Finance 101

1. Finance 101 Interactive Presentation, please ask questions at any time Discuss types of Financial Statements

2. Types of Financial Statements A business’ financial performance is measured using three related financial statements: • Balance Sheet • Income Statement • Statement of Cash Flow We will discuss all three!

3. Balance Sheet

4. Balance Sheet • The balance sheet (also called the Statement of Financial Position) reports the assets, liabilities, and equity of a business at a given point in time. • Assets = The things of value that a company owns. • Liabilities (Creditors) + Stockholders’ Equity (Owners/Shareholders) = Claims against an entity’s assets. Assets = Liabilities + Stockholders’ Equity

5. Assets Current assets Cash Marketable securities Accounts and notes receivable Inventories Prepaid expenses Property, plant & equipment Less: accumulated depreciation Other assets Total assets Liabilities Current liabilities Accounts payable Short term borrowing Income taxes payable Other accrued current liabilities Long term borrowing Deferred taxes Other liabilities Total liabilities Stockholders’ equity Preferred stock Common stock Additional paid in capital Retained earnings Total stockholders’ equity Balance Sheet Format Assets Liabilities Stockholders’ Equity

6. Balance Sheet - Definitions Assets - Resources owned or controlled by the company. They include monetary assets (cash, marketable securities and receivables) and non-monetary assets (inventories, prepaid expenses and equipment). Current Assets - Cash plus those assets which are expected to be converted to cash or consumed during the coming year. Liabilities - Outsider claims against company resources. Examples include accounts payable and bank loans. Current liabilities - Liabilities that mature within the coming fiscal year. Net Working capital - current assets less current liabilities. Stockholders’ equity - The contributed capital plus any other increments in capital from profitable operations. Retained earnings - Net earnings that remain in the business (as part of stockholders’ equity) after the payment of dividends

7. Working Capital Example

8. Liabilities Days payable outstanding (DPO) Liquidity ratios Debt ratio Operating Performance Ratios Performance ratios help put our financial data into perspective • Use performance ratios to: • review for trends • compare to competitors, industry benchmarks and business unit objectives Assets • Days Sales Outstanding (DSO) • Inventory Days Supply (IDS) • Working Capital Turnover • Permanent Investment Turnover • Return on Net Assets Equity • Return on Equity

9. Balance Sheet Strength What does this mean? • Means a company generates enough cash to service its debt, fund operations, pay a dividend to shareholders and invest for the future. • Gives a company staying power to weather difficult economic cycles.

10. Income Statement

11. Income Statement Revenues (Sales and other income) - The amounts invoiced to outside customers for the sale of products or services less returns, allowances and discounts; and non-sales income such as royalties, gain/loss on asset sales, interest income Expenses - An outflow or other using up of assets -- or incurring of liabilities -- from the rendering of goods or services Variable Costs - A cost which is constant per unit, but which varies in total directly and proportionately with production or sales volume. Fixed Costs - A cost which does not vary significantly with changes in volume within a relevant time period (one year) and range of activity.

12. Accrual Accounting Revenues and expenses are recorded in the period in which they are earned and incurred, whether or not such transactions have been finally settled by the receipt or payment of cash or its equivalent . Two Ways to Account For It: What is Revenue? Checks Received Revenue is recorded when it is earned What is Expense? Checks Written Cost of raw materials is expensed when product is sold, not when materials are purchased Cost of buildings and equipment is expensed over time as facilities are utilized (depreciated), not when initially paid for Other expenses recorded when the liability is incurred (1) Cash System (2) Accrual System

13. Financial Metrics • Sales Growth Rate • Variable Contribution Margin = (Sales revenue less variable costs) / Sales Revenue • Must be sufficient to cover fixed costs plus provide a profit • ATOI Margin Percent = ATOI / Sales

14. Cash Flow

15. Why Cash Flow? • Cash is a strategic resource used to pay company obligations and a return to shareholders: • Purchases • Salaries • Taxes • Dividends • Earnings is one element of cash flow, but it includes depreciation which is a non-cash charge • Cash may come in or go out for reasons not reflected on the income statement

16. Cash Flow– Our “Bank Account” • We begin with earnings • We “add-back” the non-cash cost of depreciation • We account for changes in working capital - we can either use cash to increase working capital or recover cash by decreasing working capital. Therefore it is the working capital changes that impact cash flow • We account for cash spent on new permanent investment: capital expenditures • We account for cash required for financing costs: corporate dividends and interest

17. What Cash Flow Tells Us • Cash flow could be either positive or negative, depending on the mission of the business. • Cash flow information tells us how much financing is required to ensure operations can continue. • Positive cash flow indicates that funds may be available for future investment.

18. Cash Flow And The Product Life Cycle • Growth businesses • Negative cash flow due to high capital expenditures • Mature • Positive cash flow – earnings plus depreciation exceed capital expenditures • Declining • Positive to negative cash flow – earnings are not growing and capital expenditures are small - is it sustainable?

19. Sample Cash Flow Statement ATOI Depreciation & Amortization Working Capital (Increase) Decrease CASH FLOW FROM OPERATIONS Capital Expenditures FREE CASH FLOW

20. Investment Analysis Concepts

21. Investment Analysis Terms Net Present Value (NPV)- The difference between the present value of cash inflows and the present value of cash outflows. NPV is used to analyze the profitability of an investment or project. Discounted cash flow (DCF) analysis – Used to evaluate investment opportunities by projecting free cash flow and then discounting (using cost of capital) to arrive at a present value. Terminal Value (TV) - used to determine the value of a project for all the years beyond the reliable discount cash flow projections.. IRR (Internal Rate of Return) - The discount rate used in evaluating investment opportunities which makes the net present value of all cash flows from a particular project equal to zero. CAGR – Compounded Annual Growth Rate

22. Cost of Capital (COC) • Weighted average cost of financing from all sources - debt (outside borrowing) and equity (shareholders) • Example • Equity 13.5% x 85% = 11.475% • Debt 4.5% x 15% = .675% • COC (Wt. Avg.) = 12.150% • Discounting at the COC allows us to compare the value of future cash flows

23. Decision Making Metrics • Highlights - • Considers time value • Analyzes investment’s entire life • Reflects shareholder value added • Impacted by size of investment Net Present Value - the difference between discounted cash inflows & outflows

24. Decision Making Metrics Discounted Payback Period - time it takes to recoup an investment’s cost - using discounted cash flow • Highlights - • Easy to compute - discounted flows • Understandable • Measure of time funds are at risk • Does not consider benefits past the payback period

25. Decision Making Metrics Internal Rate of Return- The “true” return of an investment - the DR where NPV = Zero • Represents the percentage yield of an investment • The discount rate which equates the present value of cash inflows with the present value of outflows ~ NPV = zero • The after-tax interest rate an investor could pay for funds and breakeven • Allows comparison without bias of size • Does not account for risk • Biased towards investment with quick payback • Doesn’t account for $$ size

26. Decision Making Metrics • PI = DCI/DCO • where: DCI = the sum of the disc. cash inflows • DCO = the sum of the disc. cash outflows • Values of PI are positive! • PI > 1, then investment’s return > COC • PI < 1, then investment’s return < COC • PI = 1, then investment’s return = COC • Productivity measure • More reliable than IRR • Good tool for ranking projects ProfitabilityIndex (PI) - a ratio of discounted cash inflows and outflows.

27. Inflows Sales revenue Decrease in working capital … Outflows COGP Marketing and distribution expense R&D expense General admin expense Capital Increase in working capital … Determining Cash Flows for NPV

30. What Applications Can You See for These Discounted Metrics? • Construction/equipment projects • Acquisitions (max purchase price) • Divestitures (min selling price) • Business strategy analysis • Advertising spending • Prioritizing R&D projects • New markets • Developing sales contracts • Lease vs buy

31. Value 0 100 200 300 400 500 Base % Swing Value Explained 0.03 53.4 0.01 0.04 Price annual growth rate 0 11.0 0.3 –0.3 Capital Sensitivities - Project 0 10.8 –0.25 0.25 Year 1 Market Size - Sensitivity 1.21 7.5 1.452 1.089 COGP - Project 0.03 5.5 0.04 0.02 COGS annual growth rate 0 4.6 –0.5 0.2 Market Growth Rates - Sensitivity 4.7 4.0 MLA Price/kg 4.5 5 0.07 1.6 Selling Expense 0.1 0.05 0.03 0.8 Capital Maintenance, Parts and Upgrades 0.04 0.02 0.03 0.6 R&D Expense 0.05 0.02 3.76 0.2 Price/kg 3.525 4.7 0.5 0.1 Competitive Effect - Growth Rate Reduction 0.8 0.3 Base Value: 293MM Project Sensitivity Analysis • Shows that >75% of the variability is associated with the top three sensitivities • Shows targets for further analysis

32. Determining Cash Flows for NPV A Project example using a discounted cash flow analysis and specific assumptions (e.g. 12% cost of capital) Based on a ten year time horizon post launch