Module 3 Lecture 6b
FINANCIAL FEASIBILITY
Financial Planning
Financial Statement Analysis
Financial Feasibility Details
Major Assumptions
• Project timetable and projection years
• Sales and collection
• Operating assumptions
• Financial assumptions
Projected Financial statements
• Pre-operating
• Operating
Financial Statement Analysis
Financing Study
Determine the specific requirements of the project
Identify alternative sources of financing
Determine the desirable Debt-Equity ratio
Establish the project’s financing policy
Determine the effective cost of financing
Determine the maximum amount of financing from each
source
Work out a financing scheme
Leverage
Break-Even Point (BEP)
BEP = Fixed Operating Costs + Interest Expenses
Unit Price – Unit Variable Cost
Operating Leverage – incurrence of fixed operating costs in the firm’s
income stream.
Degree of Operating Leverage (DOL) = % Change in Net Operating Income
% Change in Sales
DOL = Peso Sales – Variables Costs______
Peso Sales – Variable Costs – Fixed Costs
Leverage
Financial Leverage – financing a portion of the firm’s assets with
securities bearing a fixed or limited rate of return.
Degree of Financial Leverage (DFL) = % Change in Earnings per Share
% Change in Net Operating Income
DFL = Net Operating Income____
Net Operating Income - Interest
FINANCIAL STUDY:
Tools for Financial Planning
Funds-flow statement
• Uses and sources of funds
Cash budget
• Short-term cash needs and short-term financing
Pro-forma statements
• Shows effects of policy decisions on future financial
condition and performance of a firm
Sustainable growth modeling
• Determines whether sales growth objectives are
consistent with operating efficiency and financial ratios
Sources and Uses of Funds:
Sources:
• Net decrease in any asset other than cash or fixed assets
• Gross decrease in fixed assets
• Net increase in any liability
• Proceeds from sale of stock
• Funds provided by operations
Uses:
• Net increase in any asset other than cash or fixed assets
• Gross increase in fixed assets
• Net decrease in any liability
• Retirement or purchase of stock
• Cash dividends
Sample Problem: Financial Planning
The balance sheet of Magnolia Inc. as of November 30, 2008 is as follows:
ASSETS: EQUITIES:
Cash 12,000 Accounts Payable-suppliers P 135,000
Accounts receivable 108,000 Notes payable 22,500
Inventory 45,000 Capital Stock 630,000
Plant and equipment, net 750,000 Retained earnings 127,500
Total Assets P 915,000 Total Equities P 915,000
For December, sales are budgeted at P375,000 of which P120,000 will be in cash and the
remainder will be on credit. 50% of the month’s credit sales are collected in the month of
sale and the balance collected the following month. All of the accounts receivable in
November will be collected in December. The notes and accounts payable in November
will be paid in December. The company will pay interest for December amounting to
P750 and it will borrow P27,000 by giving a new note payable due in one year.
Purchases of inventory in December are expected to be P300,000, on account. 40% of
all inventory purchases are paid for during the month of purchase and the balance paid in
the following month. The December 31 inventory balance is budgeted at P60,000. New
equipment costing P13,500 will be purchased in cash in December. Cash operating
expenses for December are budgeted at P76,500, exclusive of depreciation. Depreciation
is budgeted at P3,000 monthly.
Prepare a cash budget for December supported by schedules and proforma income
statement and balance sheet for the same period.
Solution: Magnolia Inc.
Cash Budget
Dec Jan
Cash, Beg. 12000
Cash IN
Sales 120000
Collection of A/r 127500 127500
New Notes Payable 27000
108000
Cash, Avail 394500
CASH OUT
Payment of Payables 157500
Interest 750
Pirchase of Inventory 120000
Operating Expenses 76500
Cash, end 39750
Magnolia, Inc.: Balance Sheet
As of December 31, 2008
ASSETS: EQUITIES:
Cash 39750 A/P 180000
A/R 127500 Notes 27000
Inventory 60000 Capital 630000
PPE 747000 R/E 137250
TOTAL 974250 TOTAL 974250
Magnolia, Inc.: Income Statement
For the month ended December 31, 2008
Sales 375000
COGS 285000
GP 90000
Operating Expenses 76500
Dep'n 3000
Interest 750
NI 9750
Financial Statement Analysis
All analyses of financial data involve comparisons
Comparisons make the financial data meaningful
Comparisons are essentially intended to shed light
on how well a company is achieving its objectives
Structure of analysis:
• Longitudinal or trend
• Vertical or common-size
Overall Performance Measures
Price/earnings ratio (P/E)
= Market price per share
Net income per share
Return on assets (ROA) or Earning Power
= Net income + Interest (1 – tax rate)
Total Assets
Return on shareholders’ equity (ROE)
= Net Income____
Shareholders’ equity
Overall Performance Measures
Return on invested capital (ROIC)
= Net income + Interest (1 – tax rate)______
Long-term liabilities + Shareholders’ Equity
Operating Income Return on Investment (OIROI)
= Operating income
Total assets
= Operating profit x Total asset
margin turnover
= Operating income x Sales
Sales Total assets
Profitability Measures
Gross Margin Percentage
= Gross margin_
Net sales revenue
Profit Margin (PM)
= Net income___
Net sales revenue
Earnings per share (EPS)
= Net income_ __
No. of shares outstanding
Cash realization
= Cash generated by operations
Net income
Tests of Investment Utilization (1)
Asset turnover
= Sales revenues
Total assets
Invested capital turnover
= Sales revenues
Long-term liabilities + Shareholders’ equity
Equity turnover
= Sales revenues
Shareholders’ equity
Capital intensity
= Sales revenues
Property, plant and equipment
Days’ cash
= Cash
Cash expenses / 365
Tests of Investment Utilization (2)
Days’ receivables (collection period) Receivable turnover
= Accounts receivable = Annual credit sales
Credit Sales / 365 Accounts receivable
Days’ inventory
= Inventory____
Cost of sales / 365
Inventory turnover
= Cost of sales
Ave. Inventory
Working capital turnover
= Sales revenues___
Working capital
Current ratio
= Current assets____
Current liabilities
Acid-test (quick) ratio
= Monetary current assets or Current assets less inventories
Current liabilities Current liabilities
Tests of Financial Condition
Financial leverage ratio
= Assets
Shareholders’ equity
Debt/equity ratio
= Long-term liabilities or Total liabilities___
Shareholders’ equity Shareholders’ equity
Debt/capitalization
= Long-term liabilities
Long-term liabilities + Shareholders’ equity
Times interest earned
= Pre-tax operating profit + Interest
Interest
Cash flow/debt
= Cash generated by operations*
Total debt
*Earnings before interest, taxes, depreciation and amortization
Tests of Dividend Policy
Dividend yield
= Dividends per share
Market price per share
Dividend payout
= Dividend
Net income
Percentage analysis of Financial Statements
Common Size
• Balance sheet and income statement items are expressed as
percentages of totals
Index analysis
• Balance sheet and income statement items are expressed as
percentages of some base year
Gives insight on improvement or deterioration in financial
condition and performance
Sample Problem: Financial Statement
Huff and Puff Industries had sales of P125,000 in 2002 which was subjected to a 50%
tax rate. Given the following financial ratios for year, reconstruct the firm’s balance
sheet and income statement (Rounded to the nearest peso). Show all relevant
computations.
2002
Current ratio 1.84
Acid-test ratio 0.78
Average collection periods (based on a 365-day year and end-of- 36.50
year figures)
Inventory turnover 2.59
Debt ratio 50%
Times interest earned 4.00
Gross profit margin 40%
Operating profit margin 9.6%
Total asset turnover 1.11
Fixed asset turnover 2.02
Return on common equity 8.0%
Return on total assets 4.0%
Sample Problem: Financial Statement Analysis
Estrella Stores has sales of P6 million, an asset turnover
ratio of 6 for the year and net profits of P120,000. What is
the company’s return on assets? The company will install
new point-of-sales cash registers throughout its stores
which are expected to increase efficiency in inventory
control, reduce clerical errors and improve record keeping.
This new equipment will increase the investments in
assets by 20% and is expected to increase the net profit
margin from 2% now to 3%. No change in sales is
expected. What is the effect of the new equipment on the
earning power?
Solution:
Total Assets = Sales/Asset turnover = 6million/6 = 1
million
Return on Assets = Net Profits/Total Assets =
120,000/1,000,000 = 0.12 = 12%
Effect of New Equipment
• Total Assets = 1.2(1) = P1.2 million
• Net Profit = 6 million (0.03) = P180,000
• Return on Assets = 180,000/1.2 million = 0.15 = 15%
Therefore the new equipment will increase earning
power 25% [(15%-12%)/12%].
