Читать книгу Corporate Value Creation - Karlson Lawrence C. - Страница 15

Ms. Engel has just returned from completing an Executive Management Program at the University of Pennsylvania's Wharton School. In keeping with the school's reputation the program had an emphasis on developing quantitative skills, which wasn't a problem for Ms. Engel since she had a degree in electrical engineering. The assignment from the Professor of Finance who conducted the concluding session was for all participants to do an analysis of their company's financial statements using the skills they had just developed when they returned to their offices.

Ms. Engel's employer is Advanced Solar Systems Corporation. As the name would suggest, the Company specializes in systems that utilize solar technology to build power sources for the military and aerospace industries. One of the things that was stressed by the professors conducting the program was that while all students should have a solid grasp of the relationships they were taught that defined the financial statements, they should also remember that the statements are logical, and with a little practice they can be analyzed by running some simple calculations based on inspection rather than rigorous mathematical treatment. With this in mind and after scanning the Solar Systems Income Statement, Ms. Engel did a comparative analysis of the actual results for the Prior Year and the forecast for the Current Year. The Income Statement including the analysis is shown in Table CS 1-1.

Table CS 1-1 Advanced Solar Systems Comparative Income Statement

After looking at the Comparative Analysis, Ms Engel concluded:

• Revenue increased 12 % on a year-over-year basis driven by the demand for the company's products, what one expects of a growth company.

• The Cost of Goods Sold (COGS) had increased by 100 basis points (1 %) from 56 % to 57 %. While this is a movement in the wrong direction, it was not unexpected given the startup costs associated with the products that had been released to production at the end of the Prior Year.

• As a result of the deterioration in the COGS, the Gross Margin (GM) decreased to 43 %.

• Operating Expense decreased from 27 % to 24.5 % but in absolute terms increased slightly to $307,632,000. The reduction in percentage terms was to be expected given the Revenue Growth. The modest increase was made possible by the reduction in R&D expenses associated with the new products that were released to production at the end of Prior Year.

• Driven by the Revenue and OpExp the EBITDA increased 150 basis points (1.5 %) to 18.5 %, which is in keeping with the operating leverage obtained by managing the Operating Expenses while increasing Revenue.

• Depreciation increased from 3 % to 3.2 % of Revenue as the company continued to invest to keep up with demand and technology.

• Since the company was debt-free there was no interest expense. Management preferred to remain very liquid, so all cash on hand was invested in money market funds. The outcome of this was that very little interest was earned from the available cash.

• As expected (driven by Revenue and Operating Expenses), the Earnings before Taxes increased from 14.02 % to 15.34 % of Revenue.

• For the last two years the company's CFO and VP of Tax had been working on a program to reduce the company's taxes. This effort is expected to pay off in the Current Year and contribute substantially to the company's Net Income, which is forecasted to grow to nearly 10 % of Revenue.

After thinking about the Income Statement Analysis she just finished, Ms. Engel concluded that overall the company had a great year and management should continue to focus on growing Revenue, reducing the Cost of Goods Sold, and carefully managing Operating Expenses.

She then moved on to the Balance Sheet. She knew from her Wharton Program that the preferred way to think about Working Capital was in terms of Days Outstanding, Inventory Turns, and so forth. However, given that she was primarily interested in what was happening directionally with Working Capital, she thought this was an unnecessary complication, and made some annotations using percentages of revenue. The result of her work is included in the Balance Sheet, Table CS 1-2.

• Her first observation was that Advanced Solar's Balance Sheet was expanding rapidly.

• Her second observation was that Cash was building and if this continued, the company would be in a position to finance a major new program, do an acquisition, and pay a dividend or some combination thereof.

• Accounts Receivable needed attention, having increased from 21 % to 24 % of Revenue.

• The same could also be true for inventory, which had increased from 14 % to 16 % of Revenue. Given her experience in engineering and manufacturing she knew that if this was a result of a deterioration in inventory management as opposed to a temporary build associated with the new products, a major write-off could be in the offing since in Advanced Solar's business product enhancements and obsolescence were a way of life.

• Depreciation also increased as a percentage of Revenue driven by investments in plant and equipment. After some thought she concluded that this was not a concern because the spike could be a result of the timing associated with purchases and useful life assumptions but primarily because Depreciation as a percentage of Revenue was fairly stable in the range of 3 %.

• Since the company didn't have any Short-Term or Long-Term Debt, the only thing of note on the Liabilities and Total Shareholders' Equity side was the Accounts Payable, which had increased as a percentage of Revenue to16 percent.

Table CS 1-2 Advanced Solar Systems Comparative Balance Sheet

The take-home value from her analysis of the Balance Sheet was: Management needed to understand why Receivables and Inventory were increasing and take appropriate action. As for Accounts Payable, they needed to make sure they were paying suppliers on a timely basis since they fed Solar's manufacturing plant and played a huge role in product quality, product cost, and delivery performance.

Next, and primarily out of curiosity, she decided to take a closer look at Working Capital and the impact the changes had on the company's Cash Flow. The results are tabulated in Table CS 1-3.

Table CS 1-3 Working Capital Analysis $(000)'s

After studying Table CS 1-3 Ms. Engel observed the following:

• Accounts Receivable increased by $33,072,000 and since this was cash the company had not collected, the impact on the company's Cash was negative or a “Use of Cash.”

• Inventory increased by $17,610,000 and this inventory build had to be paid for. So like Accounts Receivable the impact on Cash was negative and also a “Use of Cash.”

• Accounts Payable was a different matter. They increased by $25,718,000 and this indicated the company had made purchases that they hadn't paid for and in a sense was using their suppliers to finance their operations. From an accounting perspective the Cash impact was a positive $25,718,000 and a “Source of Cash.”

• The company's practice was to pay all taxes by year-end. Hence, there was no change from one year to the next, so there wasn't any Taxes Payable impact on Working Capital.

• The impact of Short-Term Debt on the change in Working Capital is zero since the company didn't expect to have debt of any kind on its Balance Sheet at the end of either year.

• The net Cash impact of the changes in the company's Working Capital was a negative $24,963,000.

Ms. Engel recalled that of the three financial statements, the one that caused the most difficulty for many of the managers who attended the training program was the Cash Flow Statement. So she decided to see if she could work her way through Solar's Current Year Cash Flow Statement27 that was part of the management reporting package (Table CS 1-4).

Table CS 1-4 Advanced Solar Systems Cash Flow Statement $(000)'s

When it came to cash flow from operations, the first entry was Net Income ($125,169,000). This was logical because Net Income is what the company earned during the year and the major source of Cash Flow from Operating Activities. Depreciation ($40,181,000) was added back since it represented a charge in the Income Statement for assets that were being depleted and, since they were paid for in a prior period, didn't have any Cash impact. Interest Income ($455,000) was a different matter. It was a Source of Cash but since it wasn't generated from operations it had to be deducted. The Change in Working Capital ($24,963,000, according to the analysis she had completed and tabulated in Table CS 1-3) was a use of cash so it should be deducted when determining the Cash Flow from Operating Activities.

In summary, the Cash Flow from Operating Activities ($139,932,000) was obtained by starting with the Net Income, adding back the Depreciation, subtracting the Interest Income, and deducting the Change in Working Capital.

Ms. Engel then proceeded to the Investment section of the Cash Flow Statement. Initially she was puzzled by where the $55,000,000 of “Investments” came from. After thinking about it she concluded that since it was most probably an investment in assets, it had to be on the Balance Sheet. Sure enough, after subtracting the “Fixed Assets at Cost” at the end of the Prior Year from the forecasted “Fixed Assets at Cost” at the end of the Current Year ($692,889,000 – 637,889,000 = $55,000,000) she found the source of the $55,000,000 entry.

With this information the Cash Flow after Investing Activities ($84,932,000) was easily obtained by subtracting the $55,000,000 investment in Fixed Assets from the Cash Flow from Operating Activities ($139,932,000).

Since Solar didn't pay any dividends there wasn't any impact on Cash Flow.

When it came to Financing, Ms. Engel was fine with no impact from Debt or Shareholders' Contributions on the Cash Flow Statement since the company didn't borrow any money during the year or raise any capital from shareholders. However, she was puzzled for a moment to see the $455,000 of Interest Income entered in this section of the Cash Flow Statement. Then she realized that since it had been deducted in the operating section of the statement because it wasn't a source of operating cash it was a source of cash and had to be added back to obtain the Cash Generated ($85,386,000) during the period.

Having worked her way through the financial statements she was now at a point where she could finish her analysis by calculating the Return on Capital Employed (ROCE) and the Required Revenue (RR).

After checking her notes she recalled that the ROCE could be calculated by applying Equations [1-30] and [1-32].

[1-30]

where

[1-32]CE = TSHE + STD + LTD

Substituting values from Tables CS 1-1 and CS 1-2 the ROCE's for Prior and Current Years were obtained:

ROCEPriorYear = 14.2%

or

ROCECurrentYear = 15.2%

Ms. Engel noted that the ROCE was moving in the right direction, but she wasn't sure how these returns compared to other companies in the industry. Given the company's profitability she intuitively expected them to be higher. Also she noted that since the company was beginning to accumulate cash it could drastically increase the ROCE by paying a dividend to decrease the Total Shareholders' Equity, and concluded that maybe she should begin to purchase shares in the company as and when she had excess cash.

To deal with the question of Required Revenue she once again consulted her notes to refresh her memory. The result was the Required Revenue equation, Equation [1-65].

[1-65]

Since she planned to use the material she was preparing in a training program for her staff, she decided to only deal with the Current Year and prepared Table CS 1-5 because she felt it would simplify the process associated with applying the Required Revenue equation.

Table CS 1-5 Required Revenue $'s and %

She then proceeded to use this data and calculated each of the terms.

Ms. Engel then substituted the calculated values for each of the terms in Equation [1-65], which gave her a Required Revenue for the Current Year of $1,260,561,000, which didn't agree with the Revenue shown for the Current Year in the Income Statement ($1,255,643,000).

RRCurrentYear = 676,589,000 + 217,195,000 + 2,459,000 + 364,318,000

= $1,260,558,000

She quickly realized her mistake. The Interest Income of $455,000 actually reduced the Revenue required to cover the Net Income, Depreciation, and Taxes Paid. The correct answer was then obtained by changing the sign on the NetInt term in the Required Revenue expression.

RRCurrentYear = 676,589,000 + 217,195,000 − 2,459,000 + 364,318,000

= $1,255,643,000

While staring at the result of applying the Required Revenue equation she was struck by the fact that in order to create $125 million of Net Income, the company had to generate $364 million of Revenue to pay the taxes and $217 million of Revenue to cover Depreciation and Amortization, and only after $581 million of Revenue had been produced did the next dollar of Revenue contribute to profit.