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POLIMI Graduate School of Management

Andrea Urbinati

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financial accounting annual report financial statements business analysis

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This presentation covers the fundamental principles of financial accounting, focusing on the key documents within an annual report. It also examines important topics such as profitability and liquidity ratios for business analysis within a company.

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FINANCIAL ACCOUNTING ANDREA URBINATI, PH.D. [email protected] WHY FINANCIAL ACCOUNTING? It provides the “numbers” we normally hear about a company (revenues, profit, assets value,...) It is a “fundamental” part of company evaluation, i.e. it contributes (together with “expectations”) t...

FINANCIAL ACCOUNTING ANDREA URBINATI, PH.D. [email protected] WHY FINANCIAL ACCOUNTING? It provides the “numbers” we normally hear about a company (revenues, profit, assets value,...) It is a “fundamental” part of company evaluation, i.e. it contributes (together with “expectations”) to determine: the shares’ price and market capitalization of a company in the day by day trading (financial analysis) the target price in an M&A (financial due diligence) the selling price of shares in an IPO (financial due diligence) the credit stability (rating services) © Andrea Urbinati AGENDA Annual Report: key accounting principles and main documents Analysis of Annual Report Profitability Ratios Liquidity Ratios Summary and conclusions © Andrea Urbinati MAIN OBJECTIVES Financial Accounting identifies data and information a company must collect, organise and present to shareholders and stakeholders (banks and bondholders, customers and suppliers, public authorities) to accomplish normative duties Data and information are presented in an official document called Annual Report (Financial Statements), summarising : the monetary value of assets the company has under its availability in a given point in time (usually the end of the year) and the economic and financial transactions the company undertook in a given period of time (usually an year) “Not everything that can be counted counts and not everything that counts can be counted” (Albert Einstein) © Andrea Urbinati ACCOUNTING STANDARDS Accounting Principles or Standards define where to register (format of Financial Statements) what to register (definition of assets/liabilities, revenues/costs, cash inflows/outflows) how to register (revision of the calculation of the monetary value of accounting items).... any item or event with an economic and/or financial impact © Andrea Urbinati -balance sheet -statement of income -statement of cash flow -changes in shareholders ANNUAL REPORT: KEY DOCUMENTS equity -notes to the annual reports IAS/IFRS define the structure of annual report as constituted by 5 compulsory documents: BALANCE SHEET describing the monetary value of assets and related rights (equity and liabilities) in a given point in time (usually, midnight of 31/12 of each year) STATEMENT OF INCOME (PROFIT AND LOSS ACCOUNT) describing the economic value (revenues and costs) of physical and financial transactions undertaken by the company in a given period (usually, one year) © Andrea Urbinati ANNUAL REPORT: KEY DOCUMENTS … STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY summarising the effects on shareholders’ equity of physical and financial transactions undertaken by the company in a given period (usually, one year) STATEMENT OF CASH FLOW summarising the results (inflows and outflows) of the financial transactions undertaken by the company in a given period (usually, one year) NOTES TO FINANCIAL STATEMENTS describing the rules followed and hypothesis made in drafting of the annual report, and all complementary data and information needed to allow the reader to interpret the other documents © Andrea Urbinati MATCHING PRINCIPLE accounting accrual (rateo) si rifà a movimenti che non corrispon- dono all'uscita reale di soldi o all' entrata ma piuttosto al momento della decisione maturata The matching principle used in Annual Report is the accrual-basis accounting differenza con cash-basis Accrual-basis accounting records events based on economic activity rather than financial activity. Under accrual accounting, revenue is recorded when it is earned and realised, regardless of when actual payment is received. Similarly, expenses are “matched” to revenues regardless of when they are actually paid. Accrual-basis accounting is opposed to cash-basis accounting under which revenues are recognised when cash is received and expenses when cash is paid Net profit is then a result of the “matching” between economic events (revenues and costs) © Andrea Urbinati documenti aggiuntivi per le aziende quotate in borsa -report di auditori indipendenti per verificare ANNUAL REPORT: KEY DOCUMENTS la veridicità di quanto riportato -report sul lavoro del management e la supervisory board Listed companies are also requested to provide: the report of independent auditors, stating that the annual report gives a true and fair view of the situation of the company the report of supervisory board, stating that the decisions undertaken by the company’s management are compliant with the normative and statutory requirements a management report, providing the view of the management and also additional comments to the results reported in the annual report © Andrea Urbinati BALANCE SHEET Balance Sheet describes the monetary value of assets and related rights (equity and liabilities) in a given point in time (usually, midnight of 31/12 of each year) ASSETS LIABILITIES (RESOURCES) (RIGHTS) Assets are identified by Liabilities are defined as the presence of a direct or present obligations of an indirect contribution to entity arising from past the financial flows (or transactions or events, € equivalents) that will arrive to the companies. the settlement of which may result in the transfer € Ownership is not or use of assets, essential in recognising provision of services or assets other yielding of economic benefits in the future. IAS/IFRS do not identify a rigid framework … and therefore each company may decide how to draft its Balance Sheet © Andrea Urbinati BALANCE SHEET LIABILITIES gli investimenti solitamente ASSETS sono ammortizzati su più anni. NON-CURRENT ASSETS il valore comunque può Property, plant and equipment essere rivalutato alla fine di ogni anno (in meglio o in Investment property investment property = partecipazioni in altre aziende o altri titoli peggio), in quel caso l'amm- Goodwil beni intangibili (diritti d'autore, valore di mercato,...) N.B. per i beni intangibili per determin- ortamento di ogni anno di Other intangible assets are il valore possiamo farlo intername. vita utile cambia (sulla base di quanto speso) oppure Equity investment investimenti in equity aziendali con un benchmarking esterno Other non-current financial assets Deferred tax scarico di tasse... CURRENT ASSETS Trade and other receivables receivables, soldi che devono arrivare entro un anno e valore dell'inventario Inventories Ordered work in progress Short-term financial assets Cash and cash equivalents denaro corrente è corrente perchè di fatto già disponibile all'uso ASSETS CLASSIFIED AS HELD FOR SALE AND DISPOSAL GROUPS © Andrea Urbinati BALANCE SHEET Assets held for collection, trading, sale, or consumption within the enterprise's normal operating cycle LIABILITIES ASSETS(12 months). NON-CURRENT ASSETS Property, plant and equipment Investment property The common feature of non- Goodwil current assets held for sale and Other intangible assets disposal groups is that the Equity investment carrying value is expected to Other non-current financial assets be realised through a sale Deferred tax transaction rather than CURRENT ASSETS through continuing use. The Trade and other receivables non-current asset or disposal Inventories group is classified as held for Ordered work in progress sale when it is immediately Short-term financial assets available for sale in its Cash and cash equivalents present condition and the sale is highly probable. ASSETS CLASSIFIED AS HELD FOR SALE AND DISPOSAL GROUPS © Andrea Urbinati BALANCE SHEET ASSETS LIABILITIES (RIGHTS) SHAREHOLDERS’ EQUITY Issued capital Reserves riserve = accantonamenti di utile di esercizio, no dividendi Net profit/loss for the financial year NON-CURRENT LIABILITIES Bonds debiti nel lungo, interessi (spese Bank debts finanziarie), pensioni,.. Other financial non-current liabilities Provisions for liabilities and charges Pensions and similar obligations Deferred tax liabilities STAKEHOLDERS’ RIGHTS CURRENT LIABILITIES Bonds debiti destinati ad esaurirsi entro un anno, Bank debts payables Trade and other payables Other financial non-current liabilities Current tax liabilities tasse = debiti fiscali LIABILITIES DIRECTLY ASSOCIATED WITH ASSETS CLASSIFIED AS HELD FOR SALE AND DISPOSAL GROUPS © Andrea Urbinati BALANCE SHEET: CUCINELLI [TOTAL ASSETS] © Andrea Urbinati BALANCE SHEET: CUCINELLI [TOTAL LIABILITIES + EQUITY] At the finish of each company’s operating cycle (usually, midnight of 31/12 of each year), the value of the Total Assets has to be equal to the sum of Total Liabilities and Equity © Andrea Urbinati conto economico STATEMENT OF INCOME il conto economico segue una logica accrual based nel valutare i movimenti It describes the economic value (revenues and costs) of physical and financial economici di un azienda in un anno transactions undertaken by the company in a given period (usually, one year) It is drafted accordingly to the accrual-basis accounting IAS allow to present Statement of Income (Profit and Loss Account) under two forms: by nature, where costs are aggregated on the basis of their nature (raw materials, staff costs, depreciation and amortisation, …) by function, where costs are aggregated on the basis of the activity to which they are referred (costs of sales, selling costs, administrative costs, …) possiamo trovare il conto economico scritto per natura o per funzione © Andrea Urbinati STATEMENT OF INCOME (BY NATURE): CUCINELLI l'EBIT ci dà indicazione sull'abilità dell'azienda di operare nel mercato in cui si trova non è influenzato da fattori esterni ma solo da quanto sa fare sul mercato EBIT il costo degli stakeholder (soldi che diamo loro) è rap- presentato dalle spese finan- ziarie (interessi) E l'aspetto finanziario caratterizza l'esposizione al rischio per l'azienda con il netto profitto andiamo a aggiungere la voce nello stato patrimoniale e possiamo pagare © Andrea Urbinati i dividendi nel conto economico non rientra, ma è importante che siamo anche in grado di poter pagare gli stakeholder non solo degli interessi ma anche della somma iniziale (che rientra nelle passività e sono da estinguere attraverso il net working capital) STATEMENT OF INCOME (BY NATURE): CUCINELLI At the finish of each company’s operating cycle (usually, midnight of 31/12 of each year), the Earnings generated EBIT = in the Income OPERATING PROFIT Statement converge as shareholders’ rights rights in in the equity Equity EBIT E © Andrea Urbinati BALANCE SHEET: CUCINELLI [TOTAL LIABILITIES + EQUITY] Indeed: Indeed: At December 31, 2020 (32,069) = (33,216) + 1,147 And At December 53,083 31, +530 = 52,553 2019 53,083 = 52,553 +530 © Andrea Urbinati STATEMENT OF CASH FLOW il cash flow statement riassume i flussi finanziari di un azienda in un anno seguendo la logica cash-based It summarises the results (inflows and outflows) of the financial transactions undertaken by the company in a given period (usually, one year) IAS/IFRS consider two options in presenting the Statement of cash flow: direct method (preferred method), where cash inflows and outflows are classified by nature indirect method, where cash inflows and outflows are initially derived by adjusting net profit for the effects of non-cash transactions (e.g., depreciations) © Andrea Urbinati possiamo identificare nel cash flow statement tre categorie: - cash flow dalle operazioni STATEMENT OF CASH FLOW - cash flow da attività di investimento - cash flow da attività finanziarie Statement of cash flow classifies cash inflows and outflows in three category: cash flow from operations, i.e., financial flows related to the main revenue-producing activities of the company cash flow from investing activities, i.e., financial flows related to the acquisition and disposal of long-term assets and other non-financial investments cash flow from financing activities, i.e., financial flows related to changes in the equity capital and debts of the company, as well as in financial investments il cash flow dalle operazioni può essere calcolato partendo dall' EBIT a cui aggiungiamo: ENIT + D/A (depreciation amortization) + difference in net working capital (difference in receivables, payables and inventories) © Andrea Urbinati IL CAS FINALE SARà DATO DAI CASH FLOW DALLE VARIE ATTIVITà PIù IL CASH INIZIALE STATEMENT OF CASH FLOW: CUCINELLI [INDIRECT METHOD] © Andrea Urbinati STATEMENT OF CASH FLOW: CUCINELLI [INDIRECT METHOD] Δ Net Working Capital = -/+ Δ Receivables -/+ Δ Inventories +/- Δ Payables NET WORKING CAPITAL = ATTIVITA CORRENTI - PASSIVITà CORRENTI con il net workin capital vado a valutare l'abilità della azienda nel gestire le attività correnti (breve termine) cose che sono likely a diventare cash per pagare gli stakeholders è meglio dunque estinguere il debito usando il net working capital. il cash generato i surplus alla fine dell'anno è utile infatti per fare investimenti e pagare gli shareholders. © Andrea Urbinati il non-current cash è bene usarlo per non-current cose STATEMENT OF CASH FLOW: CUCINELLI [INDIRECT METHOD] © Andrea Urbinati STATEMENT OF CASH FLOW: CUCINELLI [INDIRECT METHOD] At the finish of each company’s operating cycle (usually, midnight of 31/12 of each year), con il cash flow statement abbiamo alla fine dell'anno il valore di cassa the overall Cash che rientra nello stato patrimoniale generated in the Cash nella voce degli asset "cash and cash equivalents" Flow Statement converge as Cash and Cash Equivalents in the Total Assets © Andrea Urbinati BALANCE SHEET: CUCINELLI [TOTAL ASSETS] © Andrea Urbinati AGENDA Annual Report: key accounting principles and main documents Analysis of Annual Report Profitability Ratios Liquidity Ratios Summary and conclusions © Andrea Urbinati OBJECTIVE AND TOOLS The aim of the analysis of an Annual Report is to provide a quick and useful overview of the company’s main results Ratio analysis, summarizing information particularly concerning the economic profit achieved and its main components (profitability analysis) and the status of liquidity and its “coherence” with existing present obligations (liquidity analysis) “Revenue is vanity, profit is sanity and cash is reality” © Andrea Urbinati le ratio invece che guardare ai numeri assoluti RATIO ANALYSIS presenti nei report annuali, danno informazioni più veritiere circa l'abilità dell'azienda di fare profitto e cassa The use of ratios instead of absolute numbers (i.e. the single item of annual report’s documents) gives more information on the ability of a company of making profit and/or generating cash con i ratio l'azienda può creare un suo trend storico per monitoraee il lavoro e misurare l'impatto degli even ti esterni, così come può Ratios allow compararsi ai ratio dei competitors to compare present with past company’s performance (usually 2-3 years) and to define an historical trend for each ratio, further investigating potential impacts of contingencies or non-ordinary events related to the company’s own activities to compare the performance of the company with that of other firms (usually main competitors), further investigating potential impacts of contingencies or non-ordinary events related to the industry/ies where the company operates © Andrea Urbinati gli indicatori guardano prevalentemente nel passato -> analisi della bontà di quanto è stato fatto RATIO ANALYSIS Ratios are powerful tools in supporting analysis of annual reports, as they provide a quick measure of company’s performance and they signal where further investigation is needed i ratio necessano cautela ove: - ci sono degli standard soggettivi e se voglio Ratios, however, have to be carefully managed: comparare due aziende devo assicurarmi di adottare gli stessi - devo capire a quali valori faccio riferimento se a quelli presi da fine anno o inizio anno in defining comparable firms, it should be taken into account also: (o una media) accounting principles adopted (e.g., IAS/IFRS, US Gaap) evaluation criteria used for main items (e.g. cost model vs. fair value model for property, plant and equipment) in calculating ratios involving balance sheet items, it is needed to define whether the calculation is made on: year-end value initial value average value © Andrea Urbinati l'analisi di profittabilità serve per valutare la capacità della PROFITABILITY ANALYSIS azienda di fare profitto e di identificare le componenti principali a seconda di che valore mettiamo al centro, assumiamo una prospettiva attoriale diversa The aim of profitability analysis is to evaluate the ability of the company in making profit and to identify its main components Profitability analysis can be done under three different perspectives: shareholders’ perspective, assuming net profit (i.e. the “reward” of shareholders) as main item of analysis overall company’s perspective, assuming operating profit (i.e. EBIT) as main item of analysis stakeholders’ perspective, analysing the effects of I (interest) and T (Taxes) on the final net profit (E) © Andrea Urbinati SHAREHOLDERS’ PERSPECTIVE ROE = PROFITTO NETTO / EQUITY Ratios commonly used under the shareholders’ perspective are: valori alti indicano efficienza nell'usare l'equity per amministrare l'azienda Net Profit ROE (Return on Equity) (%) Shareholders’ Equity It is among the most used and renown ratios. It measures the “interest rate” on shareholders’ equity, i.e. how much they earned on the investment they made in the company. The higher is the ratio, the better managers are using the equity base for running the company © Andrea Urbinati IL NET PROFIT MARGIN (NPM) = NET PROFIT/ SHAREHOLDERS’ PERSPECTIVE REVENUES indica quale parte del profitto arriva dalle revenus (considerare che fanno registrare segno più anche proventi finanziari, rivalutazioni di asset, … vendita di asset,...) Net Profit Net Profit Margin (%) Revenues It is also known as bottom line margin. It measures the percentage of profit shareholders can retain from revenues (i.e. the starting point of Income Statement). It is to remember, however, that in real companies positive contributions to profit can be referred also to: variations of fair value gains on sale of assets reversion of provisions financial incomes income from discontinued operations … It should not be taken as the only reference number for evaluating a company. © Andrea Urbinati il ROI = EBIT / TOT. ASSETS viene utilizzato per valutare generalmente i managers. inidca infatti quanto profitto OVERALL COMPANY’S PERSPECTIVE operativo si riesce a generare usando le risorse interne (assets) Ratios commonly used under the overall company’s perspective are: ROI or ROA (%) Operating Profit (EBIT) (Return on Investment Total Assets or Return on Assets) It measures the ability of managers to generate profit by using company’s assets for continuing business operations. It is also used in managers’ internal evaluation. The higher is the better. un alternativa è data dal return on sales definito come: RoS = EBIT / Revenues questo guarda più al margine di guadagno di vendita, il ROA al volume di vendita © Andrea Urbinati OVERALL COMPANY’S PERSPECTIVE … Operating Profit (EBIT) Operating Profit Margin (%) Revenues Revenues Asset Turnover Ratio (abs.) Total Assets EBITDA Margin (%) Operating Profit + Depreciation + Amortisation (eventually using Revenues notes to financial statements) They further defines the profit components related to continuing business operations, and particularly the impact of depreciation and amortisation of assets (EBITDA margin) EBITDA margin is also used for better comparing companies operating in the same industry but with a different degree of vertical integration © Andrea Urbinati STAKEHOLDERS’ PERSPECTIVE Ratios commonly used under the stakeholders’ perspective are: GEARING = DEBT / EQUITY Debt-to-Equity Ratio Total Liabilities committment of creditors and lenders vs committments of shareholders or Gearing (abs.) Shareholders’ Equity Interest Rate (IR) (%) Financial Expenses – Financial Incomes (eventually using l'interest rate è tecnicamente il Total Liabilities "costo del debito", il peso delle notes to financial statements) spese di interesse l'IR è anche calcolabile come: IR = EBIT - EBT / liabilities They measure respectively: the commitment in the company’s capital of suppliers, lenders, creditors and other non-equity investors versus the commitment of shareholders the relative weight of interest expenses (i.e., the cost of outstanding debt) on the total liabilities (the lower the ratio, the less the company is burdened by debt expense) © Andrea Urbinati STAKEHOLDERS’ PERSPECTIVE … Net Earnings Effective Tax Rate (T) (%) Pre-tax Profit ETR = NET PROFIT / EBT It measure the effective weight of taxation on the company’s profit © Andrea Urbinati PROFITABILITY ANALYSIS – FINANCIAL LEVERAGE Financial Leverage la leva finanziaria presenta un risvolto ROI - IR = differenziale competitivo interessante: all'aumentare del gearing (quindi del debito) aumenta anche il ROE ROE = [ROI + Debt-to-Equity x (ROI - IR)] x T quindi l'equity. Contraendo debito si può far dunque crescere lattività però la trappola sta nel tenere d'occhio l'effetto dell IR che può essere controproducente. La differenza ROI - IR The relation between ROI and ROE is mediated by the effect of debts deve essere positiva altrimenti distruggiam il valore per gli shareholders. Increasing Debt-to-Equity Ratio, e.g., increasing bank debts or issuing new bonds, amplifies (other things being equal) ROE over ROI … but be aware of the trap! … increasing D-to-E Ratio also amplifies IR as it increases the amount of interest to be paid la gestione finanziaria influenza il risultato per gli shareholders! © Andrea Urbinati PROFITABILITY ANALYSIS – FINANCIAL LEVERAGE n.b. la matrice non considera il debito positivamente ma per crescere l'azienda ha bisogno di debito poi deve spostarsi nel quadrante in basso a destra. The risk/operational efficiency matrix Per non rischiare, conviene fare debito quando ci si trova in un mercato in CRESCITA e non in uno incerto (rischioso) Debt-to-Equity average il ROI deve essere sempre alto non ha senso stare nel quadrante in basso a sx ROI average © Andrea Urbinati l'analisi di liquidità serve a valutare la capacità dell' azienda di disporre di denaro liquido per poter ripagare le obbligazioni a cui è soggetta LIQUIDITY ANALYSIS The aim of liquidity analysis is to evaluate the status of liquidity and its “coherence” with existing present obligations, i.e. the ability of the company to meet its financial obligations when claimed by owners of related rights le ratio dell'analisi possono seguire una prospettiva asssets-liabilities analizzando gli items liquidi nel balance sheet, oppure una di cash flow analizzando quelli del cash flow statement Ratios are then used under two different perspectives: –Assets-Liabilities perspective, analysing “liquidity” items in Balance Sheet –Cash Flow perspective, analysing “liquidity” items in Cash Flow Statement © Andrea Urbinati LIQUIDITY RATIOS: ASSETS-LIABILITIES PERSPECTIVE Ratios commonly used under the assets-liabilities perspective are: CURRENT RATIO = ASSET CORRENTI / Current Assets PASSIVITà CORRENTI Current Ratio (abs.) Current Liabilities QUICK RATIO = ASSET CORRENTI - INVENTARIO / PASSIVITà CORRENTI Quick Ratio (abs.) Current Assets – Inventories (also known as Current Liabilities Acid-Test Ratio) la differenza tra i due indicatori sta nel fatto che il test acido considera disponibilità super liquide senza contare gli inventari (praticamente solo cash disponibile a ripagare le obbligazioni) They measure to what extent company's current assets (in the quick ratio further refined by isolating only most liquid assets) are readily available to pay off its current liabilities. The higher the ratios, the better … unless they hidden the fact the company is not able to invest its money … © Andrea Urbinati i ratios devono essere alti per essere positivi, ma avere alti gli asset non significa che vada bene così. infatti l'azienda deve saper investire e avere alto il ROI -> ritorno sugli investimenti o assets (ROI = EBIT / assets) LIQUIDITY RATIOS: CASH FLOW PERSPECTIVE Ratios commonly used under the cash flow perspective are: Cash Flow-to-Debt Operating Cash Flow Ratio (abs.) Non-current Liabilities Short-term Debt Operating Cash Flow Coverage(abs.) Current Liabilities capex si riferisce a ammortamenti Operating Cash Flow nel conto economico e immobilizza- Capital Expenditure zioni e beni pluriennali nello stato patrimoniale Coverage (abs.) Capital Expenditure (CAPEX) They measure the ability of operating cash flow to meet company’s financial obligations concerning liabilities and ongoing investments. The higher the ratios, the better in questa prospettiva si guarda alla capacità esclusiva del cash flow operativo di rispondere alle obbligazioni e agli investimenti a lungo termine © Andrea Urbinati (capex) LIQUIDITY ANALYSIS The liquidity matrix Cash-to-Debt average CR average © Andrea Urbinati AGENDA Annual Report: key accounting principles and main documents Analysis of Annual Report Profitability Ratios Liquidity Ratios Summary and conclusions © Andrea Urbinati SUMMARY AND CONCLUSIONS “It is very easy for people approaching ratios for the first time to go through a series of reactions, initially seeing the calculation of the ratios as an end in itself and then later asking what use the ratios are for” Annual Report analysis sheds light on certain aspects of the company but at the very end is the analyst who has to provide his/her own interpretation Remembering that: not all the ratios have the same relevance ratios pose questions more than providing answers © Andrea Urbinati THANKYOU CONTACT INFORMATION LEGAL NOTES

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