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TMP 120 (Bogart) Week 3 Notes


TMP 120 (Bogart) Week 3 Notes TMP 120

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All lecture notes from TMP 120 (Business Strategy) with Bogart
Business Strategy
Class Notes
UCSB, TMP, tmp120, bogart, business
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This 10 page Class Notes was uploaded by on Friday October 14, 2016. The Class Notes belongs to TMP 120 at University of California Santa Barbara taught by Bogart in Fall 2016. Since its upload, it has received 2 views. For similar materials see Business Strategy in tmp at University of California Santa Barbara.


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Date Created: 10/14/16
Monday, October 10, 2016 Week 3 Lecture 5 - 10/10/16 - Financial Statements Review • Income Statement (“P&L”) - Diary of actions taken to change the business’ profitability - What’s Sold in the Period • MINUS What it cost to make • MINUS Selling and general expenses • EQUALS income for the period • Balance Sheet - “Snapshot” of company health on one date - Report: Has today (Assets) = Owes today (liabilities) + Worth today (equity) • Cashflow Statement - Tracks the movement of cash through the business over a period of time - Shows: Cash on hand at the start of the period • PLUS Cash received in the period • MINUS Cash spent in the period • EQUALS cash on hand at the end of the period • Statement of Owners’ Equity - Changes in your equity balance during the period - Ratio Analysis: • Compare a firm’s performance against their performance in another time period, other companies in their industry, and the economy • Specific ratios are more meaningful to particular types of industry - Liquidity 1 Monday, October 10, 2016 - Profitability - Asset Management - Capital Structure - Market Measures • Follow the clues! What’s going on? - Financial Ratios: What Do They Tell Us? Liquidity Ratios / Solvency Ratios: Assesses company’s short-term ability to pay its • debt as it becomes due • Profitability Ratios / Margin Ratios: Assesses company’s success or failure in generating profit • Asset Management Ratios / Turnover Ratios / Efficiency Ratios / Activity Ratios / Return Ratios: Assesses company’s effectiveness in applying its various assets • Capital Structure Ratios / Leverage Ratios: Assesses company’s long-term ability to pay its debt as it becomes due • Market Measure Ratios / Market Ratios: Investors’ view of a company and its stock value - Liquidity Ratios & Insights • Current Ratio = current assets / current liabilities - Tells us whether the company has enough money to cover short-term debts • Acid Test = cash + cash equivalents + market securities + acts receivable / current liabilities - Tells us if the firm can pay its Current liabilities within 90 days. Considers only “Quick Assets” and ignores less liquid assets like inventory • Collection Period = Average Accounts Receivable / (Sales/360) - Time it takes for a business to convert balances from Accounts receivable into cash • Days to Sell Inventory = Average inventory / (Cost of sales/360) - Shows how long it takes a company to turn its inventory into sales. Generally, a lower (shorter) DSI is preferred 2 Monday, October 10, 2016 - Profitability Ratios (Margin Ratios) & Insights • Gross Profit Margin = (sales - cost of sales) / sales - Shows the proportion of money left over the Revenues after accounting for COGs • Operating Profit Margin = income from operations / sales - Measures a firm’s pricing strategy and operating efficiency • Pretax Profit Margin = income before income taxes / sales - Company earnings before tax as a percentage of revenues • Net Profit Margin = net income / sales - Remaining profit after costs of production, administration, and financing are deducted from sales, and taxes have been recognized - Asset Management Ratios & Insights • Cash turnover = sales / average cash + equivalents - Number of times that the company’s cash has been spent through in a period of time. Measures the frequency of company’s cash account replenished through the sales revenues • Accounts Receivable Turnover = sales / average accounts receivable - Measures how many times a business can turn its accounts receivable into cash during a period • Inventory Turnover = cost of goods sold / average inventory - Shows how many times a company’s inventory is sold and replaced over a period of time • PPE Turnover = sales / average PPE - Measures how well the business is using its plant, property, and equipment assets to generate sales. A declining ratio over time may indicate that the business is over-invested in them • Total Assets Turnover = sales / average total assets - Indicates the efficiency with which a company uses its assets to generate revenues 3 Monday, October 10, 2016 • Asset to Sales = total assets / sales - Measures how much in asses a company has relative to the amount of revenues the company can generate using their assets - Returns Ratios & Insights • Return on Assets = net income + interest expense (1-tax rate) / average total assets - Indicates how efficient management is at using its assets to generate earnings • Return on Common Equity = net income / average shareholders equity - Measures the ability of a firm to generate profits from its shareholders investments in the company. Shows how much profit each dollar of common stockholders’ equity generates. • Return on Sales = net income / sales - Indicates how efficiently a company generates profits from its revenues - Capital Structure Ratios & Insights • Total Debt to Equity = total liabilities / shareholder’s equity - Indicates how much debt a company is using to finance its assets relative to amount of value represented in shareholders’ equity. A higher ratio indicates that more creditor financing (bank loans) is used than investor financing (shareholders) • Long-Term Debt to Equity = long-term liabilities / shareholder’s equity - measures percentage of a corporation’s assets financed with loans or other financial obligations lasting more than one year • Times Interest Earned = income before income taxes + interest expense / interest expense - Measures a company’s ability to meet its debt payments - Market Measure Ratios & Insights • Price-To-Earnings Ratio = market price per share / earnings per share • Earnings Yield = earnings per share / market price per share • PEG Ratio = (market price per share / earnings per share) / annual EPS growth 4 Monday, October 10, 2016 - Approximation or indicator of a stock’s possible true value. A lower PEG means that the stock is more undervalued. The PEG ratio of 1 is sometimes said to represent a fair trade-off between the values of cost and the values of growth, indicating that a stock is reasonably valued given the expected growth. A negative PEG Ratio suggests that a stock’s future earnings are expected to drop • Dividend Yield = cash dividends per share / market price per share - Measures how much a company pays out in dividends each year relative to its share price • Dividend Payout Ratio = cash dividends per share / earnings per share - Measures how much money a company is returning to its shareholders vs. retaining to reinvest in growth, pay off debt, or add to cash holdings • Price-To-Book = market price per share / book value per share - Book value of Equity on the Balance Sheet (assets = liabilities). If $100M Assets and $75M Liabilities on the B/S, the Book Value would be $25M. If there are 10M shares outstanding, each share would = $2.50 of book value. If each share sells on the market at $5, the P/B ratio would be = 2. - Investors look at this ratio for signals: • When the Stock Price > Book Value: should see high ROA. Effective asset use is baked into growth and returns • When the Stock Price < Book Value: e.g. P/B less <1: could be that the market believes the asset value is overstated (problem!!!) OR the firm is earning a very poor return on its assets. This could be fixed by better management, new strategies, and execution (opportunity!!!) • Should see a time between growth in ROE and P/B • *Note: Does not fit certain industries- e.g. high intangible assets (ignored), high debt, sustained losses, etc. Lecture 6 - 10/12/16 - Agenda: • Macpherson Skate Case 5 Monday, October 10, 2016 • Dealing with Uncertainty Sales Forecasting • • Pro Forma Statements - Increasing Returns and Duration - Identifying Success Factors - - - - - - - - - - - - - 6 Monday, October 10, 2016 - Identifying Key Success Factors by Analyzing Profit Drivers: Retail - - - - - - - - - - - Pro Forma Statements Pro forma = “As if” —> “What if”? • • Is the plan financially feasible? • Implications for current environment? • Financial and operational - Pro Forma & Related Financial Statements • Pro Forma: “What if” — A forecasted financial statement based on a declared set of assumptions to portray the financial outcome of a set of business decisions - Typical statements include • P&L, Balance Sheet, Cash Flow • Ratios based on the statements • Compare against history to check logic - Basic Assumption: Sales Drive Costs & Investments • Forecast future sales • Tie other items in income statement and balance sheet to the sales forecast 7 Monday, October 10, 2016 • Works for variable costs, most current assets and current liabilities • Not generally true for long-term/fixed assets or costs - Steps • 1. Confirm the assumption that most costs vary with sales volume • 2. Examine historical data to ascertain the extent to which percent-of-sales ratios stay constant over time • Forecast sales • Develop Pro forma B/S, P&L, Cash Flow • Do sensitivity analysis to see how financial statements respond to different percent- of-sales parameters - Thinking of the Future: Sales Forecasting • What are your assumptions? - Directions and trends in sales - Market size and share - Industry and economic conditions - Productive and financial capacity - Competitive factors: • Pricing • Strength of your value proposition • Product fit - Build a Pro Forma • Assume when not enough quantitative justification • Build a pro forma • Start with history, Table 3-1 • Look at ratios, Table 3-2 • What’s happened to: 8 Monday, October 10, 2016 - Cash/sales - AP/sales - Earnings/sales - Estimating the External Funding Required • Income statement measures profitability, and garners most investors’ attention • The CFO focuses on the balance sheet to estimate funding needs - Iterative Process • The initial financial plan in the pro forma provides the starting point for a discussion about operations • If the external amount of financing is too large, what kind of operating changes need to be made, relative to pro forma? - Different level of investment? - Sale of assets? - Different working capital policy? - Cutting costs, with associated impact on revenue? - Sensitivity Analysis • “What if” Questions: - What if sales growth is only 15% instead of 25%? - What if COGS is 84% instead of 85%? • Benefits: - Sensitivity analysis produces a range of outcomes - Sensitivity analysis induces managers to prioritize their assumptions according to importance - Scenario Analysis • Singular events can ruin the plan and you! Pay attention to: - Loss of major customer - New competition 9 Monday, October 10, 2016 - New product introductions - Change in perception/taste - Extreme fluxes in income/external factors - Other factors that you identify as critical • Contingency Planning: Plan ahead! - Simulation Analysis Assign probability distributions to each major variable • • Run many pro formas, with the variable values drawn from a Monte Carlo process • Advantage: Many scenarios • Disadvantage: Many managers do not think in terms of probabilities, and the planning issues are opaque - Growth Management • Growth is good - Larger market share in a well run company —> larger profits • But… - Rapid growth can over extend resources • If Actual Growth Exceeds Sustainable Growth: - Options: • Sell new equity • Increase financial leverage • Reduce the dividend payout • Prune away marginal activities Outsource some or all of production • • Increase prices • Merge with a “cash cow” 10


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