Miaomiao Li BSc. MSc. CPm Small, Dip. CIMA Statement of financial position and Business value Miaomiao Li BSc. MSc. CPm Small, Dip. CIMA

Learning Subjects Understanding and production of Statement of Financial position (SOFP) Calculation and explanation of Financial Indicators Common Business Evaluations techniques Balance sheet evaluation Multiple based evaluation Free cash flow evaluation

What is Statement of Financial Position (SOFP) A ‘snapshot’ of the financial position of the business at a particular point in time. Also call it Balance Sheet It is comprised of three main components: Assets, liabilities and equity These three segments give investors an idea as to what the company owns, as well as the amount invested by shareholders.

The SOFP format What has the business got? Where did it come from? Non-current assets Current assets Where did it come from? Current liabilities Long-term liabilities Capital & retained profit (owner’s equity) Cut off between current and non-current (long-term) is one year

What is Asset Assets (practical definition): item of value owned or controlled by the business that can be converted into cash Assets are reported on a company’s SOFP, and they are bought or created to increase the value of a firm Current, Non-current, and Intangible Assets

Current Assets Current assets are: a) short-term economic resources that are expected to be converted into cash within one year. b) cash or cash equivalent c) is held primarily for the purpose of being traded d) is expected to be realised in, or is intended for sales or consumption in, they entity’s normal operating cycle ------- CIMA terminology I.e. cash/cash equivalents, accounts receivable, inventory, bank balance, and various prepaid expenses.

Non Current Assets Non-current assets (previously known as Fixed assets) are long-term resources that company owns. Acquired for retention by an entity for purpose of providing a service to entity and not held for resale in normal course of trading --------CIMA Terminology I.e. land, plants, equipment/machinery and buildings.

Intangible Assets Intangible assets are non-physical, meaning they cannot be touched. They have value because they represent an advantage to a business or organization. I.e. People, Band name, License, Goodwill, copyright, etc

What type of assets are they?   Current Asset Non-Current Asset Intangible Asset Inventory Accounts Receivavles Brand Cash/Bank balance Intellectural Property People Property, Plant & Equipment

What is Liability Liabilities (practical definition) : obligations or financial debt owed by the business at a point in time Current liabilities – reasonably expected to be liquidated within a year. I.e. wages, taxes, and accounts payable, portions of long-term loan to be paid this year. Long-term liabilities – reasonably expected not to be settled within a year. I.e. long-term loan, notes payables, long-term leases,, and long-term product warranties

Are they Liabilities? On balance sheet? Liabilities? Short-term Debt Accounts Payable Tax/Interest Payable Short term Bank Loan Purchases Long term bond Salaries/Wages

Capital and Equity (Share) Capital: total amount initially input by shareholders to the business. In return for their investment, shareholders gain a share of the ownership of the company Retained profit: percentage of net earnings not paid out as dividends, but retained by the company to be reinvested in its core business, or to pay debt Owner’s equity: a source of the company's assets. Owner's equity is sometimes referred to as the book value of the company

The Accounting Equation Reveal the accounting equation and explain that this is a fundamental concept of finance. Although the numbers may change over time this relationship will always hold. Flipchart example to clarify the above Set the scene for delegates. Imagine they are planning to buy a house for £60,000. They can obtain a mortgage for £50,000 so in order to buy the house need to input £10,000 of their own money (they are the sole shareholder of their little ‘property’ company. The house can now be bought because of the accounting equation: 60,000 = 50,000 + 10,000 The £10,000 represents ‘capital’ – an amount of money put in by the ‘owner’ Now imagine a year later the house has risen in value to £70,000. The mortgage was ‘interest only’ so whilst interest has been paid (and recorded in the P&L) the mortgage outstanding is still £50,000. The equation must now balance as follows with C&R being the balancing number 70,000 = 50,000 + 20,000 The £20,000 is made up of the original £10,000 and an additional £10,000 ‘profit’ that the business has generated for its ‘owner’ in the first year of trading. Ask delegates a number of questions: What does the profit represent? (rise in value of the house) Who does it belong to? (the owner) Is it a cash profit? (no, the owner has ‘allowed’ the business to keep it, tied up in the asset How can the owner get it back? (by selling the house – analogous to a shareholder selling shares Refer back to the definition of capital and reserves on which should make more sense Assets = Liabilities + Capital & Retained profit (owner’s Equity) 13

Standard SOFP format

Siemens 2016 SOFP

Example – Statement of Financial Position

Business valuation Financial indicators Non-Financial indicators Profitability Liquidity Asset turnover Non-Financial indicators Balanced Scorecard NFPIs Benchmarking

Financial Indicators – Profitability Return on capital employed (ROCE) Gross profit margin Operating profit margin Net profit margin ROCE measures how well the business is doing in relation to the investment made by its shareholders. Profit margin measures how much a company earns (Gross/Net) relative to its sales.

The drivers of profit margin Pricing Costs Volumes Competition Quality

Financial Indicators – Liquidity Current Ratio Acid-Text (Quick) Ratio Receivable days Payable days

The drivers of liquidity Fixed Asset Inventory Current Assets Payment terms Loan

Financial Indicators – Efficiency Asset turnover Asset turnover is a financial ratio that measures the efficiency of a company's use of its assets in generating sales revenue or sales income to the company. If the ratio is 1, it means company is generating £1 revenue per pound of assets invested. Higher ratio = better performing

Example – Ratio Analysis

Enterprise Value Enterprise Value = Market Capitalization + Market Value of Debt – Cash and Equivalents

Price/earnings ratio - definition Price/earnings (P/E) is the ratio for valuing a company that measures its current share price relative to its per-share earnings.  Where EPS = earnings ÷ total shares outstanding Allows companies to be classified as over- or under-valued relative to the sector, market or historic levels

EV/EBITDA Method EV/EBITDA is a financial ratio that compares a company’s Enterprise Value to its annual EBITDA. EBITDA Multiple = Enterprise Value / EBITDA EBITDA = Earnings Before Interest, Taxes, Depreciation & Amortization.

EBITDA Formula Revenue X Less : cash operating costs (X) EBITDA Less : depreciation and amortisation Profit/loss from operations Less : Interest and tax (x) Net profit for the period x

Free Cash Flow method Free cash flow valuation method is to find out the present value of the cash flow In order to determine the value of a firm, an investor must determine the present value of operating free cash flows. Free cash flow present value = Cash flow x Cost of capital (%) (use discount factor table to find the rate)

Example – Firm value evaluation

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