Finance 101 n Interactive Presentation please ask questions

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

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!

Balance Sheet

Balance Sheet n 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

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

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

Working Capital Example WORKING CAPITAL = ACCOUNTS RECEIVABLE + INVENTORIES - ACCOUNTS PAYABLE 2009 2010 Delta Accounts Receivable $200, 000 $150, 000 -$50, 000 Positive Inventories $100, 000 $80, 000 -$20, 000 Positive Accounts Payable $100, 000 $80, 000 -$20, 000 Negative Working Capital $200, 000 $150, 000 -$50, 000 Positive

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 Liabilities n Days Sales Outstanding (DSO) n Days payable outstanding (DPO) n Inventory Days Supply (IDS) n Liquidity ratios n Working Capital Turnover n Debt ratio n Permanent Investment Turnover n Return on Net Assets n Equity Return on Equity

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

Income Statement

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.

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? What is Expense? (1) Cash System Checks Received Checks Written (2) Accrual System Revenue is recorded when it is earned 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

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

Cash Flow

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

Cash Flow– Our “Bank Account” n We begin with earnings n We “add-back” the non-cash cost of depreciation n 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 n We account for cash spent on new permanent investment: capital expenditures n We account for cash required for financing costs: corporate dividends and interest

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

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

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

Investment Analysis Concepts

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

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

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

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

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

Decision Making Metrics Profitability Index (PI) - a ratio of discounted cash inflows and outflows. 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

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

FINANCIAL VALUATION Marketing Project (000's) NPV T. V. % of NPV 2009 2010 2011 2012 2013 2014 2015 2016 2017 855 51. 3% 2018 Term. Value Sales Volume (MT) - 100 105 110 116 139 167 200 240 288 Selling Prices ($/kg) Sales Revenue $ - $4. 00 400 $4. 00 420 $4. 00 441 $4. 20 486 $4. 20 583 $4. 20 700 $4. 20 840 $4. 20 1, 008 $4. 20 1, 210 COGS COGP($/kg) COGP COGS $ - - $2. 00 200 $2. 00 210 $2. 00 221 $2. 18 253 $2. 18 303 $2. 18 364 $2. 18 437 $2. 18 524 $2. 18 629 Gross Profit % of Sales - 200 210 221 233 280 336 403 484 581 50% 50% 48% 48% 48% SG&A 350 200 PTOI Income Taxes ATOI % of Sales (350) (133) (217) - - - Cash Inflow (217) - 68 106 114 143 177 219 269 329 72 4 4 9 18 21 26 31 37 100 50 50 110 171 183 230 286 353 434 531 42 65 70 87 109 134 165 202 68 106 114 143 177 219 269 329 1, 371 0% 16% 24% 23% 24% 25% 26% 27% 1, 371 Cash Outflow Change in Working Capital Cash Outflow - 72 4 4 9 18 21 26 31 37 153 Net Cash Flow DCF Cumulative DCF (217) (72) (289) 65 58 (232) 102 81 (150) 105 75 (76) 125 79 4 156 89 92 194 98 190 238 108 298 292 118 416 1, 218 439 855

FINANCIAL VALUATION Capital Project (000's) Revenue NPV T. V. % of NPV 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 Terminal Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10 Value 100. 0 150. 0 200. 0 220. 0 300. 0 350. 0 400. 0 425. 0 Growth Rate COGP 50. 0% Gross Margin % SG&A EBIT ATOI (After-Tax Earnings) % of Sales 33. 3% 10. 0% 36. 4% 16. 7% 0. 0% 14. 3% 6. 3% 0. 0% 80. 0 105. 0 140. 0 158. 4 216. 0 252. 0 288. 0 306. 0 Depreciation Gross Profit 119 83% 10. 0 14. 0 16. 0 17. 0 20. 0 35. 0 50. 0 51. 6 74. 0 84. 0 96. 0 102. 0 20. 0% 23. 3% 25. 0% 23. 5% 24. 7% 24. 0% 10. 0 10. 0 10. 0 25. 0 40. 0 41. 6 64. 0 74. 0 86. 0 92. 0 6. 2 15. 5 24. 8 25. 8 39. 7 45. 9 53. 3 57. 0 6. 2% 10. 3% 12. 4% 11. 7% 13. 2% 13. 1% 13. 3% 13. 4% Depreciation - 10. 0 14. 0 16. 0 17. 0 Cash Inflow 6. 2 25. 5 34. 8 35. 8 49. 7 59. 9 69. 3 74. 0 Capital Expenditures 200. 0 - - - Change in Working Capital - 7. 5 8. 1 3. 5 13. 0 8. 1 - 8. 1 4. 1 - Cash Outflow 200. 0 7. 5 8. 1 3. 5 13. 0 8. 1 - 8. 1 4. 1 - Net Cash Flow (193. 8) 18. 0 26. 7 32. 3 36. 7 51. 7 59. 9 61. 2 70. 0 74. 0 308. 5 DCF (193. 8) 16. 0 21. 3 23. 0 23. 3 29. 4 27. 1 24. 7 25. 2 23. 8 99. 3 Cumulative DCF (193. 8) (177. 8) (156. 5) (133. 5) (110. 2) (80. 8) (53. 7) (29. 0) (3. 8) 20. 1 119. 4

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

Project Sensitivity Analysis Value 0 100 200 300 400 500 Base % Swing Price annual growth rate Value Explained 0. 01 Capital Sensitivities - Project Year 1 Market Size - Sensitivity COGP - Project COGS annual growth rate Market Growth Rates - Sensitivity 0. 04 0. 3 – 0. 3 0 11. 0 – 0. 25 0 10. 8 1. 089 1. 21 7. 5 0. 02 0. 03 5. 5 0 4. 6 4. 7 4. 0 0. 05 0. 07 1. 6 0. 02 0. 03 0. 8 0. 02 0. 03 0. 6 4. 7 3. 76 0. 2 0. 5 0. 1 1. 452 0. 04 – 0. 5 0. 2 MLA Price/kg 4. 5 Selling Expense 0. 1 5 Capital Maintenance, Parts and Upgrades 0. 04 R&D Expense 0. 05 Price/kg Competitive Effect - Growth Rate Reduction 0. 03 53. 4 3. 525 0. 8 0. 3 Base Value: 293 MM • Shows that >75% of the variability is associated with the top three sensitivities • Shows targets for further analysis

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