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From the Traditional Accounting to the Financial Vi ewCapital Employed and Invested CapitalMarket vs. Book ValueEnterprise Value vs. Market CapitalizationAsset and Capital Structure Ratios
Section 3.
The analytical Balance sheet: the financial view
From the Traditional Accounting to the Financial Vi ewCapital Employed and Invested CapitalMarket vs. Book ValueEnterprise Value vs. Market CapitalizationAsset and Capital Structure Ratios
The analytical Balance sheet: the financial view Fro m the Traditional Accounting to the Financial ViewCapital Employed and Invested CapitalMarket vs. Book ValueEnterprise Value vs. Market CapitalizationAsset and Capital Structure Ratios
Lists the firm’s assets and liabilities
Employments (uses of funds) Financial Resources
Assets Liabilities and Shareholders’ equity
Where does the money come from?What does the money get spent on?
The analytical Balance sheet: the financial view Fro m the Traditional Accounting to the Financial ViewCapital Employed and Invested CapitalMarket vs. Book ValueEnterprise Value vs. Market CapitalizationAsset and Capital Structure Ratios
A condensed presentation of the Balance Sheet
Shareholders’ equity
Assets Liabilities and Shareholders’ equity
Total Assets Liabilities + Shareholders’ equity
Investment of Shareholders and accumulated reinvestedprofits
Long-Term Financial Debt
Loan or debt obligation with maturities beyond one year
Short-Term Financial Debt
Loan that must be repaid in one year
Accounts Payable Amounts owed to suppliers purchases made on credit
Long-lived Assets Assets (physical or intangible) that produce benefits for more than one year
Inventories Items held for sale or used in the manufacture of products that will be sold
Accounts receivable amounts owed to the firm by customers who have purchased on credit
Cash and marketablesecurities
short-term investments easily sold and converted to cash
The analytical Balance sheet: the financial view Fro m the Traditional Accounting to the Financial ViewCapital Employed and Invested CapitalMarket vs. Book ValueEnterprise Value vs. Market CapitalizationAsset and Capital Structure Ratios
Lists the firm’s assets and liabilities
The Balance sheet does not reflect the firm’s financial position during the year
Provides a snapshot of the firm’s financial position at a given point in time .
The fiscal year may differ from one country to another
The analytical Balance sheet: the financial view Fro m the Traditional Accounting to the Financial ViewCapital Employed and Invested CapitalMarket vs. Book ValueEnterprise Value vs. Market CapitalizationAsset and Capital Structure Ratios
Lists the firm’s assets and liabilities
The Balance sheet does not reflect the firm’s financial position during the year
Provides a snapshot of the firm’s financial position at a given point in time .
The example of the LEGO Toy company
80% of Lego’s annual sales occur between September and December. What could be the impact of the seasonality factor on some of the components of the Balance Sheet?
The fiscal year may differ from one country to another
The analytical Balance sheet: the financial view Fro m the Traditional Accounting to the Financial ViewCapital Employed and Invested CapitalMarket vs. Book ValueEnterprise Value vs. Market CapitalizationAsset and Capital Structure Ratios
The analytical Balance sheet: the financial view Fro m the Traditional Accounting to the Financial ViewCapital Employed and Invested CapitalMarket vs. Book ValueEnterprise Value vs. Market CapitalizationAsset and Capital Structure Ratios
Example : the business model has major implications on the relevant items in the balance sheet
The Balance Sheet: the traditional accounting form
The analytical Balance sheet: the financial view Fro m the Traditional Accounting to the Financial ViewCapital Employed and Invested CapitalMarket vs. Book ValueEnterprise Value vs. Market CapitalizationAsset and Capital Structure Ratios
Example: JIT : Just-In-Time Computer ServicesConsolidated Statements of Financial Position Prepared According to IFRS in € millions
Asset liquidity
Maturity dates
Assets Year 2 Year 1
Goodwill 0,0 0,0Intellectual property rights, brands and other intangible assets 41,0 14,0Net Property, Plant and Equipment 78,7 66,9Financial Assets (Equity in Joint ventures, investments in shares and participations, deferred tax assets, etc.) 1,0 0,0
Total non-current assets 120,7 80,9
Inventories 15,3 14,3
Accounts receivables 18,5 13,2
Other current assets 0,0 0,0
Short-term investments 2,0 1,0Cash and cash equivalents 21,2 19,5
Total current assets 57,0 48,0
TOTAL NET ASSETS 177,7 128,9
Liabilities and Shareholders' Equity Year 2 Year 1
From the Traditional Accounting to the Financial Vi ew
The analytical Balance sheet: the financial view Fro m the Traditional Accounting to the Financial ViewCapital Employed and Invested CapitalMarket vs. Book ValueEnterprise Value vs. Market CapitalizationAsset and Capital Structure Ratios
Assets Liabilities
Fixed Assets
Current Assets:InventoryAccounts receivable
Cash & short-term investments
121
23
Shareholders’ Equity
Long-Term Financial Debt
Current LiabilitiesAccounts Payable
32
106
31
Short –Term Financial Debt 9
34
WCN = Inventory + Accounts
receivable –Accounts Payable
WCN = Inventory + Accounts
receivable –Accounts Payable
Net Fin. Debt = Financial Debt LT & ST – Cash & short-term investments
The analytical Balance sheet: the financial view Fro m the Traditional Accounting to the Financial ViewCapital Employed and Invested CapitalMarket vs. Book ValueEnterprise Value vs. Market CapitalizationAsset and Capital Structure Ratios
Year 2: WC = 15.3 M€ + 18.5M€ – (29.9 + 0.6) = 3.3 millions €
The rationale behind using Net Debt rather than Gro ss debt
The analytical Balance sheet: the financial view Fro m the Traditional Accounting to the Financial ViewCapital Employed and Invested CapitalMarket vs. Book ValueEnterprise Value vs. Market CapitalizationAsset and Capital Structure Ratios
Net Fin. Debt = Financial Debt LT & ST – Cash & short- term investments
The rationale behind using Net Debt rather than Gro ss debt
The analytical Balance sheet: the financial view Fro m the Traditional Accounting to the Financial ViewCapital Employed and Invested CapitalMarket vs. Book ValueEnterprise Value vs. Market CapitalizationAsset and Capital Structure Ratios
Analyzing financial debt
Risk of default
Autonomy/independence of the management vs pressure/intervention of creditors
From the Traditional Accounting to the Financial Vi ew
The analytical Balance sheet: the financial view Fro m the Traditional Accounting to the Financial ViewCapital Employed and Invested CapitalMarket vs. Book ValueEnterprise Value vs. Market CapitalizationAsset and Capital Structure Ratios
Fixed Assets
Net Working Capital
121
Shareholders’ Equity
Net Financial Debt
32
92
3
Invested Capital124Capital Employed 124
The financial simplified presentation of the balance sheet
The analytical Balance sheet: the financial view From the Traditional Accounting to the Financial Vi ewCapital Employed and Invested CapitalMarket vs. Book ValueEnterprise Value vs. Market CapitalizationAsset and Capital Structure Ratios
Total assets do not reflect necessarily the economic real value of the firm
Capital Employed (or Operating Assets) is a better indicator than Total Assets
Capital Employed = Invested Capital
Fixed Assets + Working Capital = Shareholders’ Equi ty + Net Fin. Debt
Fixed Assets 121
Shareholders’ Equity
Net Financial Debt
32
92
3Net Working Capital
Invested Capital
Capital Employed
Quick Check Question : Calculate capital employed of JIT Company (What does the money spent on) ?
The analytical Balance sheet: the financial view From the Traditional Accounting to the Financial Vi ewCapital Employed and Invested CapitalMarket vs. Book ValueEnterprise Value vs. Market CapitalizationAsset and Capital Structure Ratios
The two most important things in any company do not appear in its balance sheet: its reputation and its people
The analytical Balance sheet: the financial view From the Traditional Accounting to the Financial Vi ewCapital Employed and Invested CapitalMarket vs. Book ValueEnterprise Value vs. Market CapitalizationAsset and Capital Structure Ratios
The book value of a firm’s equity is not a good est imate of its “true” value
Many of the assets listed on the balance sheet are valued based on their historical cost rather than their true value today
Many of the firm’s valuable assets may not be captured on the balance sheet
Example: the value of an office building
Example: the expertise of the firm’s employees, the firm’s reputation in the marketplace, the relationships with customers and suppliers, etc.
The book value of a firm’s equity: a reminder
Shareholders’ equity = Total assets - Liabilities
An accounting measure of a shareholder’s net worth
The book value of a firm’s equity could possibly be negative
The analytical Balance sheet: the financial view From the Traditional Accounting to the Financial Vi ewCapital Employed and Invested CapitalMarket vs. Book ValueEnterprise Value vs. Market CapitalizationAsset and Capital Structure Ratios
The analytical Balance sheet: the financial view From the Traditional Accounting to the Financial Vi ewCapital Employed and Invested CapitalMarket vs. Book ValueEnterprise Value vs. Market CapitalizationAsset and Capital Structure Ratios
The analytical Balance sheet: the financial view From the Traditional Accounting to the Financial Vi ewCapital Employed and Invested CapitalMarket vs. Book ValueEnterprise Value vs. Market CapitalizationAsset and Capital Structure Ratios
Book value = Historical cost – depreciation
From a valuation perspective, book values are almost meaningless,
Traditional Accounting:
Problems:
Historical cost ≠ current cost or value
Depreciation ≠ value loss
Book value = Faire Value
should be interpreted with caution
New approach (IFRS):
Problems:
Fair value often impossible to define or arbitrary
The Market Value: an accurate assessment of the “fa ir” value
The analytical Balance sheet: the financial view From the Traditional Accounting to the Financial Vi ewCapital Employed and Invested CapitalMarket vs. Book ValueEnterprise Value vs. Market CapitalizationAsset and Capital Structure Ratios
The market value of a firm’s equity: a company’s Ma rket Capitalization
Cannot be negativeDoes not depend on historical cost of assetsOften differs substantially from book value
Market Capitalization = Market Price per Share x Number of Shares Outstanding
It depends on what investors expect those assets to produce in the future
Quick Check Question : On December 31, JIT had 3.6 million shares outstanding, and these shares are trading for a price of €14 per share. what was the JIT’s market capitalization? How does the market capitalization compare to book value of equity?
The Market-to-book ratio (or Price-to-Book Ratio (P BR))
The analytical Balance sheet: the financial view From the Traditional Accounting to the Financial Vi ewCapital Employed and Invested CapitalMarket vs. Book ValueEnterprise Value vs. Market CapitalizationAsset and Capital Structure Ratios
The ratio of a firm’s market capitalization to the book value of stockholders’ equity:
Quick Check Question : Compute the Market-to-book ratio of JIT Company?
Equity of ValueBook
Equity of ValueMarket RatioBook -to-Market =
5.132.2
50.4RatioBook -to-Market ==
Investors are willing to pay one and a half times the book value of JIT’s shares
M/B Ratio > 1
The market value of the firm’s assets exceeds their historical cost (or liquidation value)
The Market-to-book ratio (or Price-to-Book Ratio (P BR))
The analytical Balance sheet: the financial view From the Traditional Accounting to the Financial Vi ewCapital Employed and Invested CapitalMarket vs. Book ValueEnterprise Value vs. Market CapitalizationAsset and Capital Structure Ratios
Market-to-Book Ratios in 2010 of different firms and groups
Value stocks (low M/B ratios) vs growth stocks (high M/B ratios)
Source: Berk & DeMarzo (2011), Fundamentals of Corporate Finance. Pearson
The analytical Balance sheet: the financial view From the Traditional Accounting to the Financial Vi ewCapital Employed and Invested CapitalMarket vs. Book ValueEnterprise Value vs. Market CapitalizationAsset and Capital Structure Ratios
Capital Employed (= Shareholders’ Equity + Net Financial Debt) is a good estimate of a firm’s value
Enterprise Value = Market cap + Debt - Cash
Quick Check Question : JIT’s Market Cap = € 50.4 million. What was the JIT’s Enterprise Value in N+1?
It would cost € 142.4 million to buy all of JIT’s equity and pay off its debt
Enterprise Value =
Market value of Capital Employed = Market value of Equity + Net Financial Debt
The analytical Balance sheet: the financial view From the Traditional Accounting to the Financial Vi ewCapital Employed and Invested CapitalMarket vs. Book ValueEnterprise Value vs. Market CapitalizationAsset and Capital Structure Ratios
The analytical Balance sheet: the financial view From the Traditional Accounting to the Financial Vi ewCapital Employed and Invested CapitalMarket vs. Book ValueEnterprise Value vs. Market CapitalizationAsset and Capital Structure Ratios
The analytical Balance sheet: the financial view From the Traditional Accounting to the Financial Vi ewCapital Employed and Invested CapitalMarket vs. Book ValueEnterprise Value vs. Market CapitalizationAsset and Capital Structure Ratios
The analytical Balance sheet: the financial view From the Traditional Accounting to the Financial Vi ewCapital Employed and Invested CapitalMarket vs. Book ValueEnterprise Value vs. Market CapitalizationAsset and Capital Structure Ratios
Asset Structure Ratios and Capital Structure Ratios
The analytical Balance sheet: the financial view From the Traditional Accounting to the Financial Vi ewCapital Employed and Invested CapitalMarket vs. Book ValueEnterprise Value vs. Market CapitalizationAsset and Capital Structure Ratios
What can we learn from analyzing a firm’s balance sheet (book value)?
Estimate the liquidation value : the value of the firm after its assets are sold and liabilities paid
Useful information on :
How the money is raised ?
Leverage, borrowing capacity, short-term cash needs, etc.
How the firm uses its money?
The ratio of fixed assets, the ratio of current assets, liquidity of assets, etc.
Asset Structure Ratios: How the firm uses its money ?
The analytical Balance sheet: the financial view From the Traditional Accounting to the Financial Vi ewCapital Employed and Invested CapitalMarket vs. Book ValueEnterprise Value vs. Market CapitalizationAsset and Capital Structure Ratios
Used to assess the weight of each asset in the operating activity
Asset Structure Ratios: How the firm uses its money ?
The analytical Balance sheet: the financial view From the Traditional Accounting to the Financial Vi ewCapital Employed and Invested CapitalMarket vs. Book ValueEnterprise Value vs. Market CapitalizationAsset and Capital Structure Ratios
Working Capital Needs in days worth of sales – JIT
Capital Structure ratios: Where does the money come from?
The analytical Balance sheet: the financial view From the Traditional Accounting to the Financial Vi ewCapital Employed and Invested CapitalMarket vs. Book ValueEnterprise Value vs. Market CapitalizationAsset and Capital Structure Ratios
Used to assess the weight of the debt as a source of financing
Indicate the level of dependence vis-à-vis of creditors
Equity Total
DebtNet RatioEquity -Debt Ratio (gearing) Leverage ==
Equity TotalDebtNet
DebtNet Ratio Capital-to-Debt
+=
sInvestment Short term &Cash -Debt FinancialDebt Fin.Net =
Capital Structure ratios: Where does the money come from?
The analytical Balance sheet: the financial view From the Traditional Accounting to the Financial Vi ewCapital Employed and Invested CapitalMarket vs. Book ValueEnterprise Value vs. Market CapitalizationAsset and Capital Structure Ratios
Financial leverage may increase because of a decrease in shareholder equity
The significant fall in equity between 2010 and 2011 (-31%) is due to the distribution of Dia shares, which reduced shareholder’s equity by €2.2B and the payment of €0.8B in cash dividends
The analytical Balance sheet: the financial view From the Traditional Accounting to the Financial Vi ewCapital Employed and Invested CapitalMarket vs. Book ValueEnterprise Value vs. Market CapitalizationAsset and Capital Structure Ratios
Because of the difficulty interpreting the book value of equity…
… it is more informative to compare the firm’s debt to the market value of its equity
Example:
Domino’s Pizza has, based on the strength of its cash flow, consistently borrowed in excess of the book value of its assets.
In 2012, it had debt of $ 1.6 billion, with a total book value of assets of only $ 600 million and an equity book value of -$ 1.4 billion
• Fixed Assets to Total Assets decreased in 2013 when Twitter reinvested new capital into short term investments but it has since then invested in fixed assets raising the level back to 33%.
• As company with no physical products, Twitter has no inventory.
• The accounts receivables the main reason working capital is high and increasing; it decreased in 2013 when total assets increased but has also grown back since implying Twitter has not improved its positioning with advertisers.
Appendix – Increase in fixed assets, the example of Yahoo!
-200,00%
-100,00%
0,00%
100,00%
200,00%
300,00%
400,00%
500,00%
2013 2014 2015 2016
Net Sales Total Assets Net Income
2012 2013 2014 2015 2016
Net Sales -6.16% -1.32% 7.58% 4.05%
Total
Assets-1.74% 268.71% -27.04% 6.37%
Net
Income-65.36% 450.26% -157.95% 95.09%
• The growth rate of net sales began to be positivefrom 2015 and keep increasing, which indicates theimprovement of the core business.
• The growth rate of total assets keep increasing intotal, and has its peak in 2014.
� In 2014, the total assets increased muchfaster than the net sales, due to theappreciation of fair value for Alibaba’s sharesthrough its IPO.
• The growth rate of net income suffered fromfluctuations:
� In 2014, Yahoo increased its net income byselling Alibaba Group ADSs for $9.4billion .
• We can conclude that Yahoo!’s wealth creationability is not very stable, their ability to gain incomefrom daily operating activities is not good andmostly rely on other income means to maintain thegrowth of net income.
The Group’s net financial debt was €36.2 billion at 30 June 2016 compared to €37.4 billion on 31 December 2015. This decrease of €1,187 million was mainly due to a positive Group cash flow (+€107 million) and to a favorable currency effect (+€1,036 million) due t o the depreciation of the exchange rate of the pound sterling .