Research: Financial Domain & Case Studies – Part 1 Welcome to Class 18 Research: Financial Domain & Case Studies – Part 1 Chapter 8

Corporate Financial Performance Assess each of the following: Revenue Profitability Cash flow Liquidity Asset utilization Financial leverage Operating leverage Return on stockholder investment Stock value, and more

Performance Assessment: Issues to Remember  Performance is a matter of opinion  Terminology is often inconsistent

Opinion Different analysts may have different opinions about performance. They may compare a firm’s achievements to a different set of performance benchmarks. OR 2. They may be assigning different values to individual performance components.

Terminology Technicate Every profession has multiple terminologists. A “terminologist” is one who uses or creates words or phrases to "technicate" terms in order to convey a unique thought or idea. The result is "terminological incongruity“ which creates barriers to communication. “Technicate” is an original word created to demonstrate what terminologists do in creating or redefining words to describe thoughts or ideas.

Clarification = Communication Thus, we define how the term: “INVESTED CAPITAL” will be used for analysis purposes

Shareholders and Creditors. Invested Capital Invested Capital will represent the total of all funds contributed by both Shareholders and Creditors. Invested Capital $$ Shareholder Creditor Therefore…

Invested Capital [IC] = [CC] + [EC] or [CC] + [EC] = [IC] Invested Capital = Creditor Capital + Equity Capital [IC] = [CC] + [EC] or Creditor Capital + Equity Capital = Invested Capital [CC] + [EC] = [IC]

Accounting Equation [A] = [L] + [E] or [L] + [E] = [A] Assets = Liabilities + Equity [A] = [L] + [E] or Liabilities + Equity = Assets [L] + [E] = [A]

Think about it… Liabilities Equity Assets Capital Creditor Equity Invested Think about it… Liabilities Equity Assets Capital Invested Assets

Assets, Liabilities, & Equity A closer look at Assets, Liabilities, & Equity

Assets, Liabilities, & Equity For analysis purposes we will divide as follows: Assets are divided into "current" and “noncurrent.” Liabilities are divided into "current" and “noncurrent.” Equity is divided into "paid in" and "earned.“ Invested capital is divided into "borrowed" and "equity." Financial services firms generally do not divide their assets and liabilities. These organizations include S & Ls, banks, investment houses, etc. They believe the financial nature of their business does not require this distinction. Although, some analysts are likely to disagree.

Liabilities (Borrowed Capital): Assets: (1) Current Assets (assist with required payments) (2) Noncurrent Assets (enable the firm to conduct its business) [facilities, equipment, property, long-term investments, intangibles, etc.]   Liabilities (Borrowed Capital): (1) Current Liabilities or near-term debt (due within 1 yr. or the operating cycle) (2) Long-term debt (all the other debt) Shareholder Equity (Equity Capital): (1) Earned Capital (accumulated earnings that have been retained in the business) (2) Paid-in Capital (money paid by stockholders to purchase stock) Invested Capital: (1) Borrowed Capital (credit extended by suppliers, banks, and note and bondholders, etc.) (2) Equity Capital (investments by stockholders)

These are highlighted in the Financial Position Model Understanding the relationship between the different classes of accounts is fundamentally important to financial analyses. These are highlighted in the Financial Position Model

Financial Position Model Important relationship between CA & CL     Important relationship

Financial Position Model A thorough understanding of the Financial Position Model is crucial to Financial Decision-Making

The Financial decision-making domain includes: 1. Internal Financing Decisions 2. Asset/Debt Decisions 3. Debt/Equity Decisions

Financing Decisions Internal Asset/Debt Debt/Equity

1. Internal Financing Decisions: Tactical and Strategic Internal financing decisions fall into two main categories: (1) Short-term focus Tactical financing decisions (2) Long-term focus Strategic financing decisions

Internal Financing Decisions: TACTICAL Tactical financing decisions center on maximizing internal funding by changing the way things are done. For example, directing staff to consider ► SPEEDING collections of accounts receivable (ACP) ► REDUCING inventory with JIT (just-in-time) techniques Objective: Improve performance by improving current system

Internal Financing Decisions: STRATEGIC (2) Strategic financing decisions center on making significant changes to some particular aspect of the firm in order to improve cash flow. Significant changes in corporate operations, such as: ► OUTSOURCING customer service, or ► SUBCONTRACTING major manufacturing (e.g. NIKE) Objective: Improve performance by completely changing system

2. Asset and Debt Management Decisions Asset/Debt decisions include consideration of how to maximize utilization of high-ticket assets such as property, facilities, equipment, intangibles, etc. These decisions are also directed at maintaining an optimum balance between: current assets and current liabilities current and noncurrent debt current and noncurrent assets Capital budgeting: Decisions about whether to buy or sell property, plant, & equipment are part of this domain

3. Debt/Equity Decisions Debt and Equity decisions are primarily concerned with: The use and extent of long-term financing The optimum level and configuration of equity The appropriate balance between total debt and total equity. Decision-making in this domain involves considering issues such as: How much money is needed to sustain growth How should the company acquire those funds (For example, should the corporation issue bonds, issue common stock, issue preferred stock, or borrow from other sources?)

Important Financial questions: How much short-term cash is necessary and what is the best strategy to ensure that cash is available when necessary? What is the best long-term strategy for investment in this company? What is the optimum financial leverage? What are the most appropriate sources of cash in-flow?  What is the optimum relationship between equity and debt financing?

End, Research: Financial Domain & Case Studies – Part 1  End, Research: Financial Domain & Case Studies – Part 1 Re-read Chapter 8

Special note on Proxy Statements…. THEY ARE VERY IMPORTANT!!! They include: Invitation to the annual meeting Legal rights and administrative details available to the shareholders Biographies of all directors (most with pictures) Board committees & board compensation Executive compensation Shareholder proposals Information on salaries and bonuses Information on stock options and other significant declarations by the TMT

It contains information such as: Proxy Statement & DEF 14A Proxy statements are available from all publicly traded companies. It contains information such as: Invitation to the annual meeting Legal rights and administrative details available to the shareholders Biographies of all directors (most with pictures) Board committees & board compensation Executive compensation Shareholder proposals SEC Form DEF 14A is a filing with the Securities and Exchange Commission (SEC) used in combination with an annual proxy. It includes: Adequate information to allow shareholders to make informed decision when voting their shares. Date, time and place of shareholder meetings, Dissenter’s right of appraisal, modification or change of securities, voting procedures, and other relevant issues and data.