Components 1-6 Summary Notes PDF

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Component 1: Accounting Classification of Financial Stat Statements ements Financial statements need to be comparable: • •

Statements of companies may not be comparable because of different accounting standards. SA companies converted to IFRS; comparison to previous years where other accounting standards were used may be problematic.

The solution: • • •

Standardise the publish financial statements. Facilitates comparisons between companies and over time. Simplifies the calculation of financial ratios.

Assets: non-current assets + current assets Equity: ordinary shares + reserves + preference shares + non-controlling interest Debt: non-current liabilities + current liabilities.

Cash flow: cash at the beginning of the year + movement in cash during the year = cash at the end of the year.

Ratio Analysis DuPont analysis: A DuPont analysis provides the breakdown of the components that contribute to a company’s ROE (return on equity), in order to evaluate changes in the ratio. • • •

Possible to identify the individual components that contribute to the overall value of the return ratio. It is also possible to evaluate changes in the values of ratios over time to determine where possible problem areas exist. It can also be used to compare the ratios of similar firms to investigate where value is created.

Unless the tax rates are indicated in a question, you should apply the following rates: Company tax rate: 28% Capital gains tax rate: 80% VAT: 14%

DuPont Analysis ROE: 𝐏𝐫𝐨𝐟𝐢𝐭'𝐀𝐟𝐭𝐞𝐫'𝐓𝐚𝐱 𝐀𝐯𝐞𝐫𝐚𝐠𝐞'𝐄𝐪𝐮𝐢𝐭𝐲

ROA:

Leverage:

𝐏𝐫𝐨𝐟𝐢𝐭'𝐀𝐟𝐭𝐞𝐫'𝐓𝐚𝐱 𝐀𝐯𝐞𝐫𝐚𝐠𝐞'𝐓𝐨𝐭𝐚𝐥'𝐀𝐬𝐬𝐞𝐭𝐬

𝐀𝐯𝐞𝐫𝐚𝐠𝐞'𝐓𝐨𝐭𝐚𝐥'𝐀𝐬𝐬𝐞𝐭𝐬 𝐀𝐯𝐞𝐫𝐚𝐠𝐞'𝐄𝐪𝐮𝐢𝐭𝐲

Net Profit Margin:

Total Asset Turnover:

𝐏𝐫𝐨𝐟𝐢𝐭'𝐀𝐟𝐭𝐞𝐫'𝐓𝐚𝐱 𝐓𝐮𝐫𝐧𝐨𝐯𝐞𝐫

𝐓𝐮𝐫𝐧𝐨𝐯𝐞𝐫 𝐀𝐯𝐞𝐫𝐚𝐠𝐞'𝐓𝐨𝐭𝐚𝐥'𝐀𝐬𝐬𝐞𝐭𝐬

Tax Burden:

Interest Burden:

EBIT Margin:

𝐏𝐫𝐨𝐟𝐢𝐭'𝐀𝐟𝐭𝐞𝐫'𝐓𝐚𝐱 𝐏𝐫𝐨𝐟𝐢𝐭'𝐁𝐞𝐟𝐨𝐫𝐞'𝐓𝐚𝐱

𝐏𝐫𝐨𝐟𝐢𝐭'𝐁𝐞𝐟𝐨𝐫𝐞'𝐓𝐚𝐱 𝐄𝐁𝐈𝐓

𝐄𝐁𝐈𝐓 𝐓𝐮𝐫𝐧𝐨𝐯𝐞𝐫

Profitability Ratios Evaluates the efficiency with which a company utilises its capital to generate turnover • •

Small investment in assets generates large income – company is highly profitable. Large investment in assets generates small income – assets are not utilised efficiently.

Possible to calculate the profitability of different capital items. Ensure a relevant comparison between capital item and corresponding income/profit.

Return on Assets (ROA) Measures how efficiently total assets are utilised to generate turnover. It compares profit after tax with total assets. ROA =

Profit after tax 100 ´ Average total assets 1

In order to improve ROA: • • •

Improve the profit figure Reduce the amount of assets Combination of the above mentioned two

Return on Equity (ROE) Indicates the return generated on total equity. Total equity includes ordinary shareholder’s equity, preference share capital and non-controlling interest. ROE =

Profit after tax 100 ´ Averageequity 1

Solvency Ratios Solvency refers to a company’s ability to cover all its obligations when it eventually closes its operating activities. The comparison between total assets, equity and debt capital: •

If the value of assets exceeds the value of liabilities, the solvency level would most probably be sufficient.

•

If this is not the case, long term survival of the company may be at risk.

Financial Leverage Ratio The amount of total assets is compared with the amount of equity capital included in a company’s capital structure. •

The higher the value of this ratio, the weaker the solvency position.

Financial Leverage Ratio =

Average total assets Averagetotalequity

Profit Margins Indication of the percentage of turnover that shows as profits are certain deductions are made. Profit margins could influence profitability ratios. •

Higher profit margins should increase profitability levels.

EBIT Profit made before taking any finance cost and tax into consideration. EBIT margin =

Profit before tax + Finance cost 100 ´ Turnover 1

Net Profit Margin (NP) The portion of turnover available after tax is paid, belongs to equity providers. It is the indication of the portion of the turnover that belongs to: • • • NP =

Non-controlling interest shareholders. Which can be paid as ordinary or preference dividends. Can be reinvested as part of the company’s reserves.

Profit after tax 100 ´ Turnover 1

Turnover Ratios Indicates the speed with which an investment in assets is converted into turnover. • •

The higher the value of the ratio, the more timers per year the investment is utilised to generate turnover, and the higher the total profit should become. Higher turnover ratios should increase profitability levels.

Total Asset Turnover Ratio Indicates the efficiency with which total assets are utilised to generate turnover. • •

The higher the value of TA turnover ratio, the more times per year the investment in total assets is converted into turnover. If a company is able to improve TA turnover ratio while maintain same profit margins, its return on assets should increase.

TA turnover =

Turnover Averagetotal assets

Component 2: Managerial Classification of Financial Statements Corporate return is influenced by: • •

Method of financing, asset composition, tax situation etc. Management compensation (ability to generate operating income by utilising operating assets).

Operating Assets Long-Term Operating Assets (LTOC) •

PPE, trademarks, patents, manufacturing licences.

Net Operating Working Capital (NOWC) •

Operating current assets (OCA) – Operating current liabilities (OCL) = NOWC

Net Operating Capital (NOC) •

LTOC + NOWC = NOC

Non-Operating Assets •

Financial assets

• • • •

Loans granted Share investments Non-operating current assets Goodwill

1. NOPAT NOPAT = EBIT* x (1-T) Excludes: • • •

Finance cost Investment income Gain/loss on sale of PPE

EBIT* NOT EQUAL to profit before tax + finance cost EBIT* = operating profit

2. Free Cash Flow (FCF) FCF = NOPAT - ∆NOC ∆NOC = Year 2 NOC – Year 1 NOC • •

Cash flow available for distribution to external capital providers After investing in the net operating capital required to sustain future operations

Utilisation of FCF: • •

Payment of finance cost Repayment of debt capital

• • •

Dividend payments Share repurchases Purchase of marketable securities

Relationship with the value of the company: • • •

FCF is available to external capital providers Company’s value depends on expected future FCF Value = PV (future FCF @ WACC)

ROIC =

𝐍𝐎𝐏𝐀𝐓 𝐍𝐎𝐂

Negative FCF: • •

NOPAT = operating problems NOC = investment in growth

Profitable growth: •

ROIC > WACC

Positive FCF always good? NO: • •

Negative NOPAT Divestment in NOC (∆ is negative)

3. Market Value Added (MVA) MVA = market value of external capital – book value of external capital External capital = equity + debt + preference shares

4. Economic Value Added (EVA) EVA = NOC x (ROIC – WACC) Or EVA = NOC x (ROIC – WACC)

Component 3: Internal and Sustainable Growth Rates Internal Growth Rate

1. IGR =

RONA =

𝐑𝐎𝐍𝐀%%𝐱%%𝐛 𝟏%)%%(𝐑𝐎𝐍𝐀%%𝐱%%𝐛)

,-./01%2/13-%456 731%288318

Net assets = Total assets – Operating current liabilities b=

93150:3;%...