TEXPO Conference 2020: Essential Learning for CTP Candidates · 2020. 8. 9. · Addition...

TEXPO Conference 2020:

Essential Learning for CTP Candidates

Session #5 (Wed., 9/02, 3:00 – 4:00 pm)

❖ ETM6-Chapter 8:

Financial Accounting

and Reporting

❖ ETM6-Chapter 9:

Financial Planning

and Analysis

© 2018 - The Treasury Academy, Inc. - All Rights Reserved 1

Essentials of Treasury Management, 6th Ed. (ETM6) is published by the AFP

which holds the copyright and all rights to the related materials.

As a prep course for the CTP exam, significant portions of these lectures are

based on materials from the Essentials text.

To Sign up for On-Line Access

❖E-mail request to: [email protected]

❖You will receive an invitation to join the class from Canvas-Instructure

❖Click on link and use your e-mail address as Username and you can set your own password

❖First place to go is MODULES

❖Materials for all of the chapters in ETM6 are provided

2© 2018 - The Treasury Academy, Inc. - All Rights Reserved

mailto:[email protected]

Addition Information

❖There is a link to my DropBox Folder for this course on the Canvas site

❖Copies of all session lecture notes from Texpo

❖Additional handouts and other items of interest are provided there

❖Please note that the full content and on-line support are all on the Canvas site, which requires you to e-mail me for an invitation


ETM6: Chapter 8

❖ ETM6-Chapter 8:Financial Accounting & Reporting

4© 2019 – The Treasury Academy - All Rights Reserved





Overview of Chapter 8 Topics

❖Introduction❖Uses of Financial

Statements❖Accounting Concepts and

Standards❖Financial Statement

Reporting❖Accounting for Derivatives,

Hedges, and Foreign Exchange (FX)

❖Accounting for G/NFP


Introduction to Financial

Accounting and Reporting ❖Financial

statements

summarize a

company’s

operating

results and

financial

position

© 2020 – The Treasury Academy - All Rights Reserved 6

Analyzing Financial Statements

Provides Insights Into:

❖Overall liquidity level

❖Ability to generate

revenues from assets

and control costs

❖Capital structure


Accounting Concepts and

Standards

❖Global Accounting

Standards

▪ IASB & IFRS

❖U.S. Accounting Standards

▪ GAAP & SEC Filings

❖Comparison

▪ IFRS is high level/less detailed

than GAAP

▪ GAAP converging towards

IFRS standards8© 2020 – The Treasury Academy - All Rights Reserved

Audit Opinions

❖Unqualified Opinion

❖Qualified Opinion

▪Some, usually minor issues

❖Adverse

❖Disclaimer of

Opinion


This is a significant

change from the

previous ETM

Types of Financial Statements

❖Balance Sheet▪ Assets▪ Liabilities▪ Shareholders’ Equity

❖Income Statement▪Revenues▪ Expenses

❖Statement of Retained Earnings▪ Expanded discussion in ETM6

❖Statement of Cash Flows▪ Sources and Uses of Funds


Sample Balance Sheet

“Snapshot”

Assets:Current assets

Fixed assets

Depreciable fixed

assets

Intangible assets

Liabilities:Current liabilities

Long-term

liabilities

Equity

Assets = Liabilities +

Shareholders’

Equity

© 2020 – The Treasury Academy - All Rights Reserved 11Source: ETM6 - © AFP

Sample Income Statement

A record of

revenues and

expenses

Shows the net

change in

shareholders’

equity from

operations over

a specified

period


Sample Statement of Cash Flows

Shows sources and

uses of cash

Sections:

Operating

Investing

Financing

Cash from

operations

calculated by

adding back non-

cash charges

(e.g.,

depreciation)

Cash, not earnings,

repays debt

This example shows

the indirect format


Accounting for Derivatives,

Hedges and FX Translation

❖Derivative/Hedge Accounting

▪What is instrument’s intended use?

❖FX Translation Accounting

▪ Functional Currency: currency of

the primary economic environment

in which the entity operates

▪ Translation of foreign statements

to reporting currency

▪New updates on this for ETM6

❖GAAP VS IFRS14© 2020 – The Treasury Academy - All Rights Reserved

FX Transaction Accounting

❖ The new requirement is that companies report

transaction exposure in a manner similar to translation

exposure

▪ Essentially, transactions should be initially recorded at the

exchange rate on the transaction date

▪ At each subsequent balance sheet date, FX cash amounts

should be recorded at the closing FX rate on the balance

sheet date

▪ Non-monetary amounts should be recorded at the FX rate

in effect on the transaction date when fair value was

determined

▪ Most differences will be posted in the comprehensive other

income account until the disposal of the asset


Accounting for G/NFP

Organizations❖Government agencies provide

goods, services or information to benefit the public as a whole or its particular segments

❖NFP organizations serve specific constituencies who pay for some or all of the benefits provided

❖Role of GASB

▪ Governmental Accounting Standards Board

❖GFOA

▪ Government Finance Officers Assoc.


ETM6: Chapter 9

❖ ETM6-Chapter 9:Financial Planning & Analysis

17© 2020 –The Treasury Academy - All Rights Reserved





Overview of Chapter 9 Topics

❖Introduction

❖Time Value of Money

❖Cost of Capital (WACC)

❖Capital Budgeting

❖Budgeting

❖Cost Behavior

❖Financial Statement

Analysis


Basic Financial Concepts❖Time Value of Money

▪ Future Value

▪ Present Value

❖Opportunity Cost

▪ What is the right rate to use?

❖Cost of Capital

▪ Concept of WACC

❖Cost Behavior

▪ Total, Fixed, Variable, Semi-variable

▪ Operating & Financial Leverage, Econ. of Scale

❖Capital Budgeting

▪ NPV, PI, IRR

n

2FV = PV × (1 + i)

= $100 × (1 + .10)= $100 × 1.21 = $121


Concept of Opportunity Cost

❖What is the appropriate rate to use for

time value analysis?

▪ Investors look to alternative investments in a

particular risk class to discover the best rate

of return available

▪ By investing in one particular company or

investment, the investor loses the

opportunity to invest in other securities

▪ The firm must provide a return that equals

the investors’ opportunity cost


Time Value of Money

The value of cash flow is determined by:

• Amount of the cash flows.

• Appropriate interest rate.

• At what future period the

cash flow is expected to

occur.


Future Value

121$21.1100$

)10.1()10.1(100$

)10.1(100$

i)(1 PV ValueFuture

2

n

==

=

+=

+=

What is the future value of $100 if it can be

invested for two years, compounded annually, at

a rate of 10% per year?

Where:

FV = Future value

PV = Present value

i = Periodic interest rate

n = Number of periods


Source: ETM6 - © AFP

Present Value

What is the present value of $2,382 to be received after

three years, discounted at a rate of 6.00% annually?

Where:

FV = Future value

i = Periodic interest rate

n = Number of periods

000,2$191.1

382,2$

)06.1)(06.1)(06.1(

382,2$

)06.01(

382,2$

i)(1

FV ValuePresent

3n

==

=

+=

+=



PV of a Stream of Payments


31 2 n

1 2 3 n

CC C CPV ... ...

(1 i) (1 i) (1 i) (1 i)= + + + +

+ + + +

1 2 3

$200 $400 $600PV

(1 .12) (1 .12) (1 .12)

$200 $400 $600

1.12 1.2544 1.4049

$178.57 $318.88 $427.08 $924.53

= + ++ + +

= + +

= + + =

As an example, assume the following annual cash

flows: $200 in year one, $400 in year two and

$600 in year three. If the appropriate discount rate

is 12%, then the PV of the stream would be:


PV for Periods of Less Than 1

Year


Assume a payment of $50,000 to be received in 15 days at an annual

discount rate of 6%, compute the present value.


Cost of Capital and Firm Value❖Cost of capital is the basic target number that

asset returns must exceed if the company is to

create shareholder value

❖Capital Components and Costs

▪ Primary sources of “permanent” capital are long-term

debt (bonds) and equity (common stock and retained

earnings)

▪ The relevant costs of

these sources are their

marginal cost

▪ Be sure to use only

after-tax values for the costs

❖Typically calculated as WACC

▪ Weighted Average Cost of Capital

26

© 2020 – The Treasury Academy - All Rights Reserved

Cost of Debt❖Relevant cost is after-tax YTM

❖After-tax kd = Before-tax kd(1 – T)

❖Calculation Example – Assume

YTM of 5% and marginal tax rate of 30%:

▪ After-tax kd = 5%(1 – .3) = 3.5%

❖In companies with complicated tax

liabilities, the marginal tax rate may be

difficult to estimate from standard financial

statements

❖Though flotation costs of debt are usually

low, they should be considered if they are

significant


Cost of Common Equity

❖Two sources of common equity

▪ Retained earnings during the period

▪ Issue new common stock

❖CAPM may be used to estimate the

market’s required rate of return on

equity

❖Flotation costs are usually not

considered for retained earnings, but

may be significant for new common

stock issues


Common Equity Calculation Example

❖Assume a risk-free rate of 4.0%, a return on the stock market of 10.0% and a Beta of 1.2

❖In this case the cost of equity is:


E RF M RFr r (r r )

= .04 + (.10 .04)(1.2) = .112 or 11.2%

= + −

−Source: ETM6 - © AFP

Weighted Average Cost of Capital

(WACC)

❖Assume 35% of total financing is from debt and 65% is from equity, and the costs of debt and equity are those found on previous slides:


D D E EWACC = W r (1 T) W r− +

D D E EWACC = W r (1 T) W r

[.35 0.05 (1 0.3)] (.65 0.112)

8.51%

− +

= − +

=


Firm Value❖According to EVA (Economic

Value Added) concepts, a firm

must earn a rate of return on

assets that exceeds the cost of

capital in order to create

shareholder value

❖Assume a tax rate of 30%,

$50M of capital employed and

an operating profit of $6.8M


EVA = EBIT(1 Tax Rate) (WACC)(L-T Debt + Equity)

$6,800,000(1 .30) (.085)($50,000,000)

$4,760,000 $4,255,000 $505,000

− −

= − −

= − =


Capital Budgeting Metrics❖Developing strategic plans for a company’s

proposed large-dollar investments

❖For example, replacement of existing

equipment, expansion of facilities, purchase of

new equipment or introduction of a new product

line

❖Form of Cost-Benefit analysis using models

▪ Payback period

▪ Net present value

▪ Profitability index

▪ Internal rate of return


Net Present Value (NPV)

Evaluates the present value

(PV) of all inflows and

outflows of a project using

the weighted average cost of

capital as a discount rate

If the only cash outflow takes place in the present :

−NPV = PV of Cash Inflows PV of Cash Outflows

−

−31 2 n

1 2 3 n

NPV = PV of Cash Inflows Cash Cost

CC C CNPV = + + + ... + Cost

(1+ i) (1+ i) (1+ i) (1+ i)

© 2018 - The Treasury Academy, Inc. - All Rights Reserved 33Source: ETM6 - © AFP

Net Present Value (NPV)

−

−

A 1 2 3 4 5

B 1 2 3 4 5

$300 $300 $400 $100 $100NPV = + + + + $1,000

(1 + .10) (1 + .10) (1 + .10) (1 + .10) (1 + .10)

= $ 48.42

$1,000 $1,000$300 $300 $400NPV = + + + +

(1 + .10) (1 + .10) (1 + .10) (1 + .10) (1 + .10) − $1,000

= $1,124.98

Year 1 Year 2 Year 3 Year 4 Year 5

Project A $300 $300 $400 $100 $100

Project B $300 $300 $400 $1,000 $1,000

Assume an initial outlay of $1,000 and a cost of capital of 10%



Profitability Index (PI)

Present Value of Cash InflowsProfitability Index =

Present Value of Cash Outflows

Ratio of the PV gained to the cost required to

obtain that value; shows value gained per

dollar of investment

If the only cash outflow is in the present (period 0):

A

B

$951.57PI = = 0.952

$1,000

$2,124.98PI = = 2.125

$1,000


Internal Rate of Return (IRR)

Discount rate (i) for NPV = 0

or

PV of Cash Inflows = PV of Cash Outflows

=

−

−

A 1 2 3 4 5

B 1 2

NPV = PV of Cash Inflow Cost = 0

$300 $300 $400 $100 $100NPV = + + + + $1,000 0

(1 + i) (1 + i) (1 + i) (1 + i) (1 + i)

i = 7.7%

$300 $300 $400NPV = + +

(1 + i) (1 + i) (1 + i = −

3 4 5

$1,000 $1,000+ + $1,000 0

) (1 + i) (1 + i)

i = 38.1%


Capital Expenditure Analysis Summary

Method

Project

Acceptance

Criterion

Project A Project B

Net Present

Value (NPV)NPV > 0 $–48.43 $1,124.98

Profitability

Index (PI)PI > 1 0.952 2.2125

Internal

Rate of

Return

(IRR)

IRR > WACC* 7.7% 38.1%

* Weighted Average Cost of Capital (WACC) = 10% in the example © 2018 - The Treasury Academy, Inc. - All Rights Reserved 37


Risk Analysis❖ Scenario analysis

▪ “What if” analyses establishing best and worst cases

(calculates NPV for each)

❖ Sensitivity analysis

▪ Identifies and evaluates areas of greatest vulnerabilities by

varying one factor while holding others constant in an NPV

calculation

❖ Simulation

▪ Monte Carlo simulation

❖ Risk Adjusted Discount Rate (RADR)

▪ Requires high-risk endeavors to earn a higher rate of return in

order to justify the investment

❖ Risk-Adjusted Return on Capital (RAROC)

▪ Measures the expected profitability of a project from a risk-

adjusted standpoint – primarily used by financial institutions to

evaluate the profitability of investment opportunities and

relationships


Monte Carlo Simulation


Cost Types and Behaviors



Operating Leverage


Operating leverage is determined by the

extent to which fixed costs are used in a

company’s operating cost structure. The

higher the proportion of fixed costs, the

higher the company’s operating leverage.


Breakeven Analysis

−

−

Fixed CostsUnit B /E Point =

Selling Price Per Unit Variable Cost Per Unit

$10,000=

$10 $6

= 2,500 Units

Breakeven point: Level of activity for

an operation at which costs exactly

equal benefits



Business and Financial Risk

❖In determining a company’s capital structure policy, the total risk of the company’s operations and financing must be considered.

❖Total risk includes:

▪ Business risk – related to the stability and predictability of a company’s revenue stream, the greater the volatility, the greater the risk

▪ Financial risk – related to the variability of the company’s after-tax profits, usually due to costs of financing


Operating and Financial Leverage


Source: ETM6 – Exhibit 9.7 - © AFP

Operating Risk and Leverage (DOL)

❖Operating risk is a function of the mix of

variable and fixed costs in a company’s

operations

❖ It is assessed by looking at the changes

in a company’s EBIT for given change in

sales


% Change in EBITDegree of Operating Leverage =

% Change in Sales

33%Degree of Operating Leverage = = 1.65 Times

20%

Using the information from the text Exhibit 9.7


Financial Risk and Leverage (DFL)

❖Financial risk is a function of the

mix of capital sources used to

finance the company

❖ It is assessed by looking at the

changes in a company’s net

income for given change in EBIT


% Change in Net IncomeDegree of Fin. Leverage =

% Change in EBIT

50%Degree of Fin. Leverage = = 1.515 Times

33%

Using the information from the text Exhibit 9.7


Total Leverage (DTL)❖This is a measure of the total risk of

the company

❖ It is assessed by looking at the relationship between Net Income and Sales

❖ It can also be calculated as:DTL = DOL X DFL


% Change in Net IncomeDegree of Total Leverage =

% Change in Sales

50%Degree of Total Leverage = = 2.5 Times

20%

or

DTL = DOL X DFL = 1.650 X 1.515 = 2.5 Times


Financial Statement Analysis

❖Suppliers determine whether

to make sales on credit.

❖Trading partners assess the

financial ability of a counterparty

to meet contractual obligations.

❖Lenders determine whether to extend or

maintain credit.

❖Rating agencies assess credit risk of issues.

❖Investors make decisions about purchasing

and selling corporate debt and equity.


Key Financial Ratios

❖Liquidity or Working Capital

▪ Measures firm’s ability to meet its

payment obligations and cash

management efficiency

❖Efficiency or Asset Management

▪ Measures how efficiently assets

are utilized

❖Debt Management

▪ Measures level of debt and

ability to service it

❖Profitability

▪ Measures profitability in relation

to revenue and investment


Liquidity or Working Capital

Current Ratio

Measures the degree to

which current obligations

are covered by current

assets

Total Current AssetsCurrent Ratio =

Total Current Liabilities

$8,000= = 2.35

$3,400



Liquidity or Working Capital:

Quick Ratio

Measures the degree to

which a company’s current

liabilities are covered by its

most liquid current assets

(Cash) + (S-T Investments) + (A/R)Quick Ratio =

Total Current Liabilities

($1,500 + $1,300 + $1,700)= = 1.32

$3,400



Efficiency and Asset Management:

Total Asset Turnover

RevenuesTotal Asset Turnover =

Total Assets

$15,000= = 0.938 Times

$16,000

Measures how many

times the asset base

is turned over with

the flow of revenue


Efficiency and Asset Management:

Fixed Asset Turnover

RevenueFixed Asset Turnover =

Net Property, Plant & Equip

$15,000= = 2.0 Times

$7,500

Focuses on how

efficiently fixed

assets, or plant

and equipment,

are used


Debt Management:

Total Liabilities to Total Assets

Total LiabilitiesTotal Liabilities to Total Assets =

Total Assets

$7,300= = .456 or 45.6%

$16,000

Measures the

percentage of

all liabilities

relative to total

investments or

total assets


Debt Management:

Long-Term Debt to Capital

( ) ( )

( )

-

-

Long Term DebtL / T Debt to Capital =

Long Term Debt + Equity

$3,900= = .310 or 31.0%

$3,900 + $8,700

Measures the percentage

of a company’s

capitalization that is

provided by long-term

debt


Debt Management/Coverage:

Times Interest Earned (TIE) Ratio

Operating ProfitTIE =

Interest Expense

EBIT =

Interest Expense

$1,600= = 5.33 Times

$300

Measures a firm’s ability to service debt

through interest payments



Profitability: Gross Profit Margin

Gross Profit $5,800Gross Profit Margin = =

Revenues $15,000

= .387 or 38.7%

Measures the

percentage of

revenues remaining

after the cost of goods

sold is deducted from

revenue – it is also a

typical common-size

ratio measure


Profitability:

Operating & EBITDA Profit Margins

EBITOperating Profit Margin =

Revenues

$1,600= = 0.107 or 10.7%

$15,000

Measures the flow of commonly

used operating income

measures in relation to the flow

of revenue

EBITDAEBITDA Margin =

Revenues

$1,800= = 0.120 or 12.0%

$15,000


Profitability:

Net Profit Margin

Net IncomeNet Profit Margin =

Revenues

$850=

$15,000

= .057 or 5.7%

Measures the flow of

net income in

relation to the flow

of revenue


Profitability:

Return on Assets (ROA)

𝑹𝒆𝒕𝒖𝒓𝒏 𝒐𝒏 𝑨𝒔𝒔𝒆𝒕𝒔 =𝑵𝒆𝒕 𝑰𝒏𝒄𝒐𝒎𝒆

𝑻𝒐𝒕𝒂𝒍 𝑨𝒔𝒔𝒆𝒕𝒔

=$𝟖𝟓𝟎

$𝟏𝟔, 𝟎𝟎𝟎

= . 𝟎𝟓𝟑 𝒐𝒓 𝟓. 𝟑%

Measures net income in relation to

the stock of assets



Profitability:

Return on Equity (ROE)

( )

( )

Net IncomeReturn on Equity =

Total Equity

$850= = 0.098 or 9.8%

$8,700

Measures earnings shareholders and is

therefore a measure of the profitability of the

company.



Profitability:

Return on Common Equity (ROCE)

( )

( )

( )

( )

−

−

−

−

Earnings Avail. to Common S / HsReturn on Common Equity =

Common Equity

Net Income Preferred Dividends=

Total Equity Preferred Stock

$850 0= = 0.098 or 9.8%

$8,700 0

Measures earnings available to common

shareholders (net income less any preferred

stock dividends) expressed as a percentage

of common equity



Performance Measurement

❖Return on Invested Capital

(ROIC)

❖Residual Income (RI)

❖Economic Value Added (EVA)

❖Free Cash Flow (FCF)


Performance Measurement

❖Return on Invested Capital (ROIC)

▪ ROIC does not include charge for cost of capital.

▪ Positive NPV project can be rejected if it lowers

overall ROIC

▪ ROIC over a partial period may be misleading.

( ) ( )

( ) ( )

Net Income Net IncomeROIC = =

Invested Capital Long-Term Debt + Equity

$850 $850= = = 0.0675 or 6.75%

$3,900 + $8,700 $12,600


Residual Income (RI)

❖ Overcomes two of the limitations of ROIC

▪ It assigns a charge to the invested capital

▪ It is an amount of profit (or loss), whereas ROIC is just a rate of

return

❖ Assume:

▪ Net Income = $850

▪ Invested Capital = $12,600

▪ Cost of Capital = 10%


−

−

RI = Net Income - (Invested Capital x Cost of Capital)

= $850 ($12,600 x 0.10)

= $850 $1,260 = - $410

Economic Value Added (EVA)A measure of the incremental value that a

company’s investments add.

What is the EVA for the following company?

▪ Long-term debt of $3,900,000

▪ Equity of $8,700,000

▪ Marginal tax rate of 34.615%

▪ Weighted average cost of capital (WACC) of 9%

▪ Operating income (EBIT) of $1,600,000

− −

− −

−

− −

EVA = EBIT x (1 Tax Rate) (WACC) x (Long-term Debt + Equity)

= $1,600 x (1 .34615) (.09) x ($3,900 + $8,700)

= $1,046 (.09)($12,600)

= $1,046 $1,134 = $88


Performance Measurement:

Basic Free Cash Flow

❖Free Cash Flow (FCF)▪ Indicates how much cash generated during the

period is available to shareholders and creditors

▪ FCF adjusts net income for noncash charges (i.e.

depreciation and amortization) as well as working

capital and capital expenditures

▪ A commonly used measure of FCF is below

−

− −

FCF = Cash Flow from Operating Activities CapEx

= $550 $900 = $350


Other Measures for

Free Cash Flow

❖Free Cash Flow to the Firm (FCFF)▪ Represents cash flow that is available to all

providers of long-term capital

❖Free Cash Flow to Equity (FCFE)▪ Represents cash flow that is available to the

shareholders only


− −

− −

FCFF = CF from Op. Activities + (Interest Exp x (1 Tax Rate)) CapEx

FCFE = FCFF (Interest Exp x (1 Tax Rate)) + Change in Total Debt

Integrated Ratio Analysis: DuPont

Approach

ROE = Return on Sales Asset Turnover Equity Multiplier

Net Income Revenues Avg. Total Assets =

Revenues Avg. Total Assets Avg. Equity

= 0.057 0.938 1.84 = 0.098 = 9.8%

Deconstructs ROE into three key

components for more detailed analysis



Strength and Limitations of

Ratio AnalysisAdvantages:

❖ Easily computed

❖ Widely used

❖ Information easily

obtained

❖ Facilitate comparison

between companies

Disadvantages:

❖ Express static (historical), not

dynamic, relationships

❖ Summarize accounting information

and may not reflect economic value

❖ Cannot reflect qualitative value

(business strategies, managerial

talent)

❖ Use of different accounting methods

may reduce the validity of

comparisons between companies


Sample Common-Size Balance Sheet



Session Wrap-upSession 4: Financial Statements,

Analysis & Decision

❖What did we learn in this session?

❖What topics do we need to learn more about?


TEXPO Conference 2020

Essential Learning for CTP Candidates

End of This Session

We will reconvene Tomorrow @ 8:30 am

The topic will be:

More Key Concepts

Working Capital & Working Capital Metrics


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