CORPORATE

FINANCE
Lecture 2
Ph.D Chung Thúy An
Finance and Banking
an.ct@ou.edu.vn
Key Concepts and Skills

• Understand the information provided by financial statements.

• Standardized financial statements
• Financial ratios
• The DuPont identity
• Advantages and disadvantages of the financial statements
The Balance Sheet

• An accountant’s snapshot of the firm’s accounting value at a specific point in

time
• The Balance Sheet Identity is:
Assets = Liabilities + Stockholders′ equity
The Balance Sheet (Cont.)

• The assets are listed in order by the length of time it would normally take a
firm with ongoing operations to convert them into cash.
• Clearly, cash is much more liquid than property, plant, and equipment.
The Balance Sheet (Cont.)
Balance Sheet Analysis

• When analysing a balance sheet, the financial manager should be aware of

three concerns:
1. Liquidity.
2. Debt versus equity.
3. Value versus cost.
Liquidity
Balance Sheet Analysis

• Liquidity 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.
Debt versus Equity
Balance Sheet Analysis

• Bondholders generally receive the first claim on the firm’s cash flow.
• Stockholders’ equity is the residual difference between assets and liabilities.
Value versus Cost
Balance Sheet Analysis

• Under generally accepted accounting principles (G A A P), audited financial

statements of firms in the U.S. 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.
Net Working Captial

NWC usually grows

with the firm.
Income Statement

• Measures financial performance over a specific period of time

• The accounting definition of income is:
Revenue − Expenses = Income
Income Statement (Cont.)

• The operations section of the

income statement reports the
firm’s revenues and expenses
from principal operations.
Income Statement (Cont.)

• The nonoperating section of

the income statement
includes all financing costs,
such as interest expense.
Income Statement (Cont.)

• Usually a separate section

reports the amount of taxes
levied on income.
Noncash Items

• Depreciation is the most apparent. No firm ever writes a check for

“depreciation.”
• Another noncash item is deferred taxes, which does not represent a cash flow.
 Net Income is not cash.
Taxes

• The one thing we can rely on with taxes is that they are always changing.
• Average versus marginal tax rates.

the tax bill

Average =
taxable income

Marginal: Percentage paid on the next dollar earned.

• Other taxes
Cash Flow of the Firm

• In finance, the most important item that can be extracted from financial
statements is the actual cash flow of the firm.
• Since there is no magic in finance, it must be the case that the cash flow
received from the firm’s assets must equal the cash flows to the firm’s
creditors and stockholders.
𝐶𝐶𝐶𝐶(A) ≡ 𝐶𝐶𝐶𝐶(B) + 𝐶𝐶𝐶𝐶(S)
Cash Flow of the Firm
Cash Flow of the Firm
Cash Flow of the Firm

• NWC grew from $252 million in

2018 to $271 million in 2019.
• This increase of $19 million is the
addition to NWC.
Cash Flow of the Firm
Cash Flow of the Firm
Cash Flow of the Firm

The cash flow received from the

firm’s assets must equal the cash
flows to the firm’s creditors and
stockholders:
The Accounting Statement of Cash Flows

• There is an official accounting statement called the statement of cash flows.

• The three components of the statement of cash flows are:

• Cash flow from operating activities.
• Cash flow from investing activities.
• Cash flow from financing activities.
Cash Flow from Operating Activities

• To calculate cash flow from operating Operations

activities, start with net income, add Net income $ 86

back noncash items like depreciation Depreciation 90

and adjust for changes in current assets Deferred taxes 9

and liabilities (other than cash). Change in assets and liabilities

Accounts receivable −24

Inventories 11

Accounts payable 35

Cash flow from operating activities $207

Cash Flow from Investing Activities

• Cash flow from investing activities Operations

Acquisition of fixed assets −$198
involves changes in capital assets:
acquisition of fixed assets and sales of Sales of fixed assets 25

fixed assets (i.e., net capital Cash flow from operating −$173
activities
expenditures).
Cash Flow from Financing Activities

• Cash flows to and from creditors and Operations

Retirement of long-term debt −$73
owners include changes in equity and
debt. Proceeds from long-term debt 86
sales
Dividends −43

Repurchase of stock −6

Proceeds from new stock issue 43

Cash flow from financing $ 7

activities
The Statement of Cash Flows

• The statement of cash flows is the

addition of cash flows from operations,
investing activities, and financing
activities.
The Statement of Cash Flows

Source: Vinamilk financial reports 2022

The Statement of Cash Flows

Source: Vinamilk financial reports 2022

The Statement of Cash Flows

Source: Vinamilk financial reports 2022

The Statement of Cash Flows

Source: Vinamilk financial reports 2022

Cash Flow Management

• Cash flow analysis is popular as it is difficult to manipulate (or spin) cash flows;
• Total cash flow is more objective, but the underlying components may also be
“managed”
• Moving cash flow from the investing section to the operating section may
make the firm’s business appear more stable.
 Focusing on the total cash flow, not just operating cash flow
Cash Flow Management (Cont.)
Financial Statement Analysis
Financial Statements Analysis

• Standardized statements make it easier to compare financial information,

particularly as the company grows.
• They are also useful for comparing companies of different sizes, particularly
within the same industry.
• Common-Size Balance Sheets
• Compute all accounts as a percent of total assets.

• Common-Size Income Statements

• Compute all line items as a percent of sales.
Ratio Analysis

• Ratios also allow for better comparison through time or between companies.
• As we look at each ratio, ask yourself:
• How is the ratio computed?
• What is the ratio trying to measure and why?
• What is the unit of measurement?
• What does the value indicate?
• How can we improve the company’s ratio?
Categories of Financial Ratios

• Short-term solvency, or liquidity, ratios.

• Long-term solvency, or financial leverage, ratios.
• Asset management, or turnover, ratios.
• Profitability ratios.
• Market value ratios.
Liquidity Ratios

𝐶𝐶𝐶𝐶
Current Ratio =
𝐶𝐶𝐶𝐶
(𝐶𝐶𝐶𝐶 − Inventory)
Quick Ratio =
𝐶𝐶𝐶𝐶
Cash
Cash Ratio =
𝐶𝐶𝐶𝐶
Leverage Ratios

(𝑇𝑇𝑇𝑇 − 𝑇𝑇𝑇𝑇)
Total Debt Ratio =
𝑇𝑇𝑇𝑇

𝑇𝑇𝑇𝑇
Debt − Equity Ratio =
𝑇𝑇𝑇𝑇

𝑇𝑇𝑇𝑇
Equity Multiplier = = 1 + 𝐷𝐷 − 𝐸𝐸
𝑇𝑇𝑇𝑇

𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸
Times Interest Earned =
Interest

(𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸 + Depreciation and Amortization)

Cash Coverage =
Interest
Turnover Ratios

CostofGoodsSold
InventoryTurnover =
Inventory

365
Day′sSalesinInventory =
InventoryTurnover

Sales
ReceivablesTurnover =
AccountsReceivable

365
Day′sSalesinReceivables =
Receivables

Sales
TotalAssetTurnover =
TotalAssets
Profitability Ratios

NetIncome
ProfitMargin =
Sales

𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸
𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸Margin =
Sales

NetIncome
ReturnonAssets (ROA) =
TotalAssets

NetIncome
ReturnonEquity (ROE) =
TotalEquity
Market Value Ratios

Pricepershare
Price–EarningsRatio =
Earningspershare

Marketvaluepershare
Market–to–BookRatio =
Bookvaluepershare

MarketCapitalization = Pricepershare × Sharesoutstanding

EnterpriseValue EV = Marketcapitalization + Marketvalueofinterest − bearingdebt − Cash

𝐸𝐸𝐸𝐸
𝐸𝐸𝐸𝐸Multiple =
𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸
Financial Ratios

• Ratios are not very helpful by themselves: they need to be compared to

something
• Time Trend Analysis
• Used to see how the firm’s performance is changing through time.

• Peer Group Analysis

• Compare to similar companies or within industries.
DuPont Identity
Using the DuPont Identity

• ROE = Profit Margin × Total Assets Turnover × Equity Multiplier

• Profit margin is a measure of the firm’s operating efficiency—how well it
controls costs.
• Total asset turnover is a measure of the firm’s asset use efficiency—how
well it manages its assets.
• Equity multiplier is a measure of the firm’s financial leverage.
Potential Problems

• There is no underlying theory, so there is no way to know which ratios are

most relevant.
• Benchmarking is difficult for diversified firms.
• Globalization and international competition make comparison more difficult
because of differences in accounting regulations.
• Firms use varying accounting procedures.
• Firms have different fiscal years.
• Extraordinary, or one-time, events.
THANK YOU