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Lecture 2.4 - Slides

The document discusses ratio analysis and reformulation of financial statements. It covers accounting treatment of various financial instruments and relationships, as well as non-controlling interests, preferred stock, pensions, and more. Reformulation is needed to value a company from the perspective of common shareholders.

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sfalcao91
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22 views

Lecture 2.4 - Slides

The document discusses ratio analysis and reformulation of financial statements. It covers accounting treatment of various financial instruments and relationships, as well as non-controlling interests, preferred stock, pensions, and more. Reformulation is needed to value a company from the perspective of common shareholders.

Uploaded by

sfalcao91
Copyright
© © All Rights Reserved
Available Formats
Download as PDF, TXT or read online on Scribd
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Chapter 2: Ratio Analysis

Lecture 2.4: Reformulation Part 2


Reformulation
Accounting Recording – Balance Accounting Recording
Instrument Relationship Treatment Valuation Method
Sheet – Income Statement

1. Listed Price
Financial No Influence (usually Dividends recognized
Assets recorded at historical cost Non Core Operations 2. Multiple
Instrument <20% Participation) below operating result
3. Book Value

Assets recorded using the equity


method: at historical cost plus
Significant Influence accumulated share of income of Dividends recognized 1. Listed Price
Associates (usually 20-50% the subsidiary less dividends below operating result Non Core Operations 2. Multiple
Participation) paid by the subsidiary and any 3. Book Value
write-offs of the goodwill on the
purchase

Parent- Control (usually Value alongside the company (included in FCF)


Consolidated financial statements
Subsidiary >50% Participation) but watch out for minority interests
20%

• Dutch company • South Korean company


• Owns 20% of LG • Market Cap: 10,443 billion won

𝑴𝒂𝒓𝒌𝒆𝒕 𝑪𝒂𝒑𝒊𝒕𝒂𝒍𝒊𝒛𝒂𝒕𝒊𝒐𝒏
𝑷𝒉𝒊𝒍𝒊𝒑𝒔 𝑺𝒕𝒂𝒌𝒆 = × 𝑶𝒘𝒏𝒆𝒓𝒔𝒉𝒊𝒑 𝑺𝒕𝒂𝒌𝒆
𝑬𝒙𝒄𝒉𝒂𝒏𝒈𝒆 𝑹𝒂𝒕𝒆 𝑾𝒐𝒏 𝒕𝒐 𝑬𝒖𝒓𝒐𝒔

𝟏𝟎, 𝟒𝟒𝟑, 𝟎𝟎𝟎


𝑷𝒉𝒊𝒍𝒊𝒑𝒔 𝑺𝒕𝒂𝒌𝒆 = × 𝟐𝟎% = 𝟏, 𝟐𝟑𝟕 𝒎𝒊𝒍𝒍𝒊𝒐𝒏𝒔 𝒐𝒇 𝑬𝒖𝒓𝒐𝒔
𝟏, 𝟔𝟖𝟎
Acquiring
Company (Parent)

80%

Acquired
Company Noncontrolling
(Subsidiary) 20% Interests

 When a company has control over another, the results of that subsidiary are included in its financial statements.
 However, a parent company does not need to purchase 100% shares of another company to gain control over that company.
 The holders of the remaining shares are collectively referred to as noncontrolling interests or minority interests
 These represent the equity in a subsidiary that is not attributable, directly or indirectly, to the parent

 Accounting wise, these are reported as part of shareholders’ equity, although they really are not their property.
Example

Company A Company B A buys 80% of B


Assets 100 30 130
Liabilities 25 20 45
Equity 75 10 85

• Common Equity: 75 from previous A + 8 from B = 83


• Minority Interests: 2
 When reformulating, include it on the balance sheet as a separate line next to debt instead of lumping it
together with equity (but don’t include it twice!)
 Upon valuation, this needs to be removed from the enterprise value to get to equity value (same as any
other sort of debt).
COMMON FEATURES TREATMENT
 Dividends are paid out to shareholders before common stock Accounting treats preferred stock as equity or liabilities
dividends are issued. depending on its specific features
 If the company enters bankruptcy, the shareholders with
preferred stock are entitled to be paid from company assets first.
The value preferred shareholders have (the claim they have
 Annual dividends are often compulsory and not in discretion of
managers (sometimes forgone preferred dividends accumulate
on the company) differs from the value of common
and must eventually be paid out to preferred shareholders) shareholders as expected cash flows are different

 Most preferred shares have a fixed dividend, while common


stocks generally do not.
When we reformulate and value the company, we do so from
 Preferred stock shareholders typically do not hold any voting the perspective of common shareholders. As such, we need
rights, but common shareholders usually do.
to reclassify preferred stock as being part of debt instead of
equity and we need to treat preferred dividends as interest
equivalent.
Common Net Debt
Equity

Preferred Minority Interests


Equity

Enterprise Value
A pension plan is an arrangement whereby an employer provides benefits (payments) to
employees after they retire for services they provided while they were working.

Employer

Investment
Pension Plan
Administrator

Retired Employees
Defined Contribution Plan Defined Benefit Plan
The plan stipulates the contribution the The plan stipulates the benefits the employee
Definition employer will make each year and says must receive at the end and says nothing about
nothing about the benefits. the contributions
Risk Borne by employees Borne by employer
Expense recognition The moment the service is rendered by the employee – not the moment the cash flow is paid

 Accounting for defined contribution plans is rather simple since the firm’s obligation is extinguished the moment the
contribution is made.
 For defined benefit plans however, since the contributions may not be equal to the benefits, we may find:
Unfunded pension funds: value of the assets is lower than the value of the obligations
Excess pension assets: value of the assets is higher than the value of the obligations
Pension Status - S&P 500 Companies (2013)
Excess; 9%

Unfunded; 91%

Unfunded Excess
Source: Credit Suisse
 Firms are obliged to disclose the amount that is unfunded or in excess and that should be taken into
account when valuing a firm:
An unfunded pension fund must be subtracted from the firm’s value since it will lead to more
contributions in the future
Excess pension asset must be added up the firm’s value as it will lead to less contributions being
necessary in the future

Treat them as a non core activity rather than a core one!


Pension fund shortfalls do not arise directly from the activity of the company but rather from the
performance of the fund in which the firm as invested, so it does not make sense to treat it as a core part
of the company, nor it would be easy to forecast when valuing.

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