5 - Historical Operating Assumptions

5 - Historical Operating Assumptions - Historical Operating...

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Unformatted text preview: Historical Operating Assumptions Chapters 5 – recording and understanding the past Operating assumptions drive the income statement Income statement is one driver of cash flow Operating items refers to Revenues, Expenses and Expenditures that are not impacted by the company's Capital Structure i.e., they are not affected by Interest Expense Our goal is to understand the factors that have driven… EBIT (operating income) Revenue ­Cost of Goods Sold Gross Profit ­Selling General and Adminstrative Expenses EBITDA ­Depreciation and Amortization EBIT Capital Expenditures Estimating growth rates Estimating growth rates It is easier to think about (and convince people about) future growth rates than future cash flows. The terminal value (for DCF) will be largely determined by the growth rate Historical Operating Assumptions Historical Operating Assumptions Backward­looking Provide historical information about past Revenue and Profitability Historical revenue growth and margin levels are key factors in the forecasting process. They will be our reference point Useful only if the status quo is maintained, erratic growth may be due to acquisitions or divestitures Calculating growth rates Calculating growth rates ( Salest − Salest −1 ) Growth = Salest −1 Equivalent to… Salest Growth = − 1 Salest − 1 Building the historical assumptions Everything Starts with Sales Key implicit assumption Key implicit assumption Constant economies of scale Rapid growth is often accompanied by diseconomies of scale Do the historical numbers make sense? Are the growth rates sustainable? Is the past indicative of the future? Cost of Goods Sold Cost of Goods Sold We are interested in COGS as a percentage of sales Some firms include depreciation in COGS You will want to break depreciation out from COGS, so that you can vary the depreciation method. Cash Gross Profit Cash Gross Profit Cash Gross Profit = Sales – cash COGS Ignores depreciation Cash Gross Margin Cash Gross Margin Margin means that the item is divided by sales Cash Gross Margin is a key driver for commodity industries When the firm is a price taker, the low cost producer will enjoy a competitive advantage SGAE SGAE Selling, General, and Administrative Expenses We want this as a percentage of Sales Some firms include amortization in SGAE Break out the Amortization charge, so that we can vary the amortization schedule Now you are ready for EBITDA Now you are ready for EBITDA EBITDA = Cash Gross Profit – Cash SGAE Earnings before interest, taxes, depreciation, and amortization Three ways to get EBITDA Three ways to get EBITDA Take Net Income (Earnings) and add back Interest, Tax, Depreciation and Amortization expenses. Start with EBIT and just add back Depreciation and Amortization. Start with Revenue and subtract only the Cash COGS (excluding Depreciation) and Cash SG&A (excluding Amortization) EBITDA is also often called EBITDA is also often called Operating Cash Flow EBITDA is both a cash flow measure and an Operating measure Since it excludes non­cash items and it is calculated before subtracting interest expense. EBITDA is before interest expense, so it is independent of capital structure So, you can assess the impact of a Transaction on a company without having to change EBITDA EBIT ­ Earnings Before Interest and EBIT ­ Earnings Before Interest and Taxes. Sales minus the expenses that are directly related to the operations of the business, but before subtracting Interest expense and Income Taxes. EBIT Margin is simply EBIT divided by Revenue. EBIT is operating profit or operating EBIT is operating profit or operating income Capital structure does not impact Operating Profit Interest expense is irrelevant That is very important because it allows for a consistent measure of profit no matter what type of transaction is analyzed Most transactions have an impact on Interest expense because of borrowing or repaying debt Why is EBIT important? Why is EBIT important? EBIT refers to is the profits that a company is making from its core businesses, without regard to its capital structure As a result EBIT margin is used to compare relative efficiencies of companies in the same industry The last historical assumption is The last historical assumption is Capital Expenditures Cap Ex are investments made in the long term Assets of the company They primarily represent additions to Property, Plant and Equipment (PP&E) Crucial to getting the unlevered cash flow Now that you’ve seen the past You need to make sense of what you see ...
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