APPENDIX I Financial Analysis Using Financial Genome An advanced financial analysis, statement generation and business planning soft- ware application called Financial Genome is available for purchase by interested users of this book. It’s based on patented technology developed by Modernsoft, Inc., and can be downloaded from www.modernsoft.com. This unique add-in program for Excel 2000 (or later) running on Windows 95 (or later) is a profes- sional application which empowers the spreadsheet user to do financial analysis and pro forma projections with ease, speed and accuracy. While adding a financial structure to spreadsheets, Financial Genome maintains their full flexibility, and it is far more intuitive to use than conventional spreadsheets. Financial Genome easily accommodates widely different business analyti- cal needs and projections. It links together a comprehensive, knowledge-based fi- nancial dictionary of terms and relationships, an analytical engine, and data base access. The built-in financial knowledge ensures internal consistency, avoidance of spreadsheet errors, convenient data access, ready project setup, and true ana- lytical and formatting flexibility. The internal help system at any time allows the user to view the definitions of financial terms, and their relationships to formulas and statements. The software reflects the structure and definitions of financial analysis concepts and tools as discussed in this book. The application contains an example data base to get started, and a data base for TRW which ties to the company’s statements reproduced in the early chapters of this book. The software is accompanied by a series of interactive templates and graphic displays that relate directly to the various diagrams and analytical layouts covered in this book, designed to allow the user trace the effect of varying as- sumptions. Financial Genome and its accompanying templates also serve as learning tools, reinforcing the insights gained from reading this book and other fi- nancial literature. Learning is enhanced by the transparent structure and capabili- ties of the application, which allows the user to check understanding of terms and relationships on the fly, as well as through experimenting with the graphic dis- plays in the accompanying templates. Financial Genome as a Financial Analysis and Planning Tool This professional software enables the user to: • Input a typical set of financial data about a business from spreadsheets, data bases, or direct input. • Manipulate selected data for free-form analysis. hel78340_apx1.qxd 9/27/01 11:33 AM Page 425 Copyright 2001 The McGraw-Hill Companies, Inc. Click Here for Terms of Use. 426 Techniques of Financial Analysis: A Modern Approach • Create a wide range of financial reports and special statements. • Do fully integrated financial forecasting and planning. All of this can be done without the need to create formulas or relationships, or identifying spreadsheet cell locations. At the core of the application is the Finan- cial Dictionary, which contains over 350 common financial terms, statements, and ratios, as well as the built-in knowledge of all the relationships between the terms and statements, and the formulas underlying them. Once a set of input data is en- tered into the program, or a database is accessed, the application ensures full con- sistency as the analysis proceeds, because statements, ratios and special analytical views are created automatically. All calculated terms are prepared by the applica- tion from the individual inputs, which ensures accuracy. Assumptions and data values can be changed at the user’s option. A full range of features allows customization of the analysis by changing term names and statement formats, expanding or collapsing details, creating new relationships, changing time frames and databases, etc. At any point the user can display the definitions and relationships underlying any term or statement used, and access the complete built-in help system for further background information. The following capabilities are available for the Financial Genome user to perform financial analysis as described in this book or in other financial texts: • Display selected financial data individually or in any combination, and perform financial analysis using the built-in relationships or by creating new ones: Use a familiar spreadsheet structure to display and manipulate data or groups of data. Keep track of the data necessary for the analysis on an automatic input statement. Choose annual, quarterly, or monthly time periods. • Use GenomeLink to map data from spreadsheets or data bases to Financial Genome: After mapping, freely use the data as an internal data base for analysis Create internal data bases from ad hoc analyses • Automatically create the following standard financial statements: Income statement. Balance sheet. Cash flow statement. Statement of changes in shareholders’ equity. • Automatically create a special statement listing the typical assumptions used for pro forma financial forecasts: hel78340_apx1.qxd 9/27/01 11:33 AM Page 426 TEAMFLY Team-Fly ® APPENDIX I Financial Analysis Using Financial Genome 427 Forecast drivers for use in developing an integrated financial plan. Display of matching historical data for these forecast drivers. • Ability to create financial forecasts and integrated financial plans: Use the built-in forecast drivers for making key assumptions. Override with and/or add own assumptions. Test and modify data for full integration among statements. • Automatically create the following special performance statements: Ratios statement (all major financial ratios grouped by the three decision areas). Performance analysis statement displaying key performance measures. • Automatically create the following economic analysis statements: NOPAT analysis for deriving economic profit. Capital base analysis for deriving economic profit. Cost of capital analysis by category and various weighted proportions. Economic profit analysis combining all of the above. • Ability to modify built-in terms, statements, sections of statements, and free-form analyses: Rename, itemize, and duplicate individual terms. Move terms and groups of terms on the sheet. Expand and collapse statement detail. Modify groupings, names, headings. Customize formatting for printing. • Ability to override any data input or user assumptions: To modify conditions. To perform what-if analysis. Can return to original data base values at any time • Ability to change databases and timing: Switch to new database. Manually override data. Change analysis time periods. • Ability to access Excel’s many features for data manipulation and formatting: Financial formulas and relationships. Cell formatting, outlining, colors, highlighting, etc. hel78340_apx1.qxd 9/27/01 11:33 AM Page 427 428 Techniques of Financial Analysis: A Modern Approach • Ability to print out analyses and retain projects: Format print output as desired. Print statements as from any Excel spreadsheet. Save project files for future access and use. These capabilities allow the user to do professional financial analysis on typical sets of data, with the assurance that there’ll be accuracy and internal con- sistency as long as the input data themselves are correct. The analytical process can be applied to funds flow analysis as described in Chapter 3, the performance analysis of Chapter 4, the projections of Chapter 5, the growth conditions of Chapter 6, the present value analyses of Chapters 7, 8, 11 and 12 (templates), the cost of capital analyses of Chapter 9, and the financing options of Chapter 10. Be- cause the interrelationships of the business system are embodied in Financial Genome, it has capability to develop a consistent and fully integrated set of finan- cial statements, views, and performance analyses. The process of analysis is based on the familiar look and feel of the Excel application, but it’s driven by a sophisticated underlying knowledge structure and the patented FinGen technology. An intuitive control panel and a set of special tools are provided, which expand the standard Excel capabilities and tool bars. Financial Genome as a Learning Device and Guide The software contains a fully integrated help system that allows the user at any time to display not only the definitions of terms but also their relationships to other terms and their place in the analytical structure. Thus it’s possible to check one’s understanding of the underlying concepts step by step as the analysis pro- ceeds. When automatic financial statements or collections of terms like ratios are called forth by the user, it’s similarly possible to check and display the underlying structure for any term or group of terms, thus reinforcing the learning process. The user can learn by doing individual analytical tasks, checking the progress as de- sired, and also can learn by investigating the background and meaning of auto- matically calculated data, ratios, and statements. All definitions and terminology are closely aligned with the materials in this book, and the help system incorpo- rates definitions selected from this book. The special templates accompanying the software are designed as interac- tive and visual learning devices, allowing the user to trace the impact of changing assumptions on financial statements, analytical layouts, and key conceptual dia- grams as discussed in this book. There are templates for all of the major diagrams and displays, designed both for learning and also for application in a professional setting when appropriate. A chapter-by-chapter description of the templates and use of Financial Genome follows: Chapter 1: As a stage-setting discussion it contains no analytical processes. hel78340_apx1.qxd 9/27/01 11:33 AM Page 428 APPENDIX I Financial Analysis Using Financial Genome 429 Chapter 2: The business system in Figure 2–4 on page 28 is a key diagram that also reappears together with the growth model templates of Chapter 6. The inter- active template for the business system contains live cells for every element, which display the changing conditions and allow the user to interact and modify at will. A list of key assumptions drives the template, and the results are also re- flected on a linked balance sheet, income statement, and cash flow statement. In addition, a live bar graph displays the changes in funds uses and sources. The user’s input assumptions cover key operating, investment and financing decisions and policies, and the template functions as a closed system that responds to any one or a combination of changes. By toggling between assumptions and results, the user can trace the impact of the changing cash flows implicit in all parts of the structure and enhance the understanding of the dynamics of the business system. Chapter 3: The funds flow analysis covered here does not require special tem- plates, as Financial Genome has the built-in capability to create cash flow state- ments automatically from spreadsheet input data or databases. Chapter 4: The full ratio structure underlying the performance analysis in this chapter is automatically created by Financial Genome, and the user can request and display any single ratio, group of ratios, or a complete ratio statement from the underlying data. Definitions are available instantly. A special interactive tem- plate provides a visual representation of the impact on return on equity from changes in the underlying drivers. Based on the systems view of key ratios and their elements in Figure 4–4 on page 136, the template allows the user to trace si- multaneous changes in all elements affected by a change in assumptions. Alinked balance sheet, income statement, and cash flow statement accompany the diagram to give the user the corresponding impact on the financial statements. Chapter 5: The pro forma analysis discussed here is integral to Financial Genome, which in the forecasting mode can create a full set of integrated pro forma financial statements, ratios, and performance analyses based on the user’s assumptions about forecast drivers and expected conditions. It provides financial closure by identifying the fund need or excess under any set of assumptions the user wishes to try. A special interactive template illustrates the interrelated condi- tions for developing a cash budget, requiring a variety of assumptions to be de- rived first. The template assists the user in building up a set of conditions over a six-month period, including sales forecasts and collection of receivables, inven- tory movements based on purchasing patterns, and changes in accruals. The tem- plate accepts key assumptions, displays staggered collection patterns, account receivable patterns, an inventory analysis, and accrued liability changes. All of these are linked to live displays of the cash budget, pro forma income statement, and balance sheet, and provide an internally consistent set of results that cul- minate in the cumulative cash flow for the period. Changing any or several of the hel78340_apx1.qxd 9/27/01 11:33 AM Page 429 430 Techniques of Financial Analysis: A Modern Approach assumptions allows the user to visualize the impact on cash requirements and on the financial statements. Chapter 6: The business dynamics of this chapter are supported by four tem- plates, each of which allows interactive simulation of changes in policies and op- erational decisions. The first template illustrates operational break-even analysis, based on Figure 6–2 on page 198, where changes in price, variable costs, and fixed cost can be traced on a live graph. The second template displays the sus- tainable growth equation on page 215 with live cells, linked to the analytical for- mat of the financial growth model in Figure 6–7 on page 208. Also linked to this model is a live representation of the business system of Figure 2–4 on page 28, to- gether with a balance sheet, an income statement and cash flow statement, and a bar graph illustrating changes in uses and sources. This complete model allows the user to study growth conditions and to view them from all major viewpoints. The third template, a companion to the second template, allows the user to estab- lish different sets of financial and investment policies in the growth model format of Figure 6–9 on page 213, and to view a series of different cases side by side. The fourth template is an interactive representation of the five-year projection of con- ditions and policies of Figure 6–10 on page 218, which the user can vary at will and study the impact of different assumptions on the results. Chapters 7 and 8: The present value analysis concepts and structures are sup- ported by a general-purpose template which allows the user to input any desired re- turn standard, cash flow pattern, depreciation tax shield, capital investments and recoveries, and to obtain the results of all present value measures, displayed in the spreadsheet format used in both chapters (see pages 237, 238, 273, and 274 to 281). The template is accompanied by a bar graph display showing the size of movements in investment and operational cash flows, and the depreciation tax shield. Chapter 9: The cost of capital calculations are directly supported by Financial Genome’s built-in capability to develop the cost of capital for each element of the capital structure and to develop weighted average costs based on market values, book values, and target proportions. The user is required only to provide the nec- essary inputs requested by the software. Chapter 10: Financing choices are supported by a template that calculates and displays graphically the range of EBIT and earnings per share (EPS) conditions discussed in the chapter. The user can vary the conditions underlying different financing alternatives and observe the impact on the balance sheet and on the separate calculations of EPS and zero EPS. A live graph based on Figure 10–8 on page 341 displays the varying conditions. The impact of different financing choices is also implicit in the forecasting results obtained with Financial Genome. hel78340_apx1.qxd 9/27/01 11:33 AM Page 430 APPENDIX I Financial Analysis Using Financial Genome 431 Chapter 11: Business valuation as discussed here is directly supported by the forecasting capabilities of Financial Genome, which can derive both accounting measures and ratios as well as cash flow inputs such as EBIT, NOPAT, free cash flow, and others. An general purpose valuation template modeled on Figure 11–5 on page 384 allows the user to calculate the cash flow valuation of a company, based on projections of EBIT, depreciation, changes in working capital, invest- ment changes, and an estimate of ongoing value. It’s based on the same spread- sheet format as the general purpose present value template for Chapters 7 and 8. Chapter 12: Shareholder value management covers an overview of key mea- sures, including proprietary approaches, which cannot be replicated as discussed here. A basic CFROI calculation can be developed using the present value tem- plate provided, while a comparison of measures can be viewed interactively in the special template based on Figure 12–6 on page 408. Financial Genome has the built-in capability to calculate economic profit, based on the user’s inputs and assumptions. While primarily designed as educational tools, the graphic templates can also serve the professional user, for example, to demonstrate the results of policy choices. The general purpose templates like the present value analysis and busi- ness valuation structures can be used for many practical applications. As a result, this professional software application, together with the interactive templates, as- sists both the student and the practitioner in performing financial analysis better, faster, and with greater insight. How to Obtain Financial Genome • Financial Genome can be downloaded for a free thirty-day trial from Modernsoft’s web site: http://www.modernsoft.com and locating the download section on the site. The download requires a minimum of 5 megabytes of disk space. • System requirements are Microsoft Excel 2000 and later and Windows 95/98/NT4/2000 (only US English versions in all cases) • Downloads available are: 1) The Financial Genome software, including the “TFA templates” for this book (contained in the “extras” folder of the software) 2) Quickstart guide 3) Graphic tutorial 4) TFA templates for this book as a separate file • The software can be purchased by credit card after download by registering and following the on-line instructions. hel78340_apx1.qxd 9/27/01 11:33 AM Page 431 This page intentionally left blank. APPENDIX II Glossary of Key Terms and Concepts* 433 Accelerated depreciation Patterns of de- preciation write-offs that place larger pro- portions into the early years of an asset’s book life, rather than into the later years, either for accounting or for tax deduction purposes. Accounting earnings The difference be- tween recognized revenues and expenses during an accounting period, based on gen- erally accepted accounting principles. Accounts payable (payables) Obligations owed to trade creditors and suppliers as in- curred in the normal course of business; also called trade credit. Accounts payable days A translation of accounts payable into the days of average purchases outstanding at a point in time; used as an indicator of the effectiveness with which trade credit is employed. Accounts receivable (receivables) Obli- gations owed by customers and other par- ties as incurred in the normal course of business. Accounts receivable days A measure of the credit quality of accounts receivable, which expresses outstanding receivables as days’ sales outstanding in terms of average daily sales; can be compared with the credit terms under which sales were made. Accruals Recognition of revenues or ex- penses when earned or incurred, without re- gard to the actual timing of the cash transactions; used in the accrual method of accounting. Accumulated depreciation The total of past periodic depreciation charges applica- ble to depreciable assets carried on a com- pany’s balance sheet, shown as a deduction from gross property, plant, and equipment. Acid test A stringent measure of liquidity relating current cash assets (cash, cash equivalents, and receivables) to current lia- bilities. Activity-based analysis A form of eco- nomic analysis that develops the specific costs and benefits generated by an activity, product line, or business segment, based on the physical processes and resource require- ments underlying each subpart. Aftertax cash flow Cash generated from operations or from an investment net of in- come taxes, derived by adding back non- cash charges like depreciation to aftertax earnings. Aftertax value Net revenue, net cost, or net investment after adjusting for the effect of applicable income taxes. Allocation An assignment or distribution of costs or revenues to products, activity centers, or other entities using a common basis. Amortization A periodic charge reflect- ing the decline in the recorded value of an intangible asset over a specified number of years. Annualized net present value The trans- formation of a net present value into an equivalent series of annual cash flows over the life of the project, used in judging the proposal’s margin of risk. Annuity A uniform series of payments or receipts over a specified number of periods. Asset A physical or intangible item of value to a company or an individual. Asset turnover An expression of the effectiveness with which assets generate sales, defined as the ratio of net sales to total assets. * Items shown in italics are defined separately. hel78340_apx2.qxd 9/27/01 11:33 AM Page 433 Copyright 2001 The McGraw-Hill Companies, Inc. Click Here for Terms of Use. 434 Techniques of Financial Analysis: A Guide to Value Creation Balance sheet A financial statement re- flecting the recorded values of all assets, liabilities, and owners’ equity at a point in time. Balloon payment A significant principal payment due at the end of the term of a fi- nancial obligation. Bankruptcy A legal process of disposing of the assets of a business or individual to satisfy creditors’ claims in total or in part, and protecting the debtor(s) from further le- gal action. Benefit (cost/benefit) The positive ele- ment in an economic trade-off which re- lates economic earnings to economic costs in an investment, operating, or financing decision. Beta ( ␤ ) A calculated form of expressing the specific (systematic) risk of a com- pany’s common stock relative to the stock market as a whole. (Cf. volatility.) Bond A financial instrument representing a form of corporate long-term debt issued to investors; a variety of different types of bonds exist. Bond rating A published ranking of a bond developed by financial organizations to express its relative soundness on a de- fined scale. Book value The recorded value of an as- set or liability as reflected in the financial statements of a company or individual. Book value of equity The recorded value of owners’(shareholders’) equity on a com- pany’s balance sheet, representing the own- ers’ residual claim on the assets. Break-even analysis Determining the level of sales at which a company will just recover fixed and variable costs; a zero- profit condition. Breakup value The value realized from separating the parts of a multibusiness com- pany and disposing of them individually. Burden The combination of interest charges and current principal payments required by a financial obligation. Burden coverage The ratio of periodic income before taxes to the corresponding amount of burden, adjusted for income taxes; a test of the ability to service a debt obligation. Business risk The risk inherent in the expected cash flows from investments and operations, apart from the risk inherent in the form of financing used. Business system A dynamic representa- tion of the key elements and relationships governing investments, operations, and fi- nancing of a business entity. (Cf. financial model.) Call provision A provision permitting the issuing company to redeem in part or in total a bond or preferred stock issue at a date determined by the company. Capital The total amount of long-term funds committed to an enterprise in the form of ownership equity and long-term debt. Capital asset pricing model (CAPM) An analytical approach to calculating the cost of shareholders’ equity, using a risk- free interest rate, a risk premium (market premium), and a company-specific risk as- sessment beta ( ␤ ). Capital budget A selected group of in- vestment projects approved in principle for implementation, pending individual ap- proval, and related closely to a company’s business strategies. Capital expenditures Expenditures made during a stated period for investments in new fixed assets, for the purpose of replace- ment, expansion, or new business oppor- tunities. Capital investment A relatively long- term commitment of funds to a project ex- pected to generate positive net cash flows over time. Capitalization The sum of all long-term sources of capital of a company, also de- rived by subtracting current liabilities from total assets. hel78340_apx2.qxd 9/27/01 11:33 AM Page 434 [...]... securities and commodity markets; news, feature articles, and statistics on economic and business conditions; news and earnings reports for individual companies; dividend announcements; currency, commodity, and trading data; and a great deal of coverage of international business and economic conditions Major U.S and Canadian dailies also carry key financial and economic data, but their coverage and emphasis... broad range of financial information Foremost among these at the time of this writing is Yahoo Finance, which provides up-to-the-minute summary information on U.S and international financial market data, stock and other securities quotations, individual company stock data and charts, financial news, and much more Infoseek, Lycos, and Excite each offer a selection of financial data, news, and a variety... analysis, statement preparation, and financial planning Financial growth plan A model of future financial flows that tracks the results of key investment, operational, and financing dimensions under a variety of assumptions about strategies, policies, and business conditions hel78340_apx2.qxd 440 9/27/01 11:33 AM Page 440 Techniques of Financial Analysis: A Guide to Value Creation Financial leverage The magnifying... contain periodic listings and analyses of financial information oriented toward the investor and financial analyst The advent of the computer has made possible the rapid collection and analysis of company and economic data, and current information can now be obtained on-line through database access or in hard copy on a timely basis The most important sources of periodic financial and business information... publications are specialized and oriented toward a specific community of interest; others deal with financial conditions in foreign countries The titles are largely self-explanatory: Banker’s Magazine CFO Magazine Corporate Financing Credit and Financial Management Finance Financial Analysts Journal Financial Executive Financial Management Financial World Journal of Banking and Finance Journal of Commerce... by newspapers and periodicals, such as The Wall Street Journal, which indicates which company’s reports are available in its stock quotation columns hel78340_apx3.qxd 460 9/27/01 11:34 AM Page 460 Techniques of Financial Analysis: A Guide to Value Creation Financial Manuals and Services Most current financial and economic information is now available through various on-line services and information... security dealers and individuals in all parts of the country They’re electronically linked via extensive computer networks, in an amazingly flexible arrangement which allows trading between prospective buyers and sellers of such securities as government bonds, state and municipal bonds, stocks and bonds of smaller and hel78340_apx3.qxd 9/27/01 454 11:34 AM Page 454 Techniques of Financial Analysis: A Guide... inquiries, using the special catalog and information links of the latter Current Financial Information The common way to keep abreast of financial developments has long been to scan the daily financial pages of national, metropolitan, and regional newspapers The most complete and widely read financial coverage is found in The Wall Street Journal (http://www.dowjones.com) and The New York Times (http://www... stock quotations, security offerings, banking developments, and financial, industrial, and commodity trends, the Commercial and Financial Chronicle is the most comprehensive print source available The Wall Street Transcript (http://twst.com) analyzes securities from a great variety of individual companies, on both a financial and economic basis, and assesses the technical indications of stock market charts... trends It profiles major U.S and international executives in addition to hel78340_apx3.qxd 9/27/01 458 11:34 AM Page 458 Techniques of Financial Analysis: A Guide to Value Creation giving detailed articles on industr.y, company, and socioeconomic trends The magazine’s annual listing and ranking of the Fortune 500 (the best-performing U.S companies) and similar listings of banks and major foreign companies . the definitions of financial terms, and their relationships to formulas and statements. The software reflects the structure and definitions of financial analysis concepts and tools as discussed. Terms of Use. 426 Techniques of Financial Analysis: A Modern Approach • Create a wide range of financial reports and special statements. • Do fully integrated financial forecasting and planning. All. knowledge structure and the patented FinGen technology. An intuitive control panel and a set of special tools are provided, which expand the standard Excel capabilities and tool bars. Financial Genome