𝑓𝑟𝑜𝑚 𝑜𝑝𝑒𝑟𝑎𝑡𝑖𝑜𝑛𝑠𝑡 − 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝐸𝑥𝑝𝑒𝑛𝑑𝑖𝑡𝑢𝑟𝑒𝑠𝑡 𝑎𝑑𝑗𝑢𝑠𝑡𝑒𝑑 𝑐𝑎𝑠ℎ 𝑓𝑟𝑜𝑚 𝑜𝑝𝑒𝑟𝑎𝑡𝑖𝑜𝑛𝑠 𝑡𝑜 𝑡𝑜𝑡𝑎𝑙 𝑑𝑒𝑏𝑡 (2023) = 𝑆ℎ𝑜𝑟𝑡 𝑡𝑒𝑟𝑚 𝑑𝑒𝑏𝑡𝑡 + 𝐿𝑜𝑛𝑔 𝑡𝑒𝑟𝑚 𝑑𝑒𝑏𝑡𝑡 439.8 − 188.0 = = 0.13 1148.2 + 767.0 𝐶𝑎𝑠ℎ 𝑓𝑟𝑜𝑚 𝑜𝑝𝑒𝑟𝑎𝑡𝑖𝑜𝑛𝑠𝑡 − 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝐸𝑥𝑝𝑒𝑛𝑑𝑖𝑡𝑢𝑟𝑒𝑠𝑡 𝑎𝑑𝑗𝑢𝑠𝑡𝑒𝑑 𝑐𝑎𝑠ℎ 𝑓𝑟𝑜𝑚 𝑜𝑝𝑒𝑟𝑎𝑡𝑖𝑜𝑛𝑠 𝑡𝑜 𝑡𝑜𝑡𝑎𝑙 𝑑𝑒𝑏𝑡 (2022) = 𝑆ℎ𝑜𝑟𝑡 𝑡𝑒𝑟𝑚 𝑑𝑒𝑏𝑡𝑡 + 𝐿𝑜𝑛𝑔 𝑡𝑒𝑟𝑚 𝑑𝑒𝑏𝑡𝑡 340.3 − 170.6 = = 0.07 1724.2 + 875.5  Interpretation: Taking capital investments into account, Bekaert has about 7 to 13 percent coverage of their debt from their operating cash flow. In particular, the ratio improved from 2022 to 2023. Prof. Alexander Liss Financial statement analysis 164  3 The Continuing Case: Bekaert SA Solution: 3. Analyze the payout structure of Bekaert SA. Calculate dividend payout and dividend yield (use the stock price of 35€). Interpret your results.  Calculate dividend per share: Dividend paid/Shares outstanding; 88.564/53.560=1.65 Euro 𝐶𝑜𝑚𝑚𝑜𝑛 𝑠𝑡𝑜𝑐𝑘 𝑑𝑖𝑣𝑖𝑑𝑒𝑛𝑑𝑠 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒𝑡 1.65 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑝𝑎𝑦𝑜𝑢𝑡 = = = 0.347 = 34.7% 𝐵𝑎𝑠𝑖𝑐 𝑒𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 (𝐸𝑃𝑆)𝑡 4.75 𝐶𝑜𝑚𝑚𝑜𝑛 𝑠𝑡𝑜𝑐𝑘 𝑑𝑖𝑣𝑖𝑑𝑒𝑛𝑑𝑠 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒𝑡 1.65 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑦𝑖𝑒𝑙𝑑 = = = 0.047 = 4.7% 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑠ℎ𝑎𝑟𝑒 𝑝𝑟𝑖𝑐𝑒𝑡 35  Interpretation: Bekaert has a dividend payout of 34.7 percent. Thus, the firm retains about 65.3 percent (=1-34.7 percent) of their annual earnings. Regarding dividend yield, equity investors gain an additional return of 4.7 percent on their investment. Prof. Alexander Liss Financial statement analysis 165