Common size statements

These statements recast all items in a particular FS as a % of a selected item

Vertical Common Sizing

Balance Sheet
Assets Liab & Equity

Total Current assets 350000 Curr Liab

Long term Liab
Total Liabilies

Fixed Assets 150000 Common Stock(par val)

Addtnl Paid in Capital
Retained Earnings
Total S/E
Total Assets 500000 Total Liab & Equity

Income Statement Original StatemVertical Common size Statement

DM Sales 250000 100%
DL Mfg Cost COGS 120000 48%
VOH Gross Profit 130000 52%
FOH Gen & Admin Expenses 85000 34%
Selling Expenses 10000 4%
EBIT or Oper. Profit 35000 14%
Interest 10000 4%
EBT 25000 10%
Tax 7500 3%
PAT or Net Income 17500 7%
From NI, EPS can be found out

Horizontal Common Sizing - Trend Analysis

Yr 1 Yr 2
Sales 250000 260000
COGS 120000 125000
Gross Margin 130000 135000
Gen & Admin Expenses 85000 90000
Selling Expenses 10000 13500
EBIT 35000 31500

Yr 1 (Base Year)Yr 2
Sales 1 1.04
COGS 1 1.04
Gross Margin 1 1.04
Gen & Admin Expenses 1 1.06
Selling Expenses 1 1.35
EBIT 1 0.90

In yr 4 analyze the growth of Sales and COGS and tell if its favourable or unfavoura
Sales grew by 20%
COGS grew by 33%
Hence GM has grown only by 8%
It is unfavourable
 Vertical Common Sized Balance Sheet

b & Equity Assets Liab & Equity

200000 Total Current assets 70% Curr Liab 40% Curr ratio
50000 Long term Liab 10%
250000 Total Liabilies 50%

25000 Fixed Assets 30% C/S 5%

100000 APIC 20%
125000 RE 25%
250000 Total S/E 50%
500000 Total Assets 100% Total Liab & Equity 100%

on size Statement

52%

14%

30%

Yr 3 Yr 4
275000 300000
135000 160000
140000 140000
80000 85000
14000 15000
46000 40000

Yr 3 Yr 4 Yr 1 (Base Year) Yr 2 Yr 3 Yr 4
1.10 1.20 Sales 100% 104% 110% 120%
1.13 1.33 COGS 100% 104% 113% 133%
 1.08 1.08 Gross Margin 100% 104% 108% 108%
0.94 1.00 Gen & Admin E 100% 106% 94% 100%
1.40 1.50 Selling Expens 100% 135% 140% 150%
1.31 1.14 EBIT 100% 90% 131% 114%

f its favourable or unfavourable

Yr1 Yr2 Yr3 Yr4

Sales 1250 1300 1359 1400
COGS 750 785 825 850
GP 500 515 534 550
GP/Sales GM 40.000% 39.615% 39.294% 39.286%

Yr1 Yr2 Yr3 Yr4

Sales 100% 104% 109% 112%
COGS 100% 105% 110% 113%
GP 100% 103% 107% 110%
GM 100.00% 99.04% 98.23% 98.21%

COGS outgrows Sales and hence GM is decreasing over the years

Option A is right
CA/CL
Current Assets Any asset that can be converted to cash within 1year or 1 operating cycle of the company, whichever is lo
Current Liabilities Any liability which is due within 1 year or 1 operating cycle of the company, whichever is longer

What are current Assets OC

Cash and Cash Equivalents 60 days
Marketable Securities 6 months
Accounts Receivable 9 months
Inventory 18 months
Prepaid Expenses

Net working Capital = Current Assets - Current liabiities

Current Assets
Current Ratio =
Current Liabilities

Cash + Marketable Securities + Receivables or

Quick Ratio =
Current Liabilities

Cash + Cash Equivalents

Cash Ratio =
Current Liabilities
On Dec-30, CA = $300;
What is the impact to C

CR

Cash + Marketable Securities + Receivables

Defensive Interval =
Avg Daily Expenditure On Dec-30, CA = $300;
What is the impact to C

Current Assets CR
Current Ratio =
Current Liabilities
mpany, whichever is lo max(1year, 1OC)
ver is longer

CA Criteria
1 year
1 year
1 year
18 months

Current Assets - Inventory - Prepaid Expenses

Current Liabilities

Ratios > 1
On Dec-30, CA = $300; CL = $150. On Dec-31, the company paid $50 of CL using Cash. On Dec-30, Cash and CE = $
What is the impact to CR because of this transaction. What is the impact to Cash
Before After
2 2.5 CR increases as Num and Den decreased by the same value Cash Ratio
Window Dressing done by Company to boost CR

On Dec-30, CA = $300; CL = $150. On Dec-31, the company borrowed $50 Cash through short term debt due iOn Dec-30, Cash and CE = $
What is the impact to CR because of this transaction. What is the impact to Cash
Before After
2 1.75 CR decreases as Num and Den increased by the same value Cash Ratio

3/2 4/3
1.50 1.33
CR = CA/CL 1470000 2.94
500000

QR = CA-Inv-Prep/CL
1170000 2.34 Option C
500000

Before After
Current Ratio 2 2.083333 Increases-> a and b are wrong
Quick Ratio 0.884615 0.807692 Decrease -> C is right
Option C po
 Ratios < 1
On Dec-30, Cash and CE = $100; CL = $150. On Dec-31, the company paid $50 of CL using Cash.
What is the impact to Cash Ratio because of this transaction.
Before After
0.67 0.5 Cash Ratio decreases as Num and Den decreased by the same value

On Dec-30, Cash and CE = $100; CL = $150. On Dec-31, the company borrowed $50 Cash through short term debt due in 90 days
What is the impact to Cash Ratio because of this transaction.
Before After
0.67 0.75 Cash Ratio increases as Num and Den increased by the same value

2/3 3/4
0.67 0.75
> a and b are wrong
debt due in 90 days
AR Turnover = Net Credit Sales I/S
Higher the better Average AR B/S

RCP or DSO = 365 in days or Avg AR

AR turnover Credit Sales/day

Inventory Turnover = COGS I/S

Average Inventory B/S

ICP = 365 in days or Avg Inv

Inv Turnover COGS/day

AP Turnover = Net Credit Purchases I/S

Average AP B/S

PDP = 365 in days or Avg AP

AP turnover Credit Purchases/day

Input Data Assume 360 day year

Total Sales 1000 CA 342.0
Cash Sales 100 CL 40.0
COGS 720 NWC 302.0
Average AR 180 CR 8.6
Average Inv 72 QR 6.5
Net Credit Purchases 600 Cash Ratio 1.3
Average AP 40 Higher the betterAR Turnover 5
Cash 50 Lower the better RCP 72
Mkt Securities 30 Higher the betterInv Turnover 10
Prepaid Expenses 10 Lower the better ICP 36
Lower the better AP Turnover 15
Higher the betterPDP 24
CCC 84
Operating Cycle 108
 DSO Days Sales Outstanding (Another term for RCP)
RCP Receivable Conversion Period Lower the better
PDP Payable Deferral Period Higher the better
ICP Inventory Conversion Period Lower the better
CCC Cash Conversion Cycle Lower the better
OC Operating Cycle Lower the better

CCC = ICP + RCP - PDP where ICP + RCP = OC

ICP RCP

36 days 72 days

Receive Pay to Sell goods Collect money

Inventory Supplier to customer from Customer

24 days 84 days (36+72-24)

PDP
CCC

60 day year
$ OC = 108 days
$ Inventory XX AP. XX AR. XX Cash. XX
$ AP XX Cash. XX Sales XX AR. XX
Times
Times
Times COGS. XX
Times Inventory. XX
days Net Effect is
Times 1. Nominal accounts(I/S) are impacted ie Sales and COGS
Days 2. In Balance Sheet, only Cash Increases by Gross Profit(Sales - COGS)
Times - To compensate for increase in Asset side, Retained Earnings in Equity side increases
Days
Days

A B C
COGS 800000 875000 1837500
Avg Inv 50000 152500 165000
Inv Turnover 16 5.7 11.1

Option D
 A B C
Net Cred Sal 175000 145000 225000
Average AR 10000 20000 11500
AR Turnover 17.5 7.3 19.6 Times
RCP 20.9 50.3 18.7 Days

Option D is correct
Statement of Cash Flows

GAAP requires companies to follow Accrual accounting and hence

it's necessary for making a reconciliation between 'Net Income' and
'Changes in Cash balance'
In general
3 Sections - Operating, Investing, Financing Section
Operating
Investing
Financing
Sum of all 3

Operating Activities Current Assets

- Cash collected on Sales
- Payments for purchases, SG&A
- Interest Received and Dividend Received
- Interest paid
- Taxes paid

Investing Activities Non Current Assets

- Giving loans to others
- Investments - Stocks and Bonds
- PP&E and Intangibles

Financing Activities Long term liab and Shareholders equity

- Loans borrowed to run business
- Bonds (Selling & Retiring bonds)
- Equities (Issue and buyback of stock

2 methods - Direct v Indirect

- Change only in the presentation of Operating Cash flows
- Investing and Financing are reported in the same way

- Indirect method reconciles Net Income to Operating cash flow

and hence starts with NI and removes/adjusts the below 3:
A) Non-operating cashflows(Gains from Investments)
B) Non cash items(Depreciation)
C) Changes in balances of Accrual items
- Increase of CA - subtract(example - AR)
- Increase of CL - Add(example - AP)

5 Important cashflows US GAAP

1. Interest earned Operating
2. Interest paid Operating
3. Dividends received Operating
4. Dividends paid Financing
5. Taxes paid Operating

Example 1
A company following accrual method has a Sales of $1500 in 2014. Acoounts receivables on the Balance sheet has increased b
What is cash inflow to be included in Statement of Cashflows

Direct Method: Cash (plug)

AR Increase
Cash received = Sales - Increase in AR Sales
Increase in AR = Ending Balance - Opening Balance

Example 2
A company following accrual method has a COGS of $500 in 2014 in its Income Statement. Accounts Payables on the Balance s
Also Inventory in B/S has increased by $75
What is cash outflow to be included in Statement of Cashflows

Cash outflow to vendors = ?

I/S B/S
COGS AP
Inventory

Inventory has decreased by 50

COGS 500
AP 50
Inventory -50
Cash Outflow $400

COGS 500
AP -100
Inventory -50
Cash outflow $550
 Items in B/S
CA and CL Cash inflow $ 150K 150000
Non-current assets Cash outflow $200K -200000
Non-current Liabilities + Equity Cash inflow of $ 50K 50000
Change in Cash balance in B/S No change in cash balance 0

Current Assets

g term liab and Shareholders equity

IFRS(More flexible)
Operating or Invensting Purchased bonds of other companies
 Operating or Financing Issued bonds or got loans from bank - Repayment of Principal is always FINANCING Activity
Operating or Investing Purchased stock of other companies
Financing Pay div to your shareholders
Operating or Financing Current liability and hence operating

unts receivables on the Balance sheet has increased by $200 as compared to Prev B/S date - 2013

Dr Cr Dr Cr
1300 AR 1500
200 Sales 1500
1500 Dr Cr
Cash 1300
AR 200
Sales 1500
come Statement. Accounts Payables on the Balance sheet has increased by $50 as compared to Prev B/S date - 2013

Total Purchases from your supplier = COGS + Inventory increase

575
Since there is an increase in AP of $ 50 company has paid only $525 to vendor

Total purchases from your supplier = COGS - Inventory decrease

450
Since there is an increase in AP of $ 50 company has paid only $400 to vendor

Total purchases from your supplier = COGS - Inventory decrease

450
Since there is a decrease in AP of $ 100 company has overpaid $100 more than the purchases
al is always FINANCING Activity

Dr Cr
Cash 1300
AR 1300

date - 2013

Case -1
Dr Cr
Cash (plug) 525
IS COGS 500
ly $525 to vendor Inv 75
BS AP 50

Case -2 : Assume inventory decreased by $50

Dr Cr
Cash(plug) 400
COGS 500
ly $400 to vendor AP 50
Inventory 50

Case -3 : Assume inventory decreased by $50 and AP decreased by $100

Dr Cr
Cash(plug) 550
COGS 500
id $100 more than the purchases AP 100
Inventory 50
 Total Debt
Debt to Equity =
Total Shareholder's Equity

Total Debt
Debt to Capital =
Total Debt + Total Shareholder's Equity

Total Debt
Debt to Assets =
Total Assets

Average Total Assets Increases with the amount of debt

Financial Leverage =
Average Total Equity Lower the better

EBIT This explains the debt servicing capac

Interest Coverage =
Interest expense Higher the better

Earnings before Fixed charges & Taxes

Fixed Charge Coverage =
Fixed Charges
 Case - 1 Case -2 Case -3
Assets 100 100 100
Debt 0 25 50
with the amount of debt Equity 100 75 50
Fin Leverage 1.00 1.33 2.00 As debt is increasing

ins the debt servicing capacity of a Company

 Gross Profit Margin = Gross Profit
Revenue

Operating Profit
Operating Profit Margin =
Revenue

NI
Net Profit Margin =
Revenue

EBT
Pretax Margin =
Revenue

GP Margin GP/Sales 55.00%

OP Margin OP/Sales 20.00%
Pretax Margin EBT/Sales 19.50%
Net Income Margin NI/Sales 14.50%
 NI
Return on Assets(ROA)=
Avg Total Assets

ROE = ROA *
NI or NI
(Return on Equity)ROE = *
Avg Total Equity Avg Total Assets

EBIT
Return on Total Capital =
Avg Total Capital

ROE = ROA * Financial Leverage Illustration of ROE and ROA relationship

Case - 1 Case -2
NI/ Equity = NI/Assets * Assets/Equity Assets 100 100
Debt 0 25
Equity 100 75
Fin Leverag 1.00 1.33
So, ROE = ROA when there is no debt(Financial Leverage = 1) NI 50 50
ROE > ROA when there is debt in the company ROA 0.5 0.5
Hence Financial Leverage is called as Asset Multiplier ROE 0.50 0.67
ROA * FL 0.50 0.67

Vertical Common Sizing

Sales 10000000 100%
<COGS> 4500000 45%
Gross Profit 5500000 55%
<Opex> or <SG&A> 3500000 35%
Operating Profit 2000000 20%
<Interest> 50000 1%
EBT 1950000 19.5%
<Tax> 500000 5%
NI or PAT 1450000 14.5%
Financial Leverage
Average Total Assets
Average Total Equity

Case -3
100
50
50
2.00
50
0.5
1.00
1.00
Sustainable Growth Rate
Maximum Possible growth rate without raising additional external capital
g = Retention Rate * ROE

g - growth rate
ROE - Return on Equity

NI - Dividends Declared 1 - Dividend payout ratio

Retention rate = OR
NI

PE Multiple = MP per share Market Capitalization

OR
EPS NI

2 companies in the same indstry with PE 8 and 12 where as the industry average is 10

Company with PE 12 is overvalued when compared to indstry average

Company with PE 10 is undervalued when compared to industry average
ROE = 20%
NI = 1000000
Dividend payout ratio = 25%
What is g?
Retention Rate = 75%
g = Ret Rate * ROE = 15.00% Maximum growth possible
If the company wants to grow at a rate>15%, then go for external capital(Debt or Equity)
Income Statement as per Contribution Reporting(non-GAAP method)
Sales
<VC>
Contribution Margin Contribution Margin More the fixed costs, more the DOL
DOL =
<FC> EBIT
Operating Margin/EBIT
<Interest Expenses> EBIT More the interest expense, more the DFL
DFL =
EBT EBT
<Taxes>
PAT or NI
Contribution Margin
DTL = DOL * DFL
EBT

Both leverages increases risk but at the same time leverage ampllifies the profits in case of increase in sales. Hence it’s a doub
A company cannot have both DOL and DFL high as it will increase Risk -> Beta -> Cost of capital of Equity

DOL will be more if there are more FC DFL will be more if there are more Interest Expenses(Due to LT Debt
DOL will be less if there are less FC DFL will be less if there are less Interest Expenses(Due to LT Debt)

DOL 1.33 1.33 1.33

COMPANY A Sales decrease 10% Base Case Sales increase 10%

Sales 900 1,000 1100
Variable Cost 540 600 660
Contribution 360 400 440
Fixed Cost (Oper) 100 100 100
Operating Income (EBIT) 260 300 340
Change in EBIT -13.33% 13.33%
Nothing but DOL * Channge in Sales Nothing but DOL * Channge in Sales
-13.33% 13.33%

DFL 1.2 1.2 1.2

EBIT decrease 13.33% Base Case EBIT increase 13.33%

Operating Income (EBIT) 260 300 340
Fixed Cost (Interest) 50 50 50
EBT 210 250 290
TAX @ 40% 84 100 116
PAT or NI 126 150 174
No. of Shares 100 100 100
EPS 1.26 1.5 1.74

Change in EBT -16.0% 16.0%

Change in NI -16.0% 16.0%
Change in EPS -16.0% 16.0%

DTL 1.6

Change in EBT 1.6 1.6 1.60

Change in Sales = CM/EBT
d costs, more the DOL or % Change in EBIT % Chanve in EBIT = DOL * % Change in Sales
% Change in Sales

rest expense, more the DFL or % Change in EBT or NI or EPS

% Change in EBIT

DTL = % Change in EBT or NI or EPS

% Change in Sales

rease in sales. Hence it’s a double edged sword

terest Expenses(Due to LT Debt)

est Expenses(Due to LT Debt)

2 2

COMPANY B Sales decrease 10% Base Case

Sales 900 1,000
Variable Cost 540 600
Contribution 360 400
Fixed Cost (Oper) 200 200
Operating Income (EBIT) 160 200
Change in EBIT -20.00%
DOL * Channge in Sales
Higher variability in OI and hence high risk

2.0 2.0

EBIT decrease 20% Base Case

Operating Income (EBIT) 160 200
Fixed Cost (Interest) 100 100
EBT 60 100
TAX @ 40% 24 40
PAT or NI 36 60
No. of Shares 100 100
EPS 0.36 0.6

Change in EBT -40.0%

Change in NI -40.0%
Change in EPS -40.0%

Higher variability in NI and hence high risk

4

Change in EBT 4 4.00

Change in Sales = CM/EBT
in EBIT = DOL * % Change in Sales
Repurchase of TS for $10

FINANCIAL LEVERAGE Assets 100 90

Equity 50 40
2 2.25

Risky bcoz of DOL

2.00

Sales increase 10%

1100
660
440
200
240
20.00%

Risky bcooz of DFL

2.0

EBIT increase 20%

240
100
140
56
84
100
0.84

40.0%
40.0%
40.0%

4.00
Basics of Mathematical Ratios
Decrease Increase
100 80 120
250 230 270

Ratio
0.4 <1 0.35 0.44
Decreased Increased

Decrease Increase
100 80 120
50 30 70

Ratio
2 >1 2.67 1.71
Increased Decreased

Slide 41

Current ratio 33000 = 1.5

22000

Quick Ratio 25000 = 1.14

22000

Cash Ratio 5000 = 0.23

22000

Quick Ratio 2 Current Assets - Inve = 9

Current Liab Current Liab

Current Liab = 9/2 4.5

Question has invalid data
Sales 40000 Operating Profit 14000
<VC> 20000 DOL 2 <Interest> 3000
CM 20000 EBT 11000
<FC> 10000
Op Profit 10000
DTL 2.545

Ideally this should be the answer

Sales 40000 Operating Profit 10000
<VC> 20000 DOL 2 <Interest> 3000
CM 20000 EBT 7000
<FC> 10000
Op Profit 10000
DTL 2.86
DFL 1.27

DFL 1.43