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How to Use the Financial Plan

How to Use the Financial Plan. Make it simple Regroup all the inputs Sensibilities Studies Set of different Cases Base Case Best and Worst Cases (external influence) Strategic Decisions (internal) Synthesis and Graphic Presentation. Input Data Improvement.

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How to Use the Financial Plan

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  1. How to Use the Financial Plan • Make it simple • Regroup all the inputs • Sensibilities Studies • Set of different Cases • Base Case • Best and Worst Cases (external influence) • Strategic Decisions (internal) • Synthesis and Graphic Presentation

  2. Input Data Improvement • It is useful to bring all the input data together • Easier to make sensibilities studies BPcons.xls - SENSIB!A182

  3. Sensibilities studies • Goals • To cover a broad scope of possible futures • To identify the business drivers • Most important factors to determine the future • To measure the risks • Usually a few major scenarios • Base Case (or Management Case) • Best and Worst Case • Influence of major capex decisions

  4. Saigon Hotel Sensibilities

  5. How to analyze sensibilities studies • Analyze most important indicators • Profit and loss • Revenues • EBITDA • EAT • Balance Sheet • Equity • Debt • Ratios • ROCE • ROE • Debt/equity ratio • Use graphs

  6. Saigon Hotel Revenues

  7. Saigon Hotel EBITDA

  8. Saigon Hotel EAT

  9. Saigon Hotel Cash Flow

  10. Saigon Hotel Equity

  11. Saigon Hotel Financial Debt

  12. Saigon Hotel : ROCE

  13. Saigon Hotel ROE

  14. Financial analysis and leverage • Necessity to have a quick vision of the financial situation of a company • common language • comparability • Profitability ratios • to measure the efficiency and the profitability • Leverage ratios • to measure the indebtness

  15. Financial analysis and leverage • Coverage ratios • how are the debt and the interests covered by the cash-flow ? • Liquidity ratios • how liquid is the company ? • Distribution ratio • what does the company distribute to the shareholders ?

  16. Necessity of the Financial Analysis • Who needs the financial analysis ? • the banker • to assess a new loan or to maintain a credit line • the supplier • to be sure to be paid by his customers • the customer • to be sure that his supplier will stay in the business • the market (stock exchange) • to assess companies • to valuate companies

  17. What is important for the analysis ? • To be able to compare ... • different companies • with the same activity (hotels, airlines, etc.) • with different activities • one company across the time • . . . everyone must use the same indicators • necessity of a common language • no discussion on the facts • but discussion on the interpretation of the facts

  18. What is important for the analysis ? • Limits to the comparability • differences in accounting rules and practices • in different countries (laws, fiscal regulations, accounting rules) • inside the countries (internal practices of the companies) • depreciation period • research & development • brands • leads to a growing standardization of the rules • BUT … the practices remain different

  19. What is important for the analysis ? • Trust in the figures • published by the companies themselves • the Board of Directors is responsible • Risks • “window dressing” • “cover-up” • Remedies • external auditors • market authorities • stock price • complains by shareholders • the “Swissair Case : Accounts of 2000” • the “Enron Case”

  20. The Swissair CaseAccounts 2000 • Underestimation of the losses of subsidiaries • Sabena, AOM-Air Liberté • Underestimation of committed reinvestments • Sabena, AOM-Air Liberté, LTU • Hidden commitments • put options given to other shareholders in joint-ventures

  21. The Enron Case • Underestimation of “off-balance” items • Additional investments committed • False profits on asset sales • Assets were sold by Enron to Enron funded companies • Over-estimation of turn-over / activities • Enron controlled only fees on turn-over and NOT turn-over • Finally … destruction of documents and files • by the company … • … and its external auditors

  22. Profitability Ratios : the ROE • The key concept : Return on equity • ROE  Rfin  EAT/EQ • Key concept for the shareholder • profitability of their investment in shares of this company compared to alternate financial assets • other shares • fixed rates bonds (of companies or government) • How to measure the equity ? • book-value or... • ...market price • the difference can be huge for listed companies

  23. Drivers of the ROE • What are the drivers of the ROE ? • The profit margin on Sales • The productvity of capital employed • all the assets used by the company • fixed assets • working capital • cash • The financial structure of the company • level of debt vs. equity

  24. Profitability Ratios : ROCE • The Return On Capital Employed (ROCE) measures what the company earns (before interest and tax) per unit of capital employed • ROA  ROCE  EBIT/Assets • ROCE = EBIT/(FIX+WC+CASH) • in the practice the total Assets of the Balance Sheet are often used • this ratio is not influenced by the financial structure of the company • because we use the EBIT • is also called Return On Investment (ROI) or Return On Assets (ROA)

  25. ROCE after taxes • It can be useful to calculate the ROCE after taxes • ROCE* = ROCE.(1-Tc) • where Tc is the average tax rate

  26. Relation between ROE and ROA • If the company has no financial debt • ROE = ROCE* = ROCE.(1-Tc) • for the demonstration please see in a finance reference book • this is logical because in this case the total of assets is equal to the equity and no interest is paid • The higher the ROCE the higher the ROE • The lower the tax rate the higher the ROE

  27. Relation between ROE and ROA • If the company has financial debt • ROE = ROCE.(1-Tc) + (ROCE-id).(1-Tc).Dfin/EQ • where id is the average rate of interest on the debt • for the demonstration see in the book • The ROCE should be higher than the interest rate • if ROCE > id then ROE > ROCE* • if the ROCE is higher than the interest rate on the debt then the ROE is higher than the ROA after taxes • if ROCE < id then ROE < ROCE*

  28. Leverage Effect • This equation is very important in finance • ROE = ROCE.(1-Tc) + (ROCE-id).(1-Tc).Dfin/EQ • The higher the ROCE the higher the ROE • The lower the tax rate the higher the ROE • The higher the debt (Dfin) vs. equity (EQ) the higher the ROE • if the ROCE is higher than the interest rate • This is called the Leverage Effect

  29. Leverage Effect • It means that the ROE can be improved by increasing the debt level • if and only if the ROCE is higher than the interest rate • How far can the Equity be reduced and the financial debt increased ? • the company must find a bank to bring the debt • the bank will look at the risks not to be repaid • higher risks will be compensated by higher interest rates • higher interest rates will reduce the Leverage effect

  30. Risks of the Leverage Effect • The company can be in a bad situation • if the interest rate increases • if the future Free Cash flows are lower than expected • less business • additional unexpected investments to do • change in economic conditions • tax rate • exchange rate • if the shareholders want more dividends • if the bankers become nervous

  31. Leverage effect : example

  32. Saigon Hotel – Leverage Effect • Case 1 : Extension with initial capital structure • 4 Mio US$ capex and 4 Mio US$ debt • Case 2 : Extension with more equity • 2 Mio US$ equity and 2 Mio US$ debt • Case 3 : As Case 1 but continued adverse circumstances • Unit rate and occupancy • Case 4 : As Case 2 but continued adverse circumstances

  33. Saigon Hotel leverage : ROCE

  34. Reference levels for ROCE and ROE • What is a sound level for the ROCE ? • higher than the interest rate • in the range 10%-18% in western economies • the level is a reference for expected profitability of new capital expenditures • What is a sound level for the ROE ? • in the range 12%-25% • depends on the risk of the business • activity related risks (high tech vs. low tech) • maturity of the business (start up vs. mature) • financial structure (highly leveraged vs. standard)

  35. Saigon Hotel leverage : ROE

  36. 3,0 2,5 2,0 1,5 1,0 0,5 0,0 2002 2003 2004 2005 2006 2007 extension worst equity worst Saigon Hotel leverage : D/E ratio

  37. Leverage ratios • The indebtness of a company can be measured by the debt-equity ratio () • debt-equity ratio   Dfin/EQ • be sure the leases are included in the debt • Alternate : the debt ratio • debt ratio  Dfin/(Dfin+EQ) • Some authors use only the medium and long term financial debt (DMLT) • we prefer all the financial debts (possibility of switch between DMLT and DSTfin)

  38. Reference level for the debt-equity ratio • It must be sustainable for the company • payment of interests • reimbursement of the debt • Consequently it will be different from company to company depending on : • the projected Cash flows and Free Cash flows • the sensibility to outside factors • general economic situation • influence of new competitors • etc.

  39. Liquidity ratios • These ratios measure how liquid is the company • Current ratio • current ratio  currents assets / current liabilities • current ratio  (S+R+CASH) / (Dop+Dfin,short term) • Acid test (Quick test) • this ratio reflects the fact that some current assets are less liquid (inventories) • acid test  (R+CASH) / (Dop+Dfin,short term)

  40. Reference levels for liquidity ratios • All these ratios depend on the industry • Current ratio • if possible, higher than 1 • Acid test • if possible, higher than 0.7 / 0.8

  41. Distribution ratio • The pay-out ratio measures the share of the net result distributed to the shareholders • pay-out  DIV / EAT • Reference level • depends on the financial needs of the company • for listed companies : expectations of the markets • standard for mature companies : 40% to 60%

  42. General remark on the calculations of ratios • For the P&L no doubt : use the year figures • For the Balance Sheet which figures ? • at the end of the year ? • at the end of last year ? • another figure ? • Correct calculation : daily average • Use the average (end of the year/end of last year) • best estimate of the reality • Be always coherent

  43. Conclusions of the lesson • The Sensibilities studies are useful • To look at the different possible futures • To identify the business drivers • To identify the risks • The financial ratios are quick tools to analyze the financial situation of companies • By using the financial ratios one can compare • different companies • across the time • Limits of the financial ratios • can we trust the Balance Sheet & Profit &Loss ? • reference levels depend of the industry

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