LESSON 1

FINANCIAL STATEMENT ANALYSIS
Basic Financial Statements

Balance Sheet: financial statement that provides a snapshot of a venture’s financial position as of a specific date

Income Statement: financial statement that reports the revenues generated & expenses incurred over an accounting period

Statement of Cash Flows: shows how cash, reflected in accrual accounting, flowed into & out of a firm during a specific period of operation

Operating Breakeven Analysis

Variable Expenses: costs or expenses that vary directly with revenues

Fixed Expenses: costs that are expected to remain constant over a range of revenues for a specific time period

EBITDA: earnings before interest, taxes, & depreciation & amortization

EBDAT: earnings before depreciation, amortization, & taxes

EBDAT Breakeven: amount of revenues (survival) needed to cover cash operating expenses

Cash Flow Breakeven: cash flow at zero for a specific period (EBDAT = 0)

Survival Breakeven Analysis

Basic Equation:

EBDAT = Revenues (R) - Variable Costs (VC) – Cash Fixed Costs (CFC)

Where: CFC includes both fixed operating (e.g., general & administrative, & possibly marketing expenses) & fixed financing (interest) costs

When EBDAT is Zero: R = VC + CFC
Breakeven Level of Survival Revenue

Starting Point:

Ratio of variable costs (VC) to revenues (R) is a constant (VC/R) & is called the Variable Cost Revenue Ratio (VCRR)

Survival Revenues (SR) = VC + CFC

Rewriting, CFC = SR – VC

By substitution, CFC = SR[1 – (VCRR)]

Solving for SR, SR = [CFC/(1 – VCRR)]
NOPAT Breakeven Analysis

Economic Value Added (EVA): measure of a firm’s economic profit over a specified time period

NOPAT: net operating profit after taxes or EBIT times one minus the firm’s tax rate

NOPAT Breakeven Revenues (NR): amount of revenues needed to cover a venture’s total operating costs

Basic Equation: NR = TOFC/(1 – VCRR)

Where: TOFC is the total operating fixed costs which consist of cash operating fixed costs (excluding interest expenses) plus noncash fixed costs (e.g., depreciation)

Breakeven Drivers

1. Contribution Profit Margin = 1 – VCRR

higher contribution profit margins mean lower levels of survival revenues are needed to break even (EBDAT = 0)

2. Amount of Cash Fixed Costs

lower cash fixed costs result in lower levels of survival revenues needed to breakeven (EBDAT = 0)

Financial Ratios and Analysis

Financial Ratios: show the relationship between two or more financial variables

Trend Analysis: used to examine a venture’s performance over time

Cross-sectional Analysis: used to compare a venture’s performance against another firm at the same point in time

Industry Comparable Analysis: used to compare a venture’s performance against the average performance in the same industry

Financial Forecasting Process

The Financial Forecasting Process contains the following steps:

Sales forecast

Identify spontaneous assets & liabilities

Project Balance Sheet

Reconcile Balance Sheet to Income Statement

Project Income Statement

Simulation

Decision made

That is we:
1. We forecast sales over the period. Note it is the sales forecast that drives the analysis. The better the forecast, the better your analysis.

2. We identify the spontaneous assets and liabilities. Spontaneous assets and liabilities increase as sales increase. In our first cut, we assume that they go up the same percentage as sales. Quasi-spontaneous assets go up with sales, but are “lumpy.” They do not go up as a percentage of sales, but as whole units (see below – you can not buy half a piece of equipment – you must buy a whole piece). Quasi-spontaneous equity is retained earnings. Retained earnings will probably go up with sales, but not as a percentage.

3. We project the Pro-Forma Balance Sheet by increasing spontaneous assets and liabilities by the