Credit training in English

Credit Training
Dejan Jeremid
Dejan Jeremid

dejan.jeremic@hold4aim.com

Financial Services
Credit Training
Day 1.
09.45 – 10.00
• Welcome
10.00 – 11.00
• Why & How Financials are used
11.00 – 13.00
• Understanding Cash Flow
13.00 – 14.00 (Lunch)
14.00 – 18.00
• Group Exercises

Day 2.
08.00 – 10:00
• Group Exercises
10.00 – 13.00
• Example clients
13.00 – 14.00 (Lunch)
14.00 – 15.00
• Wrap-up

Why and How Financials are Used
Understanding Financial Statements
• Presented by:

Dejan Jeremid,
Regional manager at Volvo Financial Services
Financial consultant at HOLD 4 Aim
Business, life and Wingwave coach

Section #1
How are Financial Statements used in the
Lending Decision?

Confidential

Cash
Flow

Fleet
Analysis

Affiliates

Pricing

Time in
business

Industry
Review

Pay
History

Deal
Structure

Balance
Sheet
Review

Collateral
Analysis

Economic
Crisis

AML
Risk

Owners

Income
Statement
Review

Putting the Pieces Together
We are trying to assemble the puzzle pieces to get a
clear picture of the firm.
• We are trying to determine if they can, based on the
available information, repay the money we lend to them.
• Often, the picture is incomplete because we lack the time to
obtain the information, the customer is unable or unwilling
to provide the information, or we have not asked for the
information.
• Your role as an analyst is to complete as much of this picture
as you can so that a committee is convinced that the
customer will be able to repay the money we have loaned
them.

One Puzzle Piece: Financial Statements
As the financial reports of a business contain a wealth of financial
information, it is important to consider why we are analyzing and interpreting
the financial reports.

By looking at a financial statement, credit analysts can determine the following:
•

Is the business profitable?

•

Does the company have the ability to pay its bills?

•

Should we loan them money?

•

What is the capital structure of the business?

•

How does this year’s financials compare to last year?

•

How does their financial performance compare with their competitors?

•

How does the business compare to the industry norms?

Composition of a Financial Statement
At a minimum, a complete financial statement contains the following
items:
1. An Income Statement covering a period of time.
2. A Balance Sheet as of the last day in the period of time.

Both the Balance Sheet and Income Statement should be from the
same time period.
1. An Income Statement for the 12-month period ended December 31, 2008
2. A Balance Sheet as of December 31, 2008

Additional information in a complete financial statement :
•A cover letter from the accountant who prepared the statement
•Notes to the financial statements
•Cash Flow Statement
•Statement of the Changes in Retained Earnings


Section #2
Balance Sheet Structure

Confidential

Balance Sheet: Structure
A balance sheet provides a snapshot, at a SPECIFIC POINT IN
TIME, of a firm’s financial position. By financial position we mean:
1. Assets - The quantity of assets the firm has;
2. Liabilities - How much the firm owes to those who
financed those assets; and
3. Equity – After the firm satisfies those who financed its
assets, what is left for the residual owners.
These three items are a snapshot as of a specific day in the year.
Recall our earlier example where we said the Balance Sheet was
prepared as of December 31, 2008.

Fundamental Accounting Equation: Assets = Liabilities + Equity

Assets

Liabilities + Equity


• What does it mean? The equation that is the foundation of
double-entry accounting. The accounting equation shows that
all Assets are either financed by borrowing money (a Liability)
or paid for with the money of the company’s shareholders
(Equity).
• The balance sheet is a complex display of this
equation, showing that the total assets of a company are equal
to the total of liabilities and shareholder equity. Any purchase
or sale by an accounting entity has an equal effect on both sides
of the equation, or offsetting effects on the same side of the
equation.
• The equation can be rewritten several ways:
Liabilities = Assets - Equity
Equity = Assets - Liabilities

The Fundamental Accounting Equation shows that a company can:
• Fund the purchase of an asset with assets (a $50 purchase of
equipment using $50 of cash) or
• Fund it with liabilities (a $50 purchase of equipment by
borrowing $50) or
• Fund it with equity (a $50 purchase of equipment by using $50
of retained earnings).
• In the same vein, liabilities can be paid down with assets,
like cash, or by taking on more liabilities, like debt.

Balance Sheet - Structure
• Quick Discussion:
– What impact does it have on the other financial
statements if the company fund purchases with
current assets, loans, or equity?

Balance Sheet: Assets
An entity needs, cash, equipment and other resources in order to operate.
These resources are its assets.

The asset portion of the balance sheet is subdivided into:
• Current Assets – are cash and assets that are expected to be
converted into cash or used up in the near future, usually
within one year.
• Long Term Assets – are assets that will not be converted
into cash or used up in within one year.

Balance Sheet: Current Assets

Cash
Money on hand and money in bank accounts that
can be withdrawn at any time.
Accounts Receivable
Money, which is owed to a company by a customer
for products and services, provided on credit. It is
expected that this current asset will be converted
into Cash within 1 year.

Balance Sheet: Current Assets
Inventory (Stock)
On a balance sheet, the inventory item is the sum of costs of all raw
materials, work in process, and finished goods. It is expected that this
current asset will be converted into Cash or used up within 1 year.
Prepaid Expenses
When companies prepay for goods or services that will be used up within
one year, they are classified as a prepaid expense. An example would be
paying your annual insurance premium in advance.

Balance Sheet: Long Term Assets

Long Term Assets include Fixed Assets and Non-Current Assets
Fixed assets can include:
•Land
•Building
•Transportation Equipment
•Office Equipment
•Software

If certain assets accounts cannot be liquidated, in our analysis and presentation of
the balance sheet, shouldn’t we “write-down” or reduce the value of these assets?
Yes, we should reduce the value of the assets but only when we analyze the
Tangible Net Worth. The Balance Sheet must balance. What does this mean?
If a company has 100,000 in Assets, 60,000 in Liabilities and 40,000 in Equity but
we learn that 25,000 of the Assets are Goodwill, how would we evaluate the true
Equity position of the company.
We subtract the values we cannot liquidate from Equity:
Equity – Intangible Assets = Tangible Net Worth
Tangible Net Worth (“TNW”) is a more accurate measurement of a firm’s true net
worth and is often used in place of Equity. Note you do not reduce the Equity
account in your extraction. This is an analysis technique. TNW can be used to
evaluate leverage, assess risk of default, and structure transactions.

Balance Sheet - Assets
• Quick discussion:
– What impact does a growing A/R have on the cash
flow, compared to the balance sheet?
– What impact does the placement of assets as
Current or Long Term have on the cash flow?

Balance Sheet: Current Liabilities

Like Current Assets, Current Liabilities are usually repaid within 1 year.
Examples of current liability accounts include but are not limited to:
•Line of Credit Balances (Revolving and Non Revolving)
•Current Portion of Long Term Debt Balances (CPLTD)
•Accounts Payable, and Accruals.
•Other Current Liabilities

Line of Credit (LOC)
Lines of credit extended by banks and other lending institutions usually provide
the company with short term liquidity to meet its operating needs. These lines
can be structured in any number of ways but generally are renewed annually.
Sometimes they revolve. Sometimes they don’t revolve.
Let’s discuss the following items that relate to lines of credit:
•How is it similar to a Credit Card?
•Repayment and the Impact on Cash Flow
•Secured versus Unsecured
•Borrowing Base
•Availability and Utilization
•Financial and Non Financial Covenants

It is imperative that LOC are not included with term
debt when extracting financial statements.

Continued
Accounts Payable
Money which a company owes to vendors for products and services
purchased on credit. It is important that you not include any other
accounts besides Accounts Payable in the financial extraction report.
Accruals
On accrual based statements, the Company records expenses when
they arise not when they are paid. When you see accrual, think “owed
but not yet paid”.
Examples of Accrued Expenses:
•Income taxes
•Payroll
•Interest

Continued

Current Portion of Long Term Debt (CPLTD)

On the Balance Sheet, the principal that is to be repaid within the next
12 months is listed in the CPLTD account.
Example: $6.0MUSD note. 0% interest. No Balloon at the end of the
term. 60 equal payments of principal.
The current portion of long term debt would be:
$6.0MUSD / 5 = $1.2MUSD
The Long Term portion would be:
$6.0MUSD - $1.2MUSD = $4.8MUSD
It is imperative that CPLTD is distinguished from
long term debt when extracting financial statements.

Balance Sheet: Long Term Liabilities

The portion that does not have to be repaid within 12 months is listed in
the Long Term Debt (LTD) account in the Long Term Liability section of
the balance sheet.
We introduced the concept that debt that does not have to be repaid
within 1 year is considered long term. The liability
section of the balance sheet contains several
accounts, that can include term debt, that do not
have to be repaid within 1 year. These accounts
can vary but all are considered long term liabilities.

Balance Sheet: Long Term Liabilities
Examples of Long Term Liabilities include but are not limited to:
•Long Term Debt
•Subordinated Debt
•Deferred Income

Contingent Liabilities and Off Balance
Sheet Financing
Contingent Liabilities and Off Balance Sheet Financing are similar in that
neither item is included among Current or Long Term Liabilities on the
Balance Sheet. If you have an audited financial statement, it is fairly easy
to determine whether or not a firm is contingently liable by reading the
notes to the statements. Otherwise, you must interview the customer to
discover this.
An example of contingent liability would be if our firm
guaranteed another party’s debt. In the event that party defaults, our firm
becomes contingently liable for the debt.
Off Balance Sheet financing often takes the form of operating lease debt
or rentals. This information appears on the income
statement.
It is imperative that we extract this information in our
analysis because it impacts our understanding of
leverage & cash flow coverage.

Balance Sheet: Equity
Equity consists of:

1. Common Stock, an equity security that represents ownership in a
corporation. (or preferred stock, not discussed here)
2. Paid-in Capital - Funds obtained from equity investors who are
owners
3. Retained Earnings resulting from the entity’s profitable operations.
The accumulated profits of a company. These may or may not be
reinvested in the business.


Section #2-2
How to analyze the Balance Sheet

Confidential

Balance Sheet: Accounts Receivable
DOH
A/R*
Sales

x 365 = A/R DOH

*Ideally we should use Average A/R to calculate this formula. A/R Days on Hand
(“abbrevieated “DOH”) indicates how quickly a company collects cash from customers that
owe it money; i.e how long it takes to covert A/R to Cash.
The sooner it is collected, the sooner the company can put it to work to purchase more
inventory or to pay for current orders. It is helpful in analyzing the collectability of
receivables, or how fast a business can increase its cash supply.
Although businesses establish credit terms, customers do not always adhere to them. In
analyzing a business, you must know the credit terms it offers before determining the quality
of receivables. While each industry has its own average collection period (number of days it
takes to collect payments from customers), there are observers who feel that more than 10 to
15 days over stated terms should be of concern to you.
When extracting A/R for analysis, no other assets should be included on the line item.

Balance Sheet: Accounts Receivable
DOHby also reviewing the firm’s
You can supplement the analysis of A/R DOH
Accounts Receivable Aging Report. Again, ideally we should calculate A/R DOH
using average A/R but this is very difficult to do in practice. We want average
A/R because A/R on a specific balance sheet date might not reflect the average
A/R the firm carries (due to seasonality) which in turn may skew our
understanding of how timely they collect A/R.
An A/R Aging Report allows us to directly view:




Whether or not payments are being collected in a timely manner
Perform an A/R Aging analysis in order to indentify customer
concentrations which also
Allow you to identify which customers they are having collection
problems with.

Balance Sheet – A/R DOH
• Discussion item:
– Can a client who has A/R DOH of 70 days have
no overdue receivables?
– Why do we care when the A/R DOH is in an
increasing trend?

Balance Sheet: Accounts Payable
Turnover
A/P*

x 365 = A/P DOH
COGS
*Ideally, we should use average A/P for the same reasons as given for the
first two ratios.
Accounts Payable DOH measures how the company pays its suppliers in
relation to the cost of sales (or Sales when COGS not available) volume
being transacted.
A low payable turnover would indicate a healthy ratio. Conversely, a high
payable ratio could mean the company must delay payments beyond
granted terms in order to preserve Cash. Like A/R DOH, you should know
the credit terms the firm was granted by its supplier to put this ratio into the
proper context. Figures significantly higher than credit terms should be
addressed in your presentation as well as significant swings in the figure
period over period.

Balance Sheet: Working Capital and
Liquidity
Working Capital is a measure of both a company's efficiency and its short-term
financial health. Many lenders use working capital to determine a firm’s
liquidity….or how easily its Current Assets can be converted into Cash which in
turn is used to cover its Current Liabilities.
The more liquid the assets are the higher the probability they can cover current
liabilities. Illiquidity is a risk that a company might not be able to convert its assets
into Cash when most needed and in turn, not be able to cover Current Liabilities.
Moreover, having to wait for the sale of an asset can pose an additional risk if the
price of the asset decreases while waiting to liquidate.
Working Capital is the Difference between Current Assets and Current Liabilities.

Working Capital = Current Assets – Current Liabilities

Balance Sheet: Working Capital &
Liquidity difference between Current
Working Capital can either be expressed as the
Assets and Current Liabilities or the Working Capital Ratio which can be
expressed as Current Assets divided by Current Liabilities. The common name
for the Working Capital Ratio is the Current Ratio.
Current Assets
Current Ratio =

Current Liabilities

Tip: Ratios are useful because they are a
relative measurements which can be used to
compare a firm to its peers as well as to its past
performance in order to analyze the trend.

Example: If a firm has $100,000 in current assets and $80,000 in current liabilities
Its Working Capital is $100,000 - $80,000 = $20,000. If for some reason, all
current liabilities were due and payable today, the firm could cover its current
liabilities with an additional $20,000 to fund short term operations
Its current ratio would be ($100,000 / $80,000) = 1.25 to 1.00.

What does a
current ratio of 1.25 mean? How can you use it in your analysis?

Balance Sheet: Working Capital and
Liquidity
•

Positive working capital means that the company is able to pay off its shortterm liabilities by liquidating its current assets. Negative working capital
means that a company currently is unable to meet its short-term liabilities
with its current assets (cash, accounts receivable and inventory).

•

If a company's current assets do not exceed its current liabilities, then it may
run into trouble paying back creditors in the short term. The worst-case
scenario is bankruptcy. A declining working capital ratio trend over a longer
time period could also be a red flag that warrants further analysis.

•

If this trend is observed when the financials are extracted,
it should be addressed in your presentation.

Balance Sheet: Leverage

The leverage ratio (known as Gearing in the UK) is a financial ratio indicating
the relative proportion of equity and debt used to finance a company's assets.
Total Liabilities

Leverage =
Equity
Leverage is a relative measure of a company’s risk of default. This ratio indicates
the amount due to creditors within a year as a percent of the owner’s investment.
Companies with high leverage (i.e. have higher Total Liabilities relative to Equity)
have a higher risk of defaulting on their obligations to their creditors.
Normally, a business starts to have trouble when this relationship exceeds 80%.
(Alternatively, this number may take the format of 8x pronounced “Eight Times”….as
in Liabilities are eight times tangible net worth).
Leverage less than 1x is considered nominal and less than 2x is considered low.
Leverage less than 3x is considered moderately low.
Leverage from 4x to 7x is considered moderately high.
Leverage in excess of 8x is considered extremely high.

Balance Sheet: Leverage Continued
The leverage ratio should be compared to peer firms within the same
industry.
Example: If a firm had $500,000 in Total Liabilities, $300,000 in Net
Worth, what would its leverage be?
Leverage = Total Liabilities / Equity
Leverage = $500,000 / $300,000 = 1.6 to 1.00
Is this company highly leveraged?

Balance Sheet: Contingent Liabilities
and Off Balance Sheet Financing
In the last example we determined that the leverage ratio was 1.6 to 1.0 based
on the total liabilities of $500,000 and $300,000 in Net worth.
What if the same company also had other off balance sheet commitments?
Example: $1.5 million in operating leases. How would the leverage calculation
change?
Leverage = (Total Liabilities + Off Balance Sheet Commitments)/ Equity
Leverage = ($500,000 + $1,500,000) / $300,000 = 6.6 to 1.00
Is this company highly leveraged if you consider this off balance sheet
commitment?
Does your opinion of the company’s financial position change? Are the risks of
the company defaulting on its loan agreements greater or smaller?

Balance Sheet - Leverage
• Discussion item:
– Why do you think that customers who are highly
leveraged tend to default more?

• Food for thought:
– Equity in a company is like the down payment on
an asset. The more that a person has invested
relative to the total worth, the more that they will
want to retain that investment.

Balance Sheet
Balance Sheet Comments:
1)

Trade Receivables are categorized as;

2007

2008

Normal Trade

A/R Types

MTHB 336

MTHB 548

Hire Purchase

MTHB 115

MTHB 160

Normal Trade A/R increased sharply because of PT Thailindo equipment were shipped and
invoiced in Aug 2008 which will receive the money in Dec 2008. They also provide hire
purchase facility to end customers themselves which the A/R also increased sharply.
2)

Total Current Assets also includes Inventory of MTHB 649.72 in 2007 and MTHB 640.84 in
2008.

3)

Intangible Assets increased by 45% mainly due to the increase in Hire purchase
Receivables (from MTHB 58.20 to MTHB 127.33) and the decrease in Assets for Rent (from
MTHB 217.22 to MTHB 171.28).

4)

As of Aug 2008, Working Capital utilization rose by 144% due to an increase in bank
overdraft and trust receipts for imported products (non-Volvo brand). Facilities comprises of
Bank overdraft (MTHB 16.94) and Trust receipt (MTHB 102.02).

5)

CPLTD has been increasing since 2006 as ITI started floor plan financing with VFS,
Krungthai IBJ and Cathay Lease Plan.

6)

Intercompany payable in 2007 and 2008 of MTHB 174.80 (repayable on demand and
unsecured) consists of 3 related parties which are Italthai Holding (MTHB 46.80) Sakdi Sin
Prasit Co., Ltd (MTHB 10.00) and Director (MTHB 118.00).

7)

Long-Term debt dropped by 91% to MTHB 4.10 because the equipment under financing was
sold to end customers.

8)

Accumulated deficit in Retained Earnings was carried over from 1997 to 2007 due to the
financial crisis in 1997. But with profitability generated in the last few years, it managed to
recover and reported a positive earnings of MTHB 17.90 in Aug 2008.

9)

Trade receivables turnover increased from 51 days in 2007 to 86 days as of Aug 2008
mainly due to PT Thailindo deal which was pending VFS financing, but has already been
paid in Dec 2008.

10)

For contingent liability for PT Thailindo, ITI has not yet decided how to categorize the
guarantee in the financial statement and still waiting for management’s final decision.


Section #3-1
Structure of the Income Statement

Confidential

Example Income Statement (U.S.)

Income Statement
Definition:
While the Balance Sheet is a statement of financial condition at one point
in time, the Income Statement shows what revenues were earned and
what expenses were incurred OVER A PERIOD OF TIME.

The primary purpose of the income statement is to report the profitability
of the business in relation to revenues; however it can also reveal
important insights into how effectively and efficiently management is
controlling expenses.

Incomethe income statement to ask management
Statement
As an analyst, you should use
questions like:
Are Revenues growing, shrinking, or staying the same and specifically, “Why?”
How are revenues earned?
What percentage does each of their customers contribute to total revenues?
How long have they had relationships with each of these customers?
Are the relationships based on contracts?
Can I review the contracts?
What lines of business or divisions is the company engaged in…how do they make money?
How much does each line of business or division contribute to total revenues? How has this
changed year to year? Do they earn money outside of providing transportation
services, construction services; etc.?
How much revenue does one revenue-generating asset contribute to annual sales? Monthly
sales? Based on kilometers driven or hours used, can you calculate what the revenue
generated per kilometer.
Does this historical revenue generating information tie to what management says the new
equipment will produce?

Structure:

Income Statement

 Balance Sheets note the “as of” date and an Income Statements note
the period of time covered by the statement (1 month, 9 months, 12
months, etc.); otherwise, there is no point of reference to understand
the information in the statement.
 It’s important to note that not all income statements look alike but they
necessarily contain much of the same information.
 An Income Statement has a specific structure. It starts with Revenues
for the period (Top Line), lists the expenses of the period, and
generally ends with Net Income (Bottom Line)

Income Statement
Tyson Foods Inc.
Fiscal Year ended 2005 (Millions of USD)
Top Line
a)
b)
c)
d)
e)
f)
g)

Sales
Cost of Sales
Gross Profit
Operating expenses
Operating Profit
All Other income & expenses
Interest Expense
Margin before taxes
Taxes Expense
h) Net Income

100
80
20
10
10
1
5
4
1
3

$
$
$
$
$
-$
$
$
$
$

26,014
24,294
1,720
975
745
10
227
528
156
372

(+)
(-)
(-)
(-)
(-)
(-)

Bottom Line

To understand structure and meaning of every “Element of the Income Statement”
we are going to review “Tyson Foods Inc” Income Statement 2005

a) Sales

Income Statement
Sales

$

26 014

This figure is the amount of Revenues a business brought in during the time period
covered by the Income Statement. It has nothing to do with profit.
Many companies can break sales up into categories to clarify how much was
generated by each division.
Defined and separate revenue sources can make analyzing an income statement
much easier.

Income Statement
b) The Cost of Sales
It represents the cost of producing the products sold. It can include:
•
•
•
•

Raw materials
Labor force
Overhead associated to production
Sometimes Depreciation/Amortization but this account can also be included in
the operating expenses (to be analyzed)

Service based companies generally do not register cost of sales.

Income Statement
c) Gross Profit

The gross profit is the total revenue subtracted
by the cost of generating that revenue.
a) Sales:
b) Cost of Sales
c) Gross Profit

$
$
$

26,014
24,294
1,720

Income Statement
e) Operating Income
The difference between Gross Margin and Operating Expenses give us the
Operating Income, which is a measurement of the money a company
generated from its own operations. It can be used to check the health of
the core business

a) Sales
b) Cost of Sales
Depreciation
c) Gross Profit
d) Operating expenses
e) Operating Income

$
$
$
$
$
$

26,014
23,793
501
1,720
975
745

Income Statement
f) All other income or expenses
These will arise when non-recurring items or events occur and are not
expected to occur again, examples:
•Sale of fixed assets such as machinery, transport units, etc.
•Legal Claims
•Improvement to facilities
a) Sales
b) Cost of Sales
c)
d)
e)
f)

$
$
Depreciation $
Gross Profit
$
Operating expenses
$
Operating Income
$
All Other income & expenses -$

26,014
23,793
501
1,720
975
745
10

g) Interest Expense

Income Statement

Some income statements report interest income and interest
expense
separately, while others report interest expense as “Net”.
Net refers to: Net Income-Net Expense
Interest Income: Companies sometimes keep their cash in shortterm
deposit investments, the cash placed in these accounts earn
interest for the
business, which is recorded on the income statement as interest
income.
Interest Expense: Cost of Borrowing
It is imperative that we extract Interest Expense in
order to understand the Company’s ability to cover
its interest costs.

Income Statement
The amount of interest a company pays in relation to its revenue and
earnings is tremendously important because this task can be the difference
between a positive or negative result.
a) Sales
b) Cost of Sales
c)
d)
e)
f)
g)

$
$
Depreciation $
Gross Profit
$
Operating expenses
$
Operating Income
$
All Other income & expenses -$
Interest Expense
$
Margin before taxes
$

26,014
23,793
501
1,720
975
745
10
227
528

Income Statement
i) Net Income
This is the bottom line, which is the most commonly used indicator of a
company's profitability. Of course, if expenses exceed income, this
account will read as a net loss.
a) Sales
b) Cost of Sales

$
$
Depreciation $
c) Gross Profit
$
d) Operating expenses
$
e) Operating Income
$
f) All Other income & expenses -$
g) Interest Expense
$
Margin before taxes
$
Taxes Expense
$
h) Net Income
$

26,014
23,793
501
1,720
975
745
10
227
528
156
372


Section #3-2
How to analyze an Income Statement

Confidential

Income Statement Analysis
What is important of the information that we are reviewing?
Ratios for the Income Statement
•
•
•
•

Sales Growth
Gross Profit Margin
Operating profit margin
Net Profit Margin

•
•
•
•
•

EBIT
Interest coverage ratio: EBIT
EBITDA
EBITDA Margin
EBITDAR

Interest Expense

On the following slides, (F) denotes formula and (E) denotes example

Sales Growth is one of the key measurements an analyst will review.
Sales growth is measured by comparing sales figures from two periods of
time. Ideally, the sales figures should cover equal amounts of time,
otherwise, the analyst must make an adjustment.
(F) Sales (current period) – Sales (prior period)
Sales (prior period)
(E) 26,014 – 26,441
26,441
= - 0.016 x 100 = -1.6%
An analyst should ask management about any large increases in Sales
Growth. He should also ask questions if Sales volume is unchanged from the
prior period or if Sales have declined. He should ask about erratic trends.

With multiple financial statements, you compare many of the ratios to
determine what direction your company is headed in. Here are some
key ratios over a 3 year time frame for a real private traditional trucking
operation from our records. What would you say about the financial
trends of this company?
2003

2004

2005

Sales Growth

16.3%

35.1%

32.2%

Gross Profit Margin

22.8%

23.3%

23.4%

Operating Margin

2.9%

4.0%

5.1%

Net Margin

1.44%

1.96%

2.63%


Earnings Before Interest and Income Taxes (―EBIT‖)
EBIT measures of a firm’s profitability and
management’s efficiency at minimizing
operating costs. It excludes interest and
income tax expenses. You will see EBIT and
Operating Profitability used interchangeably.

Technically speaking, EBIT and Operating
Profitability are only equal if a firm does
not have any Non-Operating Income.
If a firm has significant sources of non
operating income and you use Operating
Profitability as a measure of profitability, you
will underestimate when looking at the
income statement and underestimating their
ability to cover interest and amortize debt
when looking at interest coverage ratios and
Cash Flow.

Statement of Income — Example
(figures in millions)
Operating Revenues
Net Sales
Cost of goods sold
Gross Profit
Operating Expenses
Selling, general and administrative expenses
Depreciation and amortization
Other expenses
Depreciation and Amortization
Other Expenses

Total operating expenses
Operating income
Nonoperating income
Earnings before interest and income taxes (EBIT)
Net interest expense
Earnings before income taxes
Income taxes
Net income

$20 438
$7 943
$12 495
$8 172
$960
$138
$960
$138

$9 270
$3 225
$130
$3 355
$145
$3 210
$1 027
$2 183


Earnings Before Interest and Income Taxes (―EBIT‖)
It can be calculated several ways but
the result is the same:
Net Sales – COGS – Total Operating Expenses (OPEX)
+ Non-Operating Income.
20438 – 7943 – 9270 + 130 = 3355
**************************OR********************************

Statement of Income — Example
(figures in millions)
Operating Revenues
Net Sales
Cost of goods sold
Gross Profit
Operating Expenses
Selling, general and administrative expenses
Depreciation and amortization
Other expenses
Depreciation and Amortization
Other Expenses

$20 438
$7 943
$12 495
$8$960
172
$138
$960
$138

Operating Income + Non-Operating Expenses
3225 + 130 = 3355
**************************OR********************************

Net Income + Interest Expense + Taxes
2183 + 145 + 1027 = 3355

Total operating expenses
Operating income
Nonoperating income
Earnings before interest and income taxes (EBIT)
Net interest expense
Earnings before income taxes
Income taxes
Net income

$9 270
$3 225
$130
$3 355
$145
$3 210
$1 027
$2 183

Earnings Before Interest and Income Taxes Depreciation and
Amortization (“EBITDA”)
EBITDA measures the cash earnings that may be applied to interest and debt
retirement. Like EBIT, EBITDA measures how efficiently the company is operated
which in turn is an indicator of how profitable it is. It is a good indicator of how
much Cash is generated by the company’s operating activities which is why we use
it in Cash Flow Analysis.
Depreciation and Amortization Expense do not signify a Cash Outlfow. The
Cash Outflow occurred when the Fixed Asset or Intangible Asset was acquired.
See slide #134. As a lender, we ignore depreciation and amortization because
they are non-cash charges and thus do not interfere with a company's ability to
repay debt. If you omit them from your financial extraction, you negatively impact
our understanding of the company's ability to repay debt.
Additionally, such figures are merely a reconciliation of cash-basis accounting to
accrual-basis accounting and are subject to a certain degree of flexibility corporate
accountants have when setting depreciation and amortization schedules.

EBITDA
EBITDA Margin =

Sales
EBITDA Margin is a financial metric used to assess a company's profitability by
comparing its revenue with earnings. More specifically, since EBITDA is derived
from revenue, this metric would indicate the percentage of a revenues remaining
after operating expenses.
For example, if XYZ Corp's EBITDA is $1 billion and its revenue is $10 billion, then
its EBITDA to Sales ratio (EBITDA Margin) is 10%. Ten out of every one hundred
dollars of revenues earned is retained and is available to service debt.

EBITDA Margin =

EBITDA
Sales

=

$1 billion

=

10%

$10 billion

Generally, a higher EBITDA Margin indicates that the company is able to keep its
earnings at a good level via efficient processes that have kept certain expenses
low.

EBITDA Margin =

EBITDA
Sales

Because EBITDA margin is a good measure of how efficient a firm is at keeping
expenses low and because it is a relative measurement of efficiency, it can be used
in a variety of ways which include:

Comparing several periods, you can determine if a firm is becoming more or less
profitable (efficient) over time.
It is used on the Quick and Dirty Financial Statement Analysis Tool as a way to
project EBITDA. This projected EBITDA is used to calculate a firm’s ability to
service new and existing debt. (Cash Flow Projection Analysis).
It can be used to compare a firm to another firm within one industry.
However, when comparing company's EBITDA margin, make sure that the
companies are in related industries as different size companies in different
industries are bound to have different cost structures, which could make
comparisons irrelevant.

Income Income Taxes Depreciation and
Statement
Earnings Before Interest and
Amortization and Rental or Restructuring Costs (“EBITDAR”)
Depending on the company and the goal of the user, EBITDAR can either
include restructuring costs or rent costs, but usually not both. The
EBITDAR indicator expands on EBITDA by adding an additional excluded
item to give a better indication of financial performance.
Rent is included in the measure when evaluating the financial
performance of companies, such as trucking companies that have
significant rental and lease expenses derived from business operations.

By excluding these expenses, it is easier to compare one trucking firm to
itself over time which allows an analyst to determine if they are more or
less efficient, period-over-period. You can also compare one company to
another and get a clearer picture of their operational performance relative
to their peers.

Income Statement
EBITDAR - Continued
Restructuring is included in the measure when a company has gone
through a restructuring plan and has incurred costs from the plan.
These costs, which are included on the income statement, are usually
seen as nonrecurring and are excluded to give a better idea of the
company's ongoing operations.
Both EBITDA and EBITDAR ratios and cash flow calculations are
included in the Quick and Dirty Financial Statement Analysis Tool.
 Tip: When the company has not had any rental or restructuring
costs, you use the EBITDA figure. In fact, EBITDA and EBITDAR are
equal when there is either no rental or restructuring costs listed
among the operating expenses.
 Tip: When a company has rental costs (like renting transportation or
construction equipment), use EBITDAR as the measurement of
profitability and the EBITDAR cash flow model to measure historical
and projected ability to service debt.

Income Statement –
Income Statement Comments:
1)

As of Aug 2008, Revenue growth is relative flat at 0.1% based
on annualized basis compared to last year. Despite the weak
economic conditions, the company is still able to maintain its
business volume.

2)

Based on annualized basis, Depreciation & Amortization for
Aug 2008 and Dec 2007 are remained in the same level at
MTHB 122.82.

3)

For year 2004 and 2005, no corporate income tax were paid on
the profit since the company has been granted income tax
privileges from 1999 to 2005.

4)

As of Aug 2008, Net Profit shown only MTHB 33.84 due to the
exchange rate loss for importing the equipment for PT Thailindo
deal. Despite an increase in operating expenses, PT Thailindo
deal which was booked during Q4 2008 will increase ITI’s Net
Income from 33.84 in Aug 2008 to an expected Net Income of
MTHB 45.00 in Dec 2008.

5)

The company remains profitable in the past 5 years.

Income Statement
• Quick Discussion:
– What does it mean when a company has gone
through a restructuring? Is that the same thing as
our loan restructure?

Understanding Cash Flow

Section #4-1
Cash Flow Statement

Confidential

Cash Flow Statement Construction and
Analysis

In order to construct a valid cash flow, not to mention analyze the balance
sheet and income statement ratios, you must accurately extract all the
relevant financial data from your financial statements.
DO NOT RESTATE THE FINANCIAL STATEMENT FIGURES THEY
PROVIDE IN YOUR EXTRACTION WITHOUT ANALYZING THEM!
Recall that throughout this presentation we have emphasized the
importance of extracting all the appropriate balance sheet and income
statement items. A proper financial statement extraction takes into
account many variables, regardless of local accounting standards. In
doing so, you standardize the format of the financial statement for our
internal needs and allows you to more objectively evaluate the financial
condition of the customer.
Here is a recap of what we discussed and why it is important to extract
these items:

Analysis
Extract Depreciation and Amortization Expense as these are non-Cash
expenses. These expenses are normally found among the firm’s operating expenses
on the Income Statement but occasionally they are listed among the Cost of Goods
Sold. If not found on the Income Statement you should:
Look at the Statement of Cash Flows for this information
Look at the notes to the financial statements for this information

Estimate the number by subtracting Accumulated Depreciation from the Current
Period from the Prior Period (See Slide #135…the difference in Accumulated
Depreciation between Year 1 and Year 2 is Equal to the Depreciation
Expense for the period) or
Ask management (See Next Slide)
Unless the firm has fully depreciated all its fixed assets, there should be Depreciation
Expense listed in your financial extraction. If you omit Depreciation Expense, you
negatively impact our understanding of whether or not the customer generates
enough Cash to service historical and projected debt.

Analysis
If you ask management about the location and amount Depreciation and Amortization
Expense, pay close attention to the way they answer the question. Your first question should
be: “Are Depreciation Expense and Amortization Expense buried among the expenses on the
Income Statement or have they been excluded?”
“If the answer is “Yes, depreciation and amortization are included in the expenses on the Income
Statement” then your follow up question should be “What are the exact amounts of depreciation and
amortization?” Companies that don’t know what these figures are demonstrate that they have poor
internal accounting controls in place. You should take the information they provide and show it when you
extract the financial statements. Extracting depreciation and amortization will not affect Net Income
since these figures were previously buried among the existing expenses but will positively affect the
calculation of Cash Flow. In your extraction, be sure to reduce other expenses so that Net Income is
unchanged.
If the answer is, “No, depreciation and amortization are not included on this statement” you should ask
“Have your fixed assets have been completely depreciation and have your intangible assets, such as
Goodwill, been completely amortized?” If they have been fully depreciated and amortized, then your
investigation is complete and you should mention this in your presentation. If not, find out what the
numbers are and extract these items. This will reduce Net Income by the amount you input but will not
effect Cash Flow.
Why?

Analysis
If expenses have been inflated to reduce profitability you should investigate
what expense items were inflated and what the net effect was on profitability.

If cash actually flowed out of the business, then these were real, cash
expenses so this money is not available to service existing debt or amortize
new debt. No adjustments to your extraction are required.
If cash did not flow out of the business, then these were non-cash
expenses akin to Depreciation and Amortization. Additional adjustments to
your extraction are required. I recommend categorizing these types of
expenses as Depreciation and Amortization because they are non-Cash
expenses. By this, you won’t change Net Income but you will give a clearer
picture of the company’s ability to service debt.

Analysis
Rentals signify significant off-balance sheet financing. Operating equipment leases
are an example of off balance sheet financing.
Used in calculation of off balance sheet financing which impacts the calculation of
operating leverage.
Used in the calculation of EBITDAR which can significantly impact our
understanding of their ability to service existing and newly proposed debt.
Interest Expense should be extracted as it is an important factor in the calculation of
EBIT, EBITDA, EBITDAR as well as calculating interest coverage ratios and EBITDA
Margin.
Contingent Liabilities such as guarantees of another party’s debt should be noted
and leverage recalculated to address these items. You should also address the
Company’s ability to service this debt if a lender requires them to do so.

You should only include A/R, Inventory, Lines of Credit, CPLTD, LTD, A/P, etc. on line
items designated for them in the extraction report. Including other accounts skews
the financial statement analysis.

Analysis
A few additional questions you will need to answer to construct your cash flow and
projection are:
Is the equipment the firm wishes to finance, expanding their existing fleet or
replacing equipment in their fleet?
If they are expanding, you should treat the annual principal and interest payments
as additional debt service in your analysis.
If they are replacing equipment…i.e. ending one note and starting another and if
the payments are similar, you do not have to consider this as additional debt
service.
If they are replacing equipment but the equipment being replaced has not had
any outstanding notes against it for over a year or more, then this is still additional
debt service.

Analysis
Once you have satisfied yourself that you have extracted the data in the financial
statements correctly, that you understand the answers management has provided
you, and you know whether or not you are looking at additional debt service or
replacement debt service, you are ready to analyze the financial statements and
construct a Cash Flow Statement.

Luckily, you can use spreadsheets to automate this process so it is unnecessary to
do this by hand. I do recommend that at some point, you sit down with a calculator
and see if you can recreate the calculations in the spreadsheet.

Example of Accountant Prepared Cash Flow Statement (U.S)

Cash Flow Statement

Definition:
A cash flow statement is a financial report that shows incoming and
outgoing cash during a specific period of time. The statement shows
how changes in balance sheet and income accounts affected cash and
cash equivalents.
Why is this Statement important?
As an analytical tool the statement of cash flows is useful in determining
the short-term viability of a company, particularly its ability to pay bills.

Cash Flow Statement in addition
Many publicly traded companies provide Cash Flow Statements
to the Balance Sheet and Income Statement. This document provides
aggregate data regarding all cash inflows a company receives from both its
ongoing operations and external investment sources, as well as all cash
outflows that pay for business activities and investments during a given
period.
Recall the example U.S cash flow statement. It is comprised of 3 sections which is
one typical format of a Cash Flow Statement*:
•Cash provided (used) by operating activities
•Cash provided (used) by Investing activities
•Cash provided (used for) financing activities
*Be aware that there are many Cash Flow formats but we will not cover them
in this class.

Cash Flow Statement
Because public companies tend to use accrual accounting, the income
statements they release may not necessarily reflect changes in their cash
positions.

For example, if a company lands a major contract, this contract would be
recognized as revenue (and therefore income), but the company may not
yet actually receive the cash from the contract until a later date.
While the company may be earning a profit in the eyes of accountants
(and paying income taxes on it), the company may actually end up with less
cash than when it started the period.
Even profitable companies can fail to adequately manage their cash flow,
which is why the cash flow statement is important: it helps lenders see if a
company is having trouble with cash.

Cash Flow Statement
So, if the accountant prepared cash flow statement provides all this
information, the logical question is: “Why do I need to construct another
Cash Flow Statement? Isn’t this duplicating their efforts? Why is this
necessary?”
Cash Flow Statements primarily show the sources (inflow) and uses (outflow) of
Cash.
Depending on the Cash Flow Format used by the customer, it is not always
apparent if, on a historical basis, they generated enough Cash to service debt.
Additionally, depending on the Cash Flow Format used by the customer, it may
be difficult to take their format and manually project if they can service the new
debt being proposed.
Because of these difficulties, many lenders use an alternative to the customer’s
Cash Flow Statement format to analyze how debt was serviced and if they are
capable of generating enough Cash to service the newly proposed debt.

Alternative Cash Flow Formats
There are numerous alternative Cash Flow formats but we will focus on two
the simplest to construct: Basic Cash Flow and EBITDA Cash Flow
Basic Cash Flow (abbreviated “BCF”)
Use this method to make a quick assessment of the customer’s historical
ability to service debt. It can be done in your head while sitting in front of
the customer.
BCF = Net Income + Depreciation + Amortization

If BCF>0 this is positive; If BCF < 0
this is negative

Surplus or (Deficit) BCF = Net Income + Depreciation
+ Amortization – CPLTD (pp)*

Positive results indicates there is
surplus BCF; Negative results indicate
is there is insufficient BCF.

BCF Coverage = (Net Income + Depreciation +
Amortization) / CPLTD (pp)

If > 1, BCF exceeds existing Debt
Service; If < 1, Existing BCF does not
cover existing Debt Service.

*(pp) means Prior Period.

Alternative Cash Flow: Basic Cash Flow
Sample Trucking Company
Statement Date
Months Covered

12/31/03
12

12/31/04
12

12/31/05
12

12/31/06
12

Revenues
Revenue Growth %
Depreciatin Expense
Operating Margin %
Operating Ratio %
EBITDA
EBIT
Interest Expense
Net Income
Dividends

$25,601
0.00
$2,205
8.20
91.80
$4,213
$2,008
$663
$876
$0

$32,253
25.98
$2,818
3.30
96.70
$4,055
$1,237
$759
$313
$0

$42,337
31.27
$3,996
2.23
97.77
$5,084
$1,088
$1,062
$36
$0

$44,019
3.97
$4,618
-1.54
101.54
$4,616
-$2
$1,113
-$782
$0

Cash & Equivalents
Total Current Assets
Total Assets
Goodwill
CPLTD
Total Current Liabilities
Total Liabilities
Contingent Liabilities
Equity
TNW

$19
$2,955
$14,582
$0
$3,123
$5,453
$11,140

$0
$4,145
$19,585
$0
$3,602
$7,747
$15,830

$1
$4,627
$20,980
$0
$3,253
$7,231
$17,273

$1
$4,472
$21,528
$0
$4,049
$7,407
$18,603

$3,442
$3,159

$3,755
$3,418

$3,707
$3,300

$2,925
$2,925

0.54
3.03
1.11
3.53
3.53

0.54
1.63
0.93
4.63
4.63

0.64
1.02
1.18
5.23
5.23

0.60
0.00
0.89
6.36
6.36

Current Ratio
EBIT/Interest
EBITDA/(Interest+CPLTD)
Total Liabilities/TNW
(Total Liabs+Cont. Liabs)/TNW

The Values in the adjacent
chart are in $1,000s of
USD.
Using CPLTD (pp)
1.

What is the basic cash flow
coverage for 2003 – 2006?

2.

What is the surplus (or deficit)
basic cash flow?

3.

What trend do you see?

4.

Compare the BCF trend to the
profit trend. What is the
difference?

5.

What questions would you ask
management?

BCF compared to CPLTD (pp) is the simplest way to evaluate a firm’s
ability to service historical debt. It can be done in your head or with a
calculator while visiting a customer. If you see negative trends, you can
ask the customer about them immediately.

BCF compared to CPLTD from the prior period is the most accurate way to
evaluate a firm’s ability to service debt. Recall that CPLTD from the
balance sheet represents principal on debt a company must repay within
the next 12 months. It makes sense that we use the CPLTD from the prior
period because it is due in the current period.

Example: CPLTD as of December 31, 2008 must be repaid between
January 1, 2009 and December 31, 2009. Therefore, we compare it to BCF
generated in 2009.

One small problem with using CPLTD (pp) is that you cannot analyze cash
flow coverage with only one period of data. Additionally, as an analyst, you
may want a more conservative calculation, especially if the company is
growing rapidly or during times of economic crisis. In this case, you may
want to use CPLTD from the current period (CPLTD (cp)).
If a company acquires revenue generating assets on December 31, 2008
on credit, principal and interest payments start and will continue through
2009. The revenues the assets will generate should start in 2009. It would
not be accurate to compare the revenues generated in 2008 to the principal
and interest payments on these assets but it would be conservative. Why?
If you calculate positive cash flow coverage and excess surplus cash flow
using this conservative method, you can be fairly certain that on a historical
basis, the company’s cash flow is strong.

Using CPLTD (pp)

Using CPLTD (cp)

Using Prior Period (pp) CPLTD

Net Income
Depreciation
BCF

2003
876
2205
3081

Using Current Period (cp) CPLTD

2004
313
2818
3131

2005
36
3996
4032

2006
-782
4618
3836

BCF

2003
876
2205
3081

2004
313
2818
3131

Net Income
Depreciation

2005
36
3996
4032

2006
-782
4618
3836

CPLTD (pp)
BCF Coverage

n/a
n/a

3123
1,00

3602
1,12

3253
1,18

CPLTD (cp)
BCF Coverage

3123
0,99

3602
0,87

3253
1,24

4049
0,95

Surplus (Deficit) BCF

n/a

8

430

583


-42

-471

779

-213

Net Profitability Trend
BCF CoverageTrend

n/a
n/a

Negative
n/a

Negative
Positive

Negative
Positive

BCF CoverageTrend

n/a
n/a

Negative
Negative

Negative
Positive

Negative
Negative

Statement Date
Months Covered

12/31/03
12

12/31/04
12

12/31/05
12

12/31/06
12

Revenues
Revenue Growth %
Depreciatin Expense
Operating Margin %
Operating Ratio %
EBITDA
EBIT
Interest Expense
Net Income
Dividends

$25,601
0.00
$2,205
8.20
91.80
$4,213
$2,008
$663
$876
$0

$32,253
25.98
$2,818
3.30
96.70
$4,055
$1,237
$759
$313
$0

$42,337
31.27
$3,996
2.23
97.77
$5,084
$1,088
$1,062
$36
$0

$44,019
3.97
$4,618
-1.54
101.54
$4,616
-$2
$1,113
-$782
$0

Cash & Equivalents
Total Assets
Goodwill
CPLTD
Total Liabilities
Equity
TNW

$19
$2,955
$14,582
$0
$3,123
$5,453
$11,140

$0
$4,145
$19,585
$0
$3,602
$7,747
$15,830

$1
$4,627
$20,980
$0
$3,253
$7,231
$17,273

$1
$4,472
$21,528
$0
$4,049
$7,407
$18,603

$3,442
$3,159

$3,755
$3,418

$3,707
$3,300

$2,925
$2,925

0.54
3.03
1.11
3.53
3.53

0.54
1.63
0.93
4.63
4.63

0.64
1.02
1.18
5.23
5.23

0.60
0.00
0.89
6.36
6.36

Current Ratio
EBIT/Interest

The Values in the adjacent chart are
in $1,000s of USD.

Notice that our financial
statement covers 12 months of
data in each period. This
makes our calculations simple.
What if the numbers in the last
column only represented 9
months of data instead of 12?

How would we adjust our BCF
formula? Would your opinion of
the financials change?

We would need to adjust (or ANNUALIZE) our formula so that we are comparing
12-months of basic cash flow to CPLTD that has to be repaid in 12 months.
In our example on the previous slide, the accounts in the last column only
represent 9 months of data instead of 12. We must annualize this data to construct
our cash flow. Recall that the figures are in $1,000s of USD.
The firm’s Net Loss for the first 9 months of 2006 was = (782K)
Annualize the Net Loss by dividing it by 9 months and multiplying the result by 12
months.
(782K) / 9 months = (86,9K). They lost, on average, 86,9 K per month for the first 9
months of 2006.
(86,9K) x 12 months = (1042,7K). They are projected to lose 1042,7K during the
12 months ended December 31, 2006.

Repeat for Depreciating and Amortization. There is no amortization in our example.
We must annualize this data to construct our cash flow. Recall that the figures are
in $1,000s of USD.
The firm’s Depreciation Expense for the 9 months was = 4,618K
Annualize Depreciation Expense by dividing it by 9 months and multiplying the
result by 12 months.
4,618K / 9 months = 513,1K. The firm reported 513,1K in depreciation expense per
month during the first 9 months of 2006.
513,1K x 12 months = 6157,3K. The firm is projected to report 6157,3K in
depreciation expense for the 12 months ended December 31, 2006.

It is not necessary to annualize CPLTD. This figure already represents
what is to be repaid within the next 12 months. You now have enough
information to construct a cash flow based on information from the 9 month
interim period.

Net Income
Depreciation
BCF

2003
876
2205
3081

2004
313
2818
3131

2005
36
3996
4032

2006 Annualized
-1043
6157
5115

CPLTD (pp)
BCF Coverage

n/a
n/a

3123
1,00

3602
1,12

3253
1,57


n/a

8

430

1862

BCF CoverageTrend

n/a
n/a

Negative
n/a

Negative
Positive

Negative
Positive

Projection
What if this customer wanted to finance (5) 2009 A25E with dumper bodies for
182,000 each. 8.15% interest rate. 60 months., No down payment. The monthly
payment (principal and interest) on 1 unit would be about 3703. The annual
payment on 5 units would total 222202.
The units will be additions to their fleet. If they continued to perform the way they
have performed in 2006, for the next 5 years, do you think they could service the
debt (principal and interest) they have proposed?

Net Income
Depreciation
BCF

2003
876
2205
3081

2004
313
2818
3131

2005
36
3996
4032

2006 Annualized
-1043
6157
5115

CPLTD (pp)
BCF Coverage

n/a
n/a

3123
1,00

3602
1,12

3253
1,57


n/a

8

430

1862

BCF CoverageTrend

n/a
n/a

Negative
n/a

Negative
Positive

Negative
Positive

Alternative Cash Flow: EBITDA Cash Flow
Recall that EBITDA is a good measure of how efficient a firm is at keeping its
operating expenses low. In other words, it is a good measure of Operating
Profitability.
Although it is used interchangeably with Operating Profit, these measurements are
not the same. EBITDA is superior to Operating Profits because it includes sources
of non-Operating income where Operating Profit does not.
It also disregards the effects of Interest which is related to a firm’s Investing
activities rather than its operating activities. It disregards taxes which could be
manipulated based on the amount of pre-tax income they report. Pre-tax income
can be manipulated based on inflated expenses they may report.
It also neutralizes the effect of Depreciation and Amortization because these are
non-Cash expenses that do not reflect an outflow of cash from the business.

These additional considerations make EBITDA Cash Flow better than the Basic
Cash Flow analysis. It is slightly more complex than BCF but provides an even
clearer picture of a firm’s ability to generate cash and amortize debt.

Alternative Cash Flow: EBITDA Cash
Flow
EBITDA

EBIT + Depreciation + Amortization
EBITDA Cash Flow Ratio =
Current Portion of Long Term Debt CPLTD
(pp) + Interest Expense

Like the BCF analysis, you can use either CPLTD (pp) or CPLTD (cp) for the same
reasons as discussed on slide 91. Unlike BCF analysis, Interest Expense is added
to CPLTD in the denominator because it is included in the numerator.
Note that the Quick and Dirty Financial Analysis tool uses a slightly modified
version of this formula. It uses EBITDA less Cash Taxes and Distributions
(Dividends).
EBITDA less Cash Taxes is EBIDA. EBIDA works like EBITDA except it says that
Cash taxes are a valid expense item that should be excluded when evaluating a
firm’s operating efficiency (i.e. performance).
Distributions are excluded because it is a management decision to distribute
earnings to owners in lieu of paying creditors. It would; however, be considered
irrational to distribute earnings to owners if creditors have not been paid.


Debt Service Coverage
(In 000's)
EBITDA
Dividends
Cash Flow Before Debt Service

2004
12 m
18 528
0
18 528

2005
12 m
40 273
0
40 273

2006
12 m
71 975
0
71 975

2007 F
12m
80 000
5 000
75 000

Current Maturities on Long Term Debts
Interest Expense
Total Debt Service

9 971
15 217
25 188

23 296
7 733
31 029

42 150
14 984
57 134

47 000
16 500
63 500

Cash Flow After Debt Service
Coverage Ratio

-6 660
0,74

9 244
1,30

14 841
1,26

11 500
1,18

In this example, we see the result of both the EBITDA ratio (“Coverage
Ratio” in the above example) and the Surplus EBITDA Cash flow
calculation (“Cash Flow After Debt Service” above)

Statement Date
Months Covered

12/31/03
12

12/31/04
12

12/31/05
12

12/31/06
12

Revenues
Revenue Growth %
Depreciatin Expense
Operating Margin %
Operating Ratio %
EBITDA
EBIT
Interest Expense
Net Income
Dividends

$25,601
0.00
$2,205
8.20
91.80
$4,213
$2,008
$663
$876
$0

$32,253
25.98
$2,818
3.30
96.70
$4,055
$1,237
$759
$313
$0

$42,337
31.27
$3,996
2.23
97.77
$5,084
$1,088
$1,062
$36
$0

$44,019
3.97
$4,618
-1.54
101.54
$4,616
-$2
$1,113
-$782
$0

Cash & Equivalents
Total Assets
Goodwill
CPLTD
Total Liabilities
Equity
TNW

$19
$2,955
$14,582
$0
$3,123
$5,453
$11,140

$0
$4,145
$19,585
$0
$3,602
$7,747
$15,830

$1
$4,627
$20,980
$0
$3,253
$7,231
$17,273

$1
$4,472
$21,528
$0
$4,049
$7,407
$18,603

$3,442
$3,159

$3,755
$3,418

$3,707
$3,300

$2,925
$2,925

0.54
3.03
1.11
3.53
3.53

0.54
1.63
0.93
4.63
4.63

0.64
1.02
1.18
5.23
5.23

0.60
0.00
0.89
6.36
6.36

Current Ratio
EBIT/Interest

chart are in $1,000s of USD.
Using CPLTD (pp)
1. What is the EBITDA cash
flow coverage for 2003 –
2006?

2. What is the surplus (or deficit)
EBITDA cash flow in those
periods?
3. What trend do you see?

4. What questions would you
ask management?

Statement Date
Months Covered

12/31/03
12

12/31/04
12

12/31/05
12

12/31/06
12

Revenues
Revenue Growth %
Depreciatin Expense
Operating Margin %
Operating Ratio %
EBITDA
EBIT
Interest Expense
Net Income
Dividends

$25,601
0.00
$2,205
8.20
91.80
$4,213
$2,008
$663
$876
$0

$32,253
25.98
$2,818
3.30
96.70
$4,055
$1,237
$759
$313
$0

$42,337
31.27
$3,996
2.23
97.77
$5,084
$1,088
$1,062
$36
$0

$44,019
3.97
$4,618
-1.54
101.54
$4,616
-$2
$1,113
-$782
$0

Cash & Equivalents
Total Assets
Goodwill
CPLTD
Total Liabilities
Equity
TNW

$19
$2,955
$14,582
$0
$3,123
$5,453
$11,140

$0
$4,145
$19,585
$0
$3,602
$7,747
$15,830

$1
$4,627
$20,980
$0
$3,253
$7,231
$17,273

$1
$4,472
$21,528
$0
$4,049
$7,407
$18,603

$3,442
$3,159

$3,755
$3,418

$3,707
$3,300

$2,925
$2,925

0.54
3.03
1.11
3.53
3.53

0.54
1.63
0.93
4.63
4.63

0.64
1.02
1.18
5.23
5.23

0.60
0.00
0.89
6.36
6.36

Current Ratio
EBIT/Interest

chart are in $1,000s of USD.
Using CPLTD (cp)
1. What is the EBITDA cash
flow coverage for 2003 –
2006?

2. What is the surplus (or deficit)
EBITDA cash flow in those
periods?
3. What trend do you see?

4. What questions would you
ask management?

Using CPLTD (cp)

Using CPLTD (pp)

Using Prior Period (cp) CPLTD

2003
4213

EBITDA

2003
4213

2004
4055

2005
5084

2006
4616

Debt Service

3123
663
3786

3602
759
4361

3253
1062
4315

4049
1113
5162

2004
4055

2005
5084

2006
4616

Debt Service

n/a
663
n/a

3123
759
3882

3602
1062
4664

3253
1113
4366

EBITDA Coverage

n/a

1,04

1,09

1,06

EBITDA Coverage

1,11

0,93

1,18

0,89

Surplus (Deficit) EBITDA

n/a

173

420

250


427

-306

769

-546

EBITDA CoverageTrend

n/a


n/a

Negative

Positive

Negative

EBITDA
CPLTD (pp)
Interest

n/a

Positive

Positive

CPLTD (pp)
Interest

Note the differences in EBITDA Coverage and the trend depending on whether or not you use
either CPLTD (pp) or CPLTD (cp). While using CPLTD (pp) is more accurate and yields largely
positive results, the surplus is actually not that large and disguises the fact that they have larger
debt service coming due next year.
Using CPLTD (cp) is less accurate but it is more conservative and forward-looking. As a
result, the coverage trend has mixed results which are largely negative. This firm has higher levels
of debt service coming due in 2007 possibly because of increased borrowing of term debt. Using
CPLTD (cp) shows us that this firm might have problems servicing debt if it does not become more
efficient (i.e. generate more EBITDA relative to sales) in 2007.

Statement Date
Months Covered

12/31/03
12

12/31/04
12

12/31/05
12

12/31/06
12

The Values in the adjacent chart are
in $1,000s of USD.

Revenues
Revenue Growth %
Depreciatin Expense
Operating Margin %
Operating Ratio %
EBITDA
EBIT
Interest Expense
Net Income
Dividends

$25,601
0.00
$2,205
8.20
91.80
$4,213
$2,008
$663
$876
$0

$32,253
25.98
$2,818
3.30
96.70
$4,055
$1,237
$759
$313
$0

$42,337
31.27
$3,996
2.23
97.77
$5,084
$1,088
$1,062
$36
$0

$44,019
3.97
$4,618
-1.54
101.54
$4,616
-$2
$1,113
-$782
$0

Notice that our financial
statement covers 12 months of
data in each period. This
makes our calculations simple.

Cash & Equivalents
Total Assets
Goodwill
CPLTD
Total Liabilities
Equity
TNW

$19
$2,955
$14,582
$0
$3,123
$5,453
$11,140

$0
$4,145
$19,585
$0
$3,602
$7,747
$15,830

$1
$4,627
$20,980
$0
$3,253
$7,231
$17,273

$1
$4,472
$21,528
$0
$4,049
$7,407
$18,603

$3,442
$3,159

$3,755
$3,418

$3,707
$3,300

$2,925
$2,925

0.54
3.03
1.11
3.53
3.53

0.54
1.63
0.93
4.63
4.63

0.64
1.02
1.18
5.23
5.23

0.60
0.00
0.89
6.36
6.36

Current Ratio
EBIT/Interest

What if the numbers in the last
column only represented 7
months of data instead of 12?
How would we adjust our
EBITDA Cash Flow formula?
Would your opinion of the
financials change?

We would need to adjust (or ANNUALIZE) our formula so that we are
comparing 12-months of EBITDA Cash Flow to CPLTD that has to be
repaid in 12 months. Because the denominator includes interest, this
should also be annualized.
In our example on the previous slide, the accounts in the last column only
represent 7 months of data instead of 12. We must annualize this data to
construct our cash flow. Recall that the figures are in $1,000s of USD.
The firm’s EBITDA for the first 7 months of 2006 was = 4616
Annualize the EBITDA by dividing it by 7 months and multiplying the result
by 12 months.
4616 / 7 months = 659. The firm generated EBITDA, on average, of 659K
per month for the first 7 months of 2006.
659 x 12 months = 7913. They are projected to generate EBITDA of
7913K during the 12 months ended December 31, 2006.

Repeat for Interest Expense.
We must annualize this data to construct our cash flow. Recall that the
figures are in $1,000s of USD.
The firm’s Interest Expense for the 7 months was = 1113
Annualize Interest Expense by dividing it by 7 months and multiplying the
result by 12 months.
1113 / 7 months = 159. On average, the firm reported 159K in interest
expense per month during the first 7 months of 2006.
159 x 12 months = 1908. They are projected to report 1908K in interest
expense for the 12 months ended December 31, 2006. If you know that
interest costs will be different from this because they will pay off debt
before then or they will have a change in interest costs, use that figure
instead.

It is not necessary to annualize CPLTD. This figure already represents
what is to be repaid within the next 12 months. You now have enough
information to construct a cash flow based on information from the 7 month
interim period.
Using Prior Period (cp) CPLTD

EBITDA

2003
4213

2004
4055

2005
5084

2006 Annualized
7913

Debt Service

3123
663
3786

3602
759
4361

3253
1062
4315

4049
1908
5957

CPLTD (pp)
Interest

EBITDA Coverage

1,11

0,93

1,18

1,33


427

-306

769

1956


n/a

Negative

Positive

Positive

Let’s say they answer than a FH 4x2T combination travels 5,100 km per
month and that on a monthly basis, they earn 2.4 per km. That’s 12,420 in
revenues generated per vehicle per month.
It is unnecessary to look at the other parts of the Application for Finance
Questionnaire. Why? Because the remainder of the application is
concerned with overhead costs like drivers, fuel, maintenance, insurance
etc. How overhead is managed is another way of saying how efficient
management is at keeping operating costs low. If you know what EBITDA
is then you already know how efficient management is at keeping
overhead costs low.
The question is, how do I convert 12,420 in revenues generated per
vehicle per month into EBITDA and how do I determine if this is enough to
service the debt?

Recall the formula for EBITDA Margin on slide #69. EBITDA Margin can
be used to project EBITDA.
EBITDA

EBITDA Margin =

Sales
What was the firm’s EBITDA Margin in 2006? Remember we are
comparing the annualized EBITDA to annualized Sales in 2006.

EBITDA Margin =

7,913

= 10.5%

75,461
The company retained 10.5% of Sales as EBITDA. This is a measurement
of how efficient they were in 2006. If an FH 4x2T generates 12,420 in
revenues per month, how much EBITDA will it generate in a year? Will this
be enough to service the debt on those trucks?

We projected annualized Sales in 2006 of 75,461,142. Unless something
changes, we should expect them to generate at least 75,461,142 in 2007.

The proposed trucks can generate 12,240 per month per truck. 1 truck
should generate 146,880 per year. 150 trucks should generate 22,032,000
per year.
Unless something changes, we should expect this company to generate
97,493,142 (75,461,142 + 22,032,000) in revenues in 2007.
With an EBITDA margin of 10.5%, using the additional 150 trucks, this
company should generate EBITDA of 10,223,334 in 2007, all things being
equal.

We project EBITDA of 10,223,334 in 2007.
Let’s assume that the CPLTD (cp) that we used in 2006 will stay the same
in 2007, unless you know different. CPLTD (cp) was 5,957,000.
10,223,334 – 5,957,000 leaves 4,266,337 to service the debt on the new
trucks.

The annual payment on 150 units would total 5,106,137. They would not
generate enough cash to repay the debt on all the trucks; however, we can
surmise that they could generate enough cash to cover the debt on 125
units (annual debt service on 125 units is 4,255,114) leaving no excess or
deficit EBITDA cash flow.
The firm would either need to increase revenues, decrease operating
expenses (i.e. improve EBITDA), or change the structure of the deal. It is
unlikely they can increase revenues or EBITDA to pay for the additional
units. In this case, if you lengthened the term from 36 to 48 months, they
would have just enough EBITDA to service the debt on 150 units.

Cash Flow
Cash Flow Statement Comments:
1)

EBITDA increased in FY2006 and FY2007. But EBITDA as of Aug
2008 fell by an annualized 19.5% compared to last year. However,
the large sales order to PT Thailindo will help to boost up the
EBITDA.

2)

As at Dec 2008, ITI has been granted various bank facilities which are
secured by the company’s bank deposits, the mortgage of the
company’s plant and the guarantee of the parent company. Facilities
comprises of ;
2.1) Bank Overdraft with 3 banks for MTHB 28.30 (TMB MTHB
15.30 /
BBL = MTHB 8.00 / UOB = MTHB 5.00)
2.2) Trust receipts with 1 bank for MTHB 140.00 (TMB)

Note: ITI’s major bank is Thai Military Bank Public Co., Ltd (TMB) and
ITI’s payment record is considered good
3)

Based on Working Capital Limit of THB 168.30, it has a utilization rate
of 71% (MTHB 118.96). The sharp increase in utilization amount was
due to an increase in bank overdraft and trust receipts for imported
products (non-Volvo brand). The utilization comprises of;
3.1) Bank overdraft with local banks (MTHB 16.94) @ MLR p.a.
3.2) Trust receipt with TMB bank (MTHB 102.02) @ MLR p.a.

Working Capital / Credit Lines
Line Type

Amount of Line

Utilization

Expires

Working Capital

MTHB 168.30

MTHB 118.96

2009-06

Other References
• Bank reference:
• Payment Performance:

Thai Military Bank Public Co., Ltd.
Good

Discussion Item

Cash Flow

 What does it mean to be insolvent?

Appendix A
Financial Statements

Types of U.S. Financial Statements
A complete financial statement can take one of several forms. From
a creditor’s perspective, some statement types are more desirable
than others. The 5 main types of statements, from most preferred to
least preferred include the following:
1. Audited
• Unqualified
• Qualified
• Adverse
• Disclaimed
2. Reviewed
3. Unaudited Compiled
4. In house or Direct. Also called company prepared
5. Tax Returns

Types of Financial Statements: Audited
•

•
•

In the U.S., audited financial statements may be prepared by a Certified Public
Accountant (CPA) and undergo rigorous independent verification for accuracy to assure
strict adherence to generally accepted accounting principals (GAAP). They are the
most reliable financial statement a company can present to a creditor to illustrate their
true financial condition.
These statements are the most expensive to prepare.
Please note that there are four variations of an audited financial statement. We will
discuss each on the following slides:
1. Unqualified
2. Qualified
3. Adverse Opinion
4. Disclaimed Opinion

Audited Statement: 4 types
Whenever a statement is audited, the auditor expresses an opinion
about the information contained in the statement. The terms
Unqualified, Qualified, Adverse, and Disclaimed refer directly to the
opinion expressed about the statement.
Let’s start with sample language you will find on the transmittal
letter of an audited statement:
“We have audited the accompanying balance sheets of Conveyor, Inc as
of December 31, 2005 and December 31, 2006, and the related statement
of earnings, stockholders equity……..We conducted our audits in
accordance with generally accepted accounting principals………In our
opinion, the financial statements referred to above present fairly, in all
material respects, the financial position of Conveyor Inc.”

Audited Statement: 4 types

The auditors opinion letter is usually a letter with 3 paragraphs.
In the first paragraph, the scope of the work performed by the
accounting firm is described, it states clearly that the financial
statements are the responsibility of management and it is the CPA’s
responsibility to express an opinion on the financial statements based
on the audit.

In the second paragraph, the auditor elaborates on the scope of the
work performed…often indicating that they conducted the audit “in
accordance with Generally Accepted Accounting Principals [GAAP]”
The third paragraph is where the auditor gives an opinion about the
statements. It may be in a third or fourth paragraph as well depending
upon the circumstances.

Audited Statement: Unqualified
Example Opinion:
“It is our opinion that the financial statements present fairly, in all material
respects, the financial position of Conveyor, Inc. as of December 31, 2005
and December 31, 2006”

Their opinion is not qualified….. in that the auditor has not made
any comments to lead you to believe that the information
contained in the Financial Statement are unfair or worse,
inaccurate.

Audited Statement: Qualified
Example Opinion:
“It is our opinion , except for the effects of such inventory adjustments, if
any, that might have been determined to be necessary had we been able to
verify the amounts in question, the financial statements….present fairly, in all
material respects, the financial position of Conveyor, Inc. as of December
31, 2005 and December 31, 2006.”

The auditor’s opinion is qualified….. in that they have not made a
qualified endorsement of the statement’s accuracy.
As an analyst, you should take this qualified opinion into account when
you review the statements.

Audited Statement: Adverse Opinion
Let’s assume that, as a result of the audit, the accounting firm
determines that Conveyor, Inc. has a material amount of operating
leases (off balance sheet leases, listed only as lease expense on the
income statement) that are properly capital leases (the asset and
related debt listed on the balance sheet). Consequently, the company
should increase its capital assts by the amount of the equipment it has
obtained under the capital leases and increase the amount of long-term
debt it records in the liabilities section of its balance sheet.
Example Opinion: “In our opinion………..the financial statements referred to
above do not present fairly, in all material respects, the financial position of
Conveyor, Inc. as of December 31, 2005 and December 31, 2006, as the results
of its operations and its cash flows for each of the two fiscal years in the period
ended December 31, 2006, in conformity with GAAP”

Audited Statement: Adverse Opinion
Continued
In the example opinion, the auditor disagreed with a management
decision that (in the auditor’s opinion) materially alters three of the basic
financial statements of the company and the information it provides to
users, like you. Those statements do not, in the auditor’s opinion, fairly
present the financial position of the company.
You should contact the Company and investigate the reason for the
auditor’s adverse opinion.

Audited Statement: Disclaimed Opinion
Let’s go back to the qualified opinion and assume that the extent of
confusion about the ending inventory amounts is so great that the
accounting firm feels unable to express any opinion about the financial
statements. The opinion paragraph in the transmittal letter might now
state the following:
“…we did not have access to the company's records prior to 2006 so that we
could not properly verify ending inventory balances for 2005 by means of other
auditing procedures, nor could we properly verify the company’s 2006 cost of
goods sold.”

Furthermore “…because the company did not maintain adequate
records with respect to inventory values, we were unable to verify
inventory balances and related expense amounts…..The scope of our
work was not sufficient to enable us to express, and we do not
express, an opinion on the financial statements referred to herein..”

Audited Statement: Disclaimed Opinion
Continued
The statement on the prior slide effectively reduces the value of
the information contained in the statement to that of a compiled or
reviewed statement because the accounting firm does not offer an
opinion about the fairness of the financial statements.

Remember that management has the final responsibility for the
content and composition of the data and information in a financial
statement. Any negative opinion reflects upon them and should be
considered when analyzing statements and making a credit
decision.

Financial Statements: Reviewed
Statement
If an Unaudited Financial Statement is prepared by an accountant, the
financials are prepared to certain professional standards.
When
prepared to these standards, the statement is referred to as a Reviewed
Statement.
A review consists primarily of inquiries of the company’s personnel and
analytical procedures applied to financial data. The data is; however,
provided by the company’s management and is not tested in detail for
accuracy.
These statements are less expensive to prepare than Audited
Statements.

Financial Statements: Compiled
Statement
Compiled Financial Statements are prepared from information
provided by the company without any attempt to independently verify
their accuracy.

This type of statement may be prepared by anyone. The data is
provided by the company’s management and is put into the form of a
Balance Sheet and Income Statement. It may or may not comply
with US or International accounting standards. Additionally, there is
no testing of the data to assure its accuracy.
Compared to Reviewed statements, these statements are less
expensive to prepare.

Financial Statement: In house or Direct
Statement
These statements are prepared for management’s internal
discussion and may or may not represent the true financial condition
of the company.
Compared to accountant prepared statements, these statements are
the least expensive to prepare.

Financial Statements: Key Points
Key Points to Remember:
•At a minimum, a complete financial statement consists of:
Balance Sheet
Income Statement
•There are multiple types of financials statements.
From a creditor’s perspective, the most desirable is an
Unqualified, Audited Statement.
The least desirable is an internally prepared or tax return statement.
Qualified, Adverse and Disclaimed accountant opinions must always
be discussed in your presentation.

Balance Sheet – Long Term Assets

Appendix B

Balance Sheet: Long Term Assets –
Accumulated Depreciation
Other than land (although there are exceptions to this), most fixed assets
depreciate over time. That is, the asset is used up over time. Examples
of
Fixed
Assets
that
depreciate
include
transportation
equipment, buildings, software, etc. They are listed on the balance sheet
at their original acquisition cost. We sometimes refer to this as the Gross
Value.

The account used to measure how much of an asset has been used up or
depreciated is called Accumulated Depreciation. The difference between
an an asset’s Gross Value and Accumulated Depreciation is its Net Book
Value.

Gross Value – Accumulated Depreciation = Net Book Value

Balance Sheet: Long Term Assets –
Depreciation Types
There are many ways to measure how these assets become used up or
depreciate. The methods used to measure how they depreciate are
varied and depend on the type of asset.
Types of Depreciation include:
•Straight-Line
•Accelerated (Double Declining)
•Modified Accelerated Cost Recovery System (MACRS)
This class will focus on the Straight-Line Method
Under the Straight-Line Method, a standard truck may have an useful life
of 5 years. So each year, the truck loses 1/5th of its value. In two years,
2/5ths of the value has depreciated.

Straight-Line Depreciation Method
Example: A truck is acquired for $100,000 (USD) at the beginning of the year. It has a 5
year useful life, that is, its value will depreciate to zero at the end of 5 years.
At the end of 1 year, 1/5 of the truck’s acquisition cost is depreciated.
The acquisition cost is still $100,000 but $20,000 (1/5th of $100,000) in depreciation has
accumulated leaving a net book value of $80,000 at the end of the first year.
$100,000 - $20,000 = $80,000
$100,000 is the original acquisition cost of the truck; its gross value. $20,000 in depreciation
has accumulated during the year; hence the name, Accumulated Depreciation. $80,000 is
the net book value of the truck. The net book value does not necessarily represent the
truck’s actual market value. At the end of the second year, $40,000 in depreciation will
accumulate and the net book value of the truck will decline to $60,000.
Do you see the difference between the truck’s gross value (Gross Fixed Asset) value and its
net book value (Net Fixed Asset) value? Do you understand the difference between net
book value and market value of this asset?

Straight-Line Depreciation Method

Example: A truck is acquired for $100,000 (USD) cash on January 1, 2008. It has a 5 year
life, that is, its value will depreciate to zero at the end of 5 years.
Balance Sheet

Dec. 31, 2008

Dec. 31, 2009

Dec. 31, 2010

Dec. 31, 2011

Dec. 31, 2012

Year 1

Year 2

Year 3

Year 4

Year 5

$100,000

$100,000

$100,000

$100,000

$100,000

$100,000

Asset
Acquired

Acquisition Cost

Jan 1, 2008

No Cash
Outflow

No Cash
Outflow

No Cash
Outflow

No Cash
Outflow

No Cash
Outflow

$0

$20,000

$40,000

$60,000

$80,000

$100,000

$100,000

$80,000

$60,000

420,000

$20,000

$0

$0

$20,000

$20,000

$20,000

$20,000

$20,000

No Cash
Outflow

No Cash
Outflow

No Cash
Outflow

No Cash
Outflow

No Cash
Outflow

Cash Outflow
Less:
Accumulated
Depreciation
Net Book Value

Income
Statement
Depreciation
Expense


Other Non-Current Assets
Non-current assets can include a variety of asset accounts that are not
expected to be converted into cash within the next 12 months.
•Cash Value of Life Insurance
•Certain Notes Receivable

From a lender’s perspective, some types of assets may not be
convertible into Cash; that is, if you were forced to liquidate the
company’s Balance Sheet, these assets do not have any value. They
are intangible. These include but are not limited to:
•Goodwill
•Non Compete Agreements
•Intangibles

Balance Sheet: Inventory DOH
Inventory*
x 365 = A/R DOH
COGS
*One flaw in this formulas is that it compares a whole year (or y-t-d) Cost
of Sales with inventory at a specified time; it does not recognize seasonal
fluctuations.
Low inventory turnover can indicate possible overstocking, obsolescence,
or poor production planning, while a very high turnover ratio can be a
warning of the possibility of stock-outs and delayed shipments.
Inventory DOH will tell you how long it will take to turn 1 dollar of inventory
into 1 dollar of sales.

Balance Sheet: Leverage
In addition to leverage, we should also be concerned with our total
exposure relative to the company’s Equity.

Example: A company has requested financing for $3.0MUSD in
equipment. If financed, $3.0MUSD will be our total exposure with this
company. The company currently has $500KUSD in Equity and
$5.0MUSD in Total Liabilities. Additionally, the company has $250KUSD
in Goodwill and other intangible assets.
•What is the company’s leverage ratio?
•How much do the owner have invested in the company versus our
proposed exposure?

Balance Sheet: Capital Structure
Capital structure is a mix of a company's long-term debt, specific short-term debt, common
equity and preferred equity. The capital structure is how a firm finances its overall operations
and growth by using different sources of funds.

Debt comes in the form of bond issues or long-term notes payable, while equity is classified
as common stock, preferred stock or retained earnings. Short-term debt such as working
capital requirements is also considered to be part of the capital structure.
A company's proportion of short and long-term debt is considered when analyzing capital
structure. When extracting this information, you should categorize debt as current or long
term. It is highly unusual for a company to have long term debt and no current portion of
long term debt.
When people refer to capital structure they are most likely referring to a firm's debt-to-equity
ratio, which provides insight into how leveraged or risky a company is.
Usually a company more heavily financed by debt poses greater risk, as this firm is relatively
highly levered.

Appendix D

Income Statement Additional Information

Income Statement
d) Operating Expenses
These are commonly known as selling, general and administrative expenses
(SGA) and consume the gross profit. They arise during the ordinary course
of running a business. Operating expense may include the following:

•
•
•
•
•
•

Insurance
Operating Lease Expense
Salaries paid to the employees
Travel expenses
Legal & Other Professional Fees
Depreciation and Amortization charges

In your presentation, when you analyze Operating Expenses; you should discuss
management’s efficiency because management’s goal is to keep operating expense
as low as possible in order to maximize profits while not damaging the business.

Income Statement
Depreciation & Amortization Expense
Recall that no cash flows out of the business when we record Depreciation
and Amortization Expense. They are non-Cash Expenses. We need
Depreciation and Amortization expense broken out for the Cash Flow
analysis. These expenses could be included among the Cost of sales or
Operating Expenses. They could be located on the company’s Cash Flow
statement or located in the Notes to the Financial Statement. If not found,
it is imperative that you ask management what these figures are and
extract them in your analysis.

Gross Profit Margin:

• This first indicator shows the ability of a company to earn a profit.
• Represents the residual profit from each sales dollar after accounting
the Cost of Goods Sold.
• Because it is expressed as a percentage, it can be compared to earlier
or subsequent periods or even be compared to similar firms.
(F) Gross Profit
Revenues
(E)

1,720
26,014

x 100

= 0.071 x 100 = 7.1%
An analyst should ask management about any large changes in Gross Profit
Margin period-over-period. If this figure is positive and unchanged periodover-period, then this is a good indicator that costs are in line with revenues.
If it is negative, costs exceed revenues and questions should be asked.

Operating Profit Margin
It represents the residual profit per dollar of sales after accounting for all
major operating costs. When looking at operating margin to determine the
quality of a company, it is best to look at the change in operating margin
over time. If a company's margin is increasing, it is earning more per dollar
of sales. The higher the margin, the better.
(F) Operating Income
Revenues
(E)

745
26,014

= 0.08 x 100 = 2.8%

An analyst should ask management about any large changes in Operating
Profit Margin period-over-period. If this figure is positive and unchanged periodover-period, then this is a good indicator that costs are in line with revenues. If
it is negative, costs exceed revenues and questions should be asked.


Net Profit Margin

It represents the residual profit per dollar of sales after accounting for all
major operating and non-operating costs.
If a company's Net Profit Margin is increasing, it is earning more per dollar
of sales. The higher the margin, the better.
(F) Net Income
Revenues
(E)

372
26,014
= 0.01 x 100 = 1.3%

An analyst should ask management about any large changes in Net Profit
Margin period-over-period. If this figure is positive and unchanged period-overperiod, then this is a good indicator that costs are in line with revenues. If it is
negative, costs exceed revenues and questions should be asked.

Interest Coverage Ratio:
This ratio computes the number of times ordinary income before interest and taxes
covers interest payments. Companies with poor interest coverage should be viewed
cautiously. As an analyst, you should address poor interest coverage.
The ratio is calculated by dividing a company's earnings before interest and taxes
(EBIT) of one period by the company's interest expenses of the same period. An
interest coverage ratio below 1 indicates the company is not generating sufficient
profits to satisfy interest expenses.

(F)

E B I T
Interest Expense

(E)

3355
145

= 23.1

Thank you!
Dejan Jeremid
Dejan Jeremid

dejan.jeremic@hold4aim.com

Credit training in English

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