Operating Assets Net Financial Assets C I Capital Markets Debtholders Or Debt issuers Shareholders F d FCF = C – I = F + d OI = NOPAT= OR – OE Key: F = net cash flow to debtholders and issuers d = net cash flow to shareholders C = cash flow from operations I = cash investment OR = operating revenue OE = operating expense OI = operating income FCF = NOPAT - ΔNOA
The Process of Fundamental Analysis q Where does the firm operate? q Where is the firm currently? q Where is the firm going? q What is the firm worth? 15 Step 2: Analyzing financial statements to know profitability and risk Step 1: Knowing the business Industry and strategy analysis Step 3: Developing forecasts of earnings (profits, payoffs) Step 4 : Convert forecasts to a valuation
Primary Objectives of Profitability Analysis • Evaluate the firm relative to past performance or relative to other firms’ performance • Identify the cause of increases (decreases) in profitability • Determine if the change in profitability is likely to be permanent or transitory 16
Overview • How can you measure the profitability? • RNOA • ROE • What are the drivers of the profitability? • Profit margin and asset turnover • Financial leverage • Evaluate business activities to generate a return on shareholders’ equity: • Operating • Investing • Financing 17
Preparation for Profitability Analysis 18
Measuring Net Operating Assets, Net Financial Obligations, and Equity 19 NOA NFO SE NOA NFA SE OA FO SE FA OL Or OA: operating assets OL: operating liabilities FA: financial assets FO: financial obligations NOA: net operating assets NFO: net financial obligations NFA: net financial assets SE: shareholders’ equity
Reformulating Balance Sheet 20 Operating Assets OA Operating Liabilities OL Financial Asssets FA Financial Obligations FO Shareholders' Equity SE Total Assets OA+FA Debt + Equity OL+FL+SE Operating Assets OA Financial Obligations FO Less Operating Liabilities (OL) Less Financial Assets (FA) Net Financial Obligations NFO Shareholders' Equity SE Net Operating Assets NOA Net Fiancial Obligations + Shareholders' Equity NFO + SE Balance Sheet Reformulated Balance Sheet
Measuring Profit 21 NOA NFO Equity Or Net operating profit after tax = Net financial expense after tax + Net income Net operating profit after tax + Net financial income after tax = Net income NOPAT NFE (after tax) NI NOA NFA Equity NOPAT NFI (after tax) NI
NOPBT = net operating profit before tax NOPAT = net operating profit after tax NFA = net financial assets NFO = net financial obligations NFE = net financial expense NFI = net financial income 22
Reformulating Income Statement NOPBT + NFI before tax - Tax reported = NI 23 Net operating profit before tax or operating income before tax) NOPBT - Tax on NOPBT = NOPAT NFI before tax - Tax on NFI = NFI after tax NOPAT + NFI after tax = NI
Calculating Net Operating Profit After Tax (NOPAT) Tax reported = Tax on NOPBT + NFI x Tax Rate Tax on NOPBT = Tax reported - NFI x Tax Rate NOPAT = NOPBT – Tax on NOPBT = NOPBT – (Tax reported - NFI x Tax Rate) 24 NOA NFA Equity NOPBT = $1,000 NFIBT = $500 Tax reported = $250 Tax rate = 30% NFI x Tax Rate = $500 x .30 = $150 Tax on NOPBT = $250 - $150 = $100
Reformulating Income Statement NOPBT - NFE before tax - Tax reported = NI 25
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