Financial Statement Analysis

Fahmi Ben Abdelkader

2017

Writing a Financial Report: Some Guidelines

Table of contents

1. A guiding principle .................................................................................................................... 2

2. An example of analysis grid ...................................................................................................... 3
3. Financial ratios: the toolkit of the financial analyst ................................................................. 4
3.1. Growth Analysis ................................................................................................................. 4
3.2. Profitability analysis ..........................................................................................................8
3.3. Illiquidity Risk Analysis ................................................................................................... 12
4. Guidance on Data collection and financial statement documents ......................................... 13
5. Assessment and required documents ..................................................................................... 19
6. Detailed marking-scheme ....................................................................................................... 19
7. Index FAQ .............................................................................................................................. 20

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 Financial Statement Analysis
Fahmi Ben Abdelkader
2017

1. A guiding principle

Wealth creation …

requires investments …

that need to be funded …

and be sufficiently profitable

In the long run, a company can survive only if it creates value for its shareholders and meets
its commitments towards all its stakeholders.

To do so, it must:

Generate wealth

Invest

Finance its investments

Generate a sufficient return on

investment

Anticipate and manage illiquidity risk

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 Financial Statement Analysis
Fahmi Ben Abdelkader
2017

2. An example of analysis grid

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 Financial Statement Analysis
Fahmi Ben Abdelkader
2017

3. Financial ratios: the toolkit of the financial analyst

This section provides a selection of most common financial ratios that you can use for your
financial report.

3.1. Growth Analysis

Wealth creation at a glance
Ratio definition
Net Sales Growth rate

Total Assets Growth rate

EBITDA Growth rate

Net Income Growth rate

FAQ 1. How to calculate growth rate when the value goes from positive to
negative or from negative to positive ?

Investment Policy: How the firm uses its money?

Ratio definition

Balance Sheet
Fixed Assets / Total Assets Common-Size measures: Asset Structure

Inventory / Total Assets Asset (i)

Assets Structure Ratios =
Accounts Receivable / Total Assets
Total Assets

Cash & Equivalent / Total Assets

Fixed Assets (I) Balance sheet data: total non-current
assets

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 Financial Statement Analysis
Fahmi Ben Abdelkader
2017

Operating Working Capital (II) = Inventories

+ Accounts Receivable (including other
receivables)
– Accounts Payable (including Other
operating liabilities)

Capital Employed (I)+(II) Fixed Assets + Operating Working Capital

FAQ 2. Should we include “other operating assets” and “other

operating liabilities” in the calculation of Operating Working capital?

Please note that you should include “other operating assets” (which are expected to
be converted in cash in less than one year) and “other operating liabilities” (which
are due in less than one year) when computing net working capital. Otherwise, the
equation “Capital employed = Invested Capital” may not be effective.

Examples of other operating assets: prepayments, deferred tax assets, and other
trade receivables

Examples of other operating and accrued1 liabilities : tax payables, social security,
salaries due to employees, Medicare, deferred tax liabilities, prepayments, etc.

Operating Working capital needs= Inventories + Accounts Receivable

(including other receivables) – Accounts Payable (including other operating
liabilities)

FAQ 3. Net Working Capital or Working capital needs?

There are several denominations for Operating Working Capital:

● Operating Working Capital (OWC)

● Working Capital Requirements (WCR)

● Working capital needs

● « Working capital »

1An accrued liability is an expense that a business has incurred but has not yet paid. A company can accrue liabilities for
any number of obligations, and the accruals can be recorded as either short-term or long-term liabilities on a company's
balance sheet. Payroll taxes, including Social Security, Medicare and federal unemployment taxes are liabilities that can be
accrued in preparation for payment before the taxes are past due.

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 Financial Statement Analysis
Fahmi Ben Abdelkader
2017

Financial Resources: Where does the money come from?

Ratio definition

Financial Leverage Net Debt

Leverage (gearing) Ratio = Debt - Equity Ratio =
Total Equity

Debt-to-capital ratio Net Debt

Debt - to - Capital Ratio =
Net Debt + Total Equity
Long-term debt / Total Liabilities Balance Sheet
Common-Size measures: Liabilities Structure
Short-term debt / Total Liabilities
Accounts payable / Total Liabilities
Shareholders' Equity (I) Balance sheet data: total shareholders’ Equity

Net Financial Debt (II) Net Fin. Debt = Financial Debt - Cash & Short term Investments

Financial debt = Long-term financial debt + Other non-current

liabilities2 + Short-term financial debt
Invested Capital (I)+(II) = Shareholders' Equity + Net Debt

2 Other non-current liabilities (Obligations, deferred tax, etc.)

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 Financial Statement Analysis
Fahmi Ben Abdelkader
2017

Analysis of the Cash cycle

Working Capital Needs in days’ worth of

Ratio definition
sales

Inventory days
+ Receivable days (Including Other Operating item
Receivable)
Operating item Days = * 365
Sales
- Payable Days (including Other operating
liabilities)
= Operating Working Capital days Working Capital Needs
Working Capital Needs Days = * 365
worth of sales Sales

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 Financial Statement Analysis
Fahmi Ben Abdelkader
2017

Cash Analysis
Ratio definition
Cash From Operating Activities (I)
Data from Cash Flow Statement
Cash From Investing Activities (II)
Free Cash Flow (I+II)
FCFF =EBIT * (1- t) + Noncash charges (D&A) – Increase in
Working capital - Capex

FCFE = Net income + Noncash charges (D&A) – Increase in

Working capital - Capex + Net Borrowing

3.2. Profitability analysis

Margin Analysis
Ratio definition
Net Revenue 100%
Cost of sales
Gross Margin
Operating expenses
EBITDA Margin
Common-size analysis - income statement :
Depreciation & amortization
EBIT Margin Profit & expenses % of Net Revenue
Net financial expenses
Pretax Income
- Corporate income tax
Net Profit Margin

NOPAT (Net Operating Profit After

Tax) NOPAT % of Net Revenue

NOPAT = EBIT * (1 - Effective Corporate Tax Rate )

Corporation Tax
Effective Corporate Tax Rate = *100
Earnings Before Tax

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 Financial Statement Analysis
Fahmi Ben Abdelkader
2017

ROIC (Return On Invested Capital)

Ratio definition

NOPAT (Net Operating Profit After Tax)

(I)
NOPAT = EBIT * (1 - Effective Corporate Tax Rate )

Net Revenue
* Turnover rate of Capital employed (II) Turnover rate of invested capital =
Invested Capital
= ROIC (Return On Invested Capital) NOPAT
ROIC =
(I) * (II) Invested Capital

FAQ 4. The particular case of negative Net Debt, negative net cost of debt, and the
calculation of ROIC

Example:

Cash = 70, Gross debt = 50, Equity = 200

net debt = - 20 => meaningless

Financial leverage = -20 / 200 = -10% => meaningless

Financial expenses = 2, Financial revenue = 3

Net cost of debt = -1 / -20 = 5% => false

Suggested solution:

Consider “gross debt” rather than “net debt” and “financial expenses” rather than “net financial expenses)

Net cost of debt = Financial expenses / Gross debt = 2 / 50 = + 4%

Financial leverage = Gross debt / Equity = 50 / 200 = + 25%

NOPAT + financial revenues

ROIC =
Fixet Assets + WC + Cash

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 Financial Statement Analysis
Fahmi Ben Abdelkader
2017

FAQ 5. The particular case of negative Net Cost of Debt

Example:

Cash = 30, Gross debt = 50, Equity = 200

net debt = + 20

Financial leverage = +20 / 200 = 10%

Financial expenses = 2, Financial revenue = 3

Net cost of debt = -1 / 20 = -5% => false

Suggested solution:

Consider “financial expenses” rather than “net financial expenses)

Net cost of debt = Financial expenses / net financial debt = 2 / 20 = + 10%

NOPAT + financial revenues

ROIC =
Fixet Assets + WC

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 Financial Statement Analysis
Fahmi Ben Abdelkader
2017

Return On Equity

Ratio definition
Net Income
ROE (Return On Equity) ROE =
Equity

The Financial Leverage Effect

Ratio definition

NOPAT
ROIC (I) ROIC =
Invested Capital

Net Fin. expenses * (1 - Tax rate)

Net cost of debt (after tax) (II) Net Cost of Debt =
Net Fin. Debt

ROIC - Net cost of debt (I) - (II)

Net Debt
* Financial Leverage (III) Leverage (gearing) Ratio = Debt - Equity Ratio =
Total Equity
= The Financial Leverage Effect
The Financial Leverage Effect = (ROIC - NCD )*
Net Financial Debt
((I) - (II))*(III) Equity

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 Financial Statement Analysis
Fahmi Ben Abdelkader
2017

3.3. Illiquidity Risk Analysis

Short-term illiquidity risk

Ratio definition

Current Assets
Current ratio Current Ratio =
Current Liabilities

Current Assets - Inventories

Quick ratio Quick Ratio =
Current Liabilities

Cash & Cash equivalents + ST investments

Cash ratio Cash Ratio =
Current Liabilities

Cash flow from operations to short-term Cash Flow from Operations

debt ratio
CFO to ST Debt Ratio =
Current Liabilities

Long-term illiquidity risk

Ratio definition
Long-term debt / Total Liabilities Balance Sheet
Short-term debt / Total Liabilities Common-Size measures: Liabilities Structure

Net Debt
Financial Leverage Leverage (gearing) Ratio = Debt - Equity Ratio =
Total Equity

Equity
Solvency ratio Solvency Ratio =
Equity + Total Liabilities
EBIT
Interest Coverage ratio Interest Coverage Ratio =
Net Financial Expenses
Cash Flow from Operations
Interest Coverage ratio (Cash) Interest Coverage Ratio (Cash) =
Net Financial Expenses

FAQ 6. Negative Net Financial Expenses and the calculation of interest

coverage Ratio
The interest coverage ratio is relevant only when net financial expenses (= - financial
expenses + financial income) are negative, in other words, when financial expenses exceed
financial income.
If financial income exceeds financial expenses, it is meaningless to calculate interest
coverage, because there are no interest expenses to cover.

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 Financial Statement Analysis
Fahmi Ben Abdelkader
2017

Net Fin. Debt

Debt to EBITDA Debt to EBITDA =
EBITDA
Net Fin. Debt
Debt to Cash flow from operations ratio Debt to CFO =
Cash Flow from Operations

4. Guidance on Data collection and financial statement

documents

Target company
- It would be better to choose a (non-financial3) listed company to ensure data availability.
- Non listed companies are acceptable, but be sure to have sufficient data
- Please note that Lufthansa will be analyzed in class
- Ideally, a company that is facing financial or operating difficulties ☺
- It would be great, if possible, to have data concerning one of the major competitors of
your target company (advisable work but not mandatory)
Financial statement documents
Some companies provide overly-detailed financial documents with too much information.
Many details are useless for our purpose
You should aggregate details according to the simplified financial statement documents
that we have seen in class (see below)

3 Financial statements for banks present a different analytical problem than statements for manufacturing and service

companies. As a result, analysis of a bank's financial statements requires a distinct approach that recognizes a bank's
unique risks.

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 Financial Statement Analysis
Fahmi Ben Abdelkader
2017

Income Statement
By function or by nature format?
Both are acceptable
Please ensure to get data – at least - on the following items (highlighted in green):
Guidance notes
Net Revenue
Cost of sales If these data are not available, you can report and
Gross Margin derive:
Cost of sales & operating expenses = Net Revenue -
Operating expenses EBITDA
EBITDA If EBITDA is not explicitly recorded, you can
compute :
EBITDA = EBIT - Depreciation & amortization
Depreciation & amortization If Depreciation & amortization is not explicitly
recorded: you can find information on this items in
the Cash Flow Statement or in the notes relative to
Income Statement (See Annual Report)

EBIT
Net financial expenses
Pretax Income
Corporate income tax
Net Income

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 Financial Statement Analysis
Fahmi Ben Abdelkader
2017

FAQ 7. What should we do when EBITDA is not explicitly recorded in the

income statement?

If EBITDA is not explicitly recorded, you can find information on this items in the Cash
Flow Statement or in the notes relative to Income Statement (See Annual Report)

You can compute EBITDA as follows:

EBITDA = EBIT* - Depreciation & amortization

In some income statements, the EBIT might be called “Operating Income” or “Results
from operating activities”, etc. Whatever the appellation, please ensure that the proxy
for the EBIT corresponds to the operating income before deduction of financial
expenses (revenues).

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 Financial Statement Analysis
Fahmi Ben Abdelkader
2017

FAQ 8. Amortisation & depreciation falls in the expenses category (under

Personnel) expenses and not at the end of the statement!

The example of Heineken

=> This is because the company uses the "by nature " format of the income statement
and not the "by function" format. (cf. section 4. Income statement)

In this case the EBIT = Results from operating activities

EBITDA = Results from operating activities - Amortization and depreciation

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 Financial Statement Analysis
Fahmi Ben Abdelkader
2017

Cash Flow Statement

Please ensure to get data – at least - on the following items (highlighted in green):

Net Earnings

+ Depreciation and amortization

+ Other adjustments to reconcile net income to
cash
- Increase in working capital

= Cash From Operating Activities (I)

- Capital expenditures
- Acquisitions and other investing activity
+ Sales of property, plant and equipment
+ Divestments of subsidiaries and other operations

= Cash From Investing Activities (II)

- Dividends paid
+ Sale or purchase of shares
+ Increase/decrease in short-term borrowing
+ Increase/decrease in long-term borrowing

= Cash From Financing Activities (III)

Change in cash and cash equivalents = I+II+III

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 Financial Statement Analysis
Fahmi Ben Abdelkader
2017

Balance Sheet
Assets
Goodwill
Intellectual property rights, brands and other intangible assets
Net Property, Plant and Equipment
Financial Assets (Equity in Joint ventures, investments in shares and
participations, deferred tax assets, etc.)
Total non-current assets

Inventories
Accounts receivables
Other receivables (prepayments, deferred tax assets and other trade receivables)
Short-term investments
Cash and cash equivalents
Total current assets

TOTAL NET ASSETS

Liabilities and Shareholders' Equity

Share Capital
Reserves
Retained earnings
Others (non-controlling interest, minority interests, etc.)
Total Shareholders' Equity

Long-term financial debt

Other non-current liabilities (Obligations, deferred tax, etc.)
Non-current liabilities

Short-term financial debt

Accounts payable
Other operating liabilities (tax payables, social security, salaries due to
employees, prepayments, deferred tax liabilities, etc.)
Current liabilities
Total Liabilities
TOTAL LIABILITIES AND EQUITY

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 Financial Statement Analysis
Fahmi Ben Abdelkader
2017

5. Assessment and required documents

This work will account for 50% of the total grade.

Evaluation will be based on (i) the calculation of financial ratios (in the excel file), and (ii) the
analysis of these ratios (in the power-point document).

Required documents:

1. An excel file with financial statement data and financial ratios (see the example of
Carlsberg)
2. A power-point document including your presentation

6. Detailed marking-scheme

Detailed marking-
Structure of the Financial report scheme
Strategic and Economic Assessment 3
Growth analysis (Sales vs Assets/EBITDA/NetIncome) 3
Investment policy analysis 3
Financial policy analysis 3
Working capital in days worth of sales 3
Cash cycle - Free cash flow analysis 3
Margin analysis & cost structure 3
Margin analysis & peers analysis 2
Operational return (ROIC) & asset turnover 3
Operational return (ROIC) & EVA analysis 1
Operational return (ROIC) & peers analysis 2
ROE & Leverage effect 3
ROE & Residual income 1
Illiquidity risk 2
Solvency risk 2
SWOT analysis 3
Total 40
Total /20 20

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 Financial Statement Analysis
Fahmi Ben Abdelkader
2017

7. Index FAQ

FAQ 1. How to calculate growth rate when the value goes from positive to negative or from
negative to positive ? ........................................................................................................................... 4
FAQ 2. Should we include “other operating assets” and “other operating liabilities” in the
calculation of Operating Working capital? ................................................................................... 5
FAQ 3. Net Working Capital or Working capital needs? .............................................................................. 5
FAQ 4. The particular case of negative Net Debt, negative net cost of debt, and the calculation of
ROIC ........................................................................................................................................................ 9
FAQ 5. The particular case of negative Net Cost of Debt............................................................................ 10
FAQ 6. Negative Net Financial Expenses and the calculation of interest coverage Ratio ................ 12
FAQ 7. What should we do when EBITDA is not explicitly recorded in the income statement? ... 15
FAQ 8. Amortisation & depreciation falls in the expenses category (under Personnel) expenses
and not at the end of the statement! ............................................................................................ 16

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