Categories
Designing High Performance Organizations

Key Takeaways

  1. Level 2 Listening: listen for values and to the person – not to the actual problem. Listen to what matters most and not to the goal/outcome. DO NOT try to relate to the person speaking by sharing your own experiences. Just listen
  2. Organizational Structure need to align with the company strategy
  3. Keep things you want to do in the ‘want to’ – I’m doing it because I want to. If you move it to the ‘have to’ – I have to do it (because of pay or something) – it takes the fun out of it and I would probably stop doing it
  4. In a crisis – go back to basics. Simplify and create clarity around what’s important to solve the problem – and what’s not 
  5. It takes 7 times for someone to hear something before they internalize it. It takes 30 times for someone to hear something to change their behavior
  6. Leaders’ words matter!
  7. When interviewing someone, listen to the stories people tell and how they connect together. Think about how the stories connect to each other, and see if there’s good connection. Ask questions like: ‘how did you get from story a to story b? What did you learn’? 
  8. Connecting with people on a value level is deep and can help bridge a lot of disagreements


Categories
Financial Analysis and Valuation

Financial Statements & Performance Evaluation

ADD SLIDES FROM FOLDER – LECTURE WEEK 3

Categories
Financial Analysis and Valuation

Liability vs Debt

Liability VS Debt: 

LIABILITY 

Accountants describes liability as a present contractual commitment to another entity that entrails settlement by probably future transfer or use of assets on an agreed upon date (or timing) when the obligating event has already occurred. There is no exact definition of debt in accounting, and not all liabilities are debt. Also, it is possible that some types of debt are not considered a liability by accountants (off-balance sheet financing).  

DEBT 

For our purposes, debt is an amount contractually owed to another party that has an explicit or implicit interest payment that we can measure. That includes notes, mortgages, bonds (debentures), and other financing instruments that typically have an explicit or implicit interest rate. That EXCLUDES liabilities such as deferred income taxes, unearned revenue, and most other operating liabilities (for example, accounts payable (AP), wages payable, accruals, etc.) 

====================== 

ROIC – Return On Invested Capital = NOPLAT/Invested Capital (=debt + equity) 
NOPLAT = Net Operating Profits After Tax (to get the tax rate = taxable income/tax expense) 
NWC (Net Working Capital) = current assets – current liabilities 

NOPLAT 
• ROIC 
Invested Capital 
• NOPLAT= EBIT* (I-t) 
• Total Invested Capital = Equity plus interest bearing debt
Reorganizing the Balance Sheet: 
Invested Capital 
• By separating line items and rearranging the accounting identity, 
Operating Nonoperating 
Assets 
Assets 
Operating 
+ Debt + Equity 
Liabilities 
• We can create two new terms, invested capital and total funds invested: 
Operating 
Assets 
Operating 
Liabilities 
Nonoperating 
Assets 
Invested capital equals 
operating assets less 
operating liabilities. 
Total funds invested equals 
invested capital plus 
nonoperating assets. 
USCMarshall 
School of Business 
= Debt + Equity 
Total funds invested can 
also be measured by 
summing debt plus equity 
FBE 529 - Scott Abrams - Spring 2021 
165
Invested Capital: Operating 
pers ective 
Operating 
Assets 
Operating Liabilities 
Invested Capital 
Nonoperating Assets 
Total Funds Invested 
Operating assets include current operating assets (working cash, accounts 
receivable, inventory, prepaid expenses), along with PP&E and net other long- 
term operating assets. Include capitalized leases and R&D as operating assets. 
Operating liabilities include non-interest-bearing current liabilities; the most 
common are related to suppliers (accounts payable), employees (accrued 
salaries), customers (deferred revenue and customer advances), and the 
government (income taxes payable). 
Nonoperating assets include excess cash, marketable securities, notes 
receivable, prepaid pension assets, nonconsolidated subsidiaries, and other 
equity investments). 
Total funds invested from an operatinq perspective.
Invested Capital: 
Financin Pers ective 
Debt 
Debt 
Equivalents 
Equity 
Equity Equivalents 
Total Funds 
Invested 
Debt includes all interest-bearing debt from banks and public capital markets. 
Debt equivalents include off-balance-sheet debt and one-time debts owed to 
others that are not part of ongoing operations (e.g., severance payments as part 
of a restructuring, an unfunded pension liability, or expected environmental 
remediation following a plant closure). 
Equityincludes original investor funds (common stock and additional paid-in 
capital, net of treasury stock repurchased), investor funds reinvested into the 
company (retained earnings and accumulated other comprehensive income), 
and investor funds to be paid out shortly (dividends payable). 
Equity equivalents include accounts that arise because of noncash 
adjustments to retained earnings; they are similar to debt equivalents but are 
not deducted from enterprise value to determine equity value (e.g., most 
deferred-tax accounts and income-smoothing provisions). 
Total funds invested from a financinq perspective.
Categories
Financial Analysis and Valuation

Financial Statements, Growth & Ratio Analysis

The flow of the financial statements..

Statement of Cash Flows 
(in millions) 
Balance Sheet, 12/31/20X4 
12/31/20X4-12/31/20X5 
Cash 
All other assets 
Liabilities 
Capital Stock 
Retained earnings 
30.0 
1 ,233.2 
1 ,263.2 
652.0 
172.0 
439.2 
1 ,263.2 
Operating activities 
Investing activities 
Financing activities 
Net increase in cash 
Beginning cash 
Ending cash 
Income Statement, 
Net sales 
Expenses 
Net income 
11.5 
(92.8) 
(14.7) 
10.0 
30.0 
40.0 
1 ,530.o 
1,434.5 
95.5 
Balance Sheet, 
Cash 
All other assets 
Liabilities 
Capital Stock 
Retained Earnings 
40.0 
1 ,284.o 
1 ,324.0 
632.0 
194.0 
1,324.0 
498.0 
Statement of Retained Earnings 
12/31/20X4 - 12/31/20X5 
Retained eamings, 
Net income 
Dividends 
Retained earnings, 
12/31/20X4 
12/31/20X5 
439.2 
95.5 
36.7 
498.0
 

Income Statement: Operating income vs non-operating income –  If we’re looking to value OPERATIONS ONLY, we’re stopping at the EBIT! After the EBIT come the financial performance.  
Operating Income: the income generated by the firm’s core business operations.
Non-operating Income: income generated by investments the firm has made in assets that are unrelated to the firm’s primary business. For example: 

  • Gains from the sale of investments 
  • The sale of a subsidiary or division 
  • Costs incurred from restructuring 
  • Currency exchange 
  • The write-off of obsolescent inventory 
Net sales 
Cost of goods sold 
Gross Margin 
Selling, general, and administrative expenses 
Operating income 
Other income 
Earnings before interest and taxes (EBIT) 
Interest expense 
Earnings before taxes 
Income taxes 
Income after tax and before extraordinary items 
Extraordinary items 
Net income 
Preferred dividends 
Net income available to common shareholders 
3,365 
2,252 
1,113 
654 
459 
200 
659 
28 
631 
252 
379 
56 
323 
22 
301

The Balance Sheet: provides a snapshot of the firm’s financial position at a moment in time and a detailed account of the company’s assets’ liabilities (debts), and shareholders’ equity. The balance sheet equation requires that the sum of the book values of the firm’s assets equal the sum of the debts the firm owes to its creditors plus the investment of the stockholders’ equity.  

Consolidation Rules: 

  • An equity investment involving more than 20% but less than 50% of the equity of another firm is recorded as an investment. This will typically show up on the balance sheet as ‘investments in unconsolidated subsidiaries’. 
  • If the firm owns more than 50% of a subsidiary, then the rules of accounting call for consolidation of the subsidiary into the firm’s balance sheet and income statement. A minority interest account appears between liabilities and shareholders’ equity, representing the value of the minority-owned shares, because 100% of the value of the subsidiary’s assets were incorporated into the consolidated balance sheet. 
  • The presence of a long-term investment category on a firm’s balance sheet signifies the presence of a potentially significant non-operating asset that will need to be valued. This means that the analyst will need to dig deeper into the footnotes of the financial statement to determine the exact nature of the investments in order to determine an appropriate approach to valuing them. This line item (sometime referred to as long-term investments because they are assets the company intends to hold for longer than one year) can consist of stocks and bonds of other companies, real estate, as well as cash set aside for a specific purpose. 
Ownership: 
Accounting 
Method 
Balance Sheet 
Income 
Statement 
20-50% 
Cost 
Investment shown at 
cost 
Dividends recorded as 
income 
Equity 
Investment originally 
shown at cost, 
adjusted for income 
(+) and dividends (-); 
% of profits recorded 
as income 
>50% 
Consolidation 
100% of subsidiary 
balance sheet 
consolidated; results 
a noncontrolling 
interest (NCI) 
100% of profits 
recorded as net 
income; income 
attributable to 
noncontrolling 
interest then 
subtracted out

Ratio Analysis

Categories of ratios: 

  • Profitability Ratios 
    • Profit margin (net income/sales) 
    • Return on assets (ROA) = net income/total assets 
    • Return on equity (ROE) = net income/total equity 
  • Short-term solvency (liquidity ratios) 
    • Current ratio (CA/CL) 
    • Quick ratio (CA-inventory)/CL 
  • Long-term solvency 
    • Leverage ratios 
      • Total liabilities to total assets (TL/TA) 
      • Total liabilities to total equity (TL/TE) 
      • Total assets to Owners’ equity (equity multiplier): TA/TE 
      • Total debt to equity (TD/TE) 
    • Coverage ratios 
      • Times interest earned/EBIT interest coverage (EBIT/interest) 
      • Cash coverage/EBITDA Interest coverage (EBIT + Depreciation)/Interest 
  • Asset utilization ratios (AKA Activity) 
    • Total assets turnover (sales/total assets) 
    • Inventory turnover (COGS/inventory) 
      • The longer inventory sits on a company’s shelves, the lower the rate of return on those assets, and the greater their vulnerability to falling prices and obsolescence. You want to keep your inventory turning, however not at the expense of your overall profit margins or business strategy 
    • Days in inventory (365/inventory turnover) 
    • Receivables turnover (sales/avg. Accounts receivable) 
    • Avg. Collection period (365/receivables turnover) 
  • Valuation multiples 

Benchmarking using ratios: so, what is a good benchmark? 

It is often not clear what is a ‘good’ or ‘bad’ level for a financial ratio and no one benchmark exists for all companies in all valuation contexts. We know ratios vary over time and we know they vary by industry – we also know that companies tend to regress towards the mean – so a common benchmark is the company’s industry or comparable group. That said – deviations from the ‘norm’ might be good and indicate an industry leader and a potential competitive advantage. 

Sales Growth Rate (CAGR = Compounded Annual Growth Rate)

Formula and Calculation of CAGR 
CAGR 
where: 
1 
EV = Ending value 
BV = Beginning value 
n = Number of years

ales growth is an important driver of the need to invest in various types of assets and of the company’s value. It also provides some indication of the effectiveness of firm’s strategy and product development activities. 

Analyzing Growth: 

Growth can be disaggregated into three main components: 

  • Portfolio Momentum: organic revenue growth a company enjoys because of overall expansion in the market segements of its portfolio 
  • Market share performance: organice revenue growth from a company gaining or losing share in a particular market 
  • Mergers and acquisitions: inorganic growth a company achieves when it buys or sells revenues through acquisitions or divestments 

Growth and Value: growth translates to value when return on invested capital (ROIC) exceeds the cost of capital(!!!). Sustaining high growth is much more difficult than sustaining ROIC. Despite some variation on the patterns of growth, high growth is not sustainable, due to the natural cycles of products. 

Types of Growth and Value Creation 
Q.) 
o 
Q.) 
1 
2 
3 
Above average value creation 
Create new markets through new products 
Convince existing customers to buy more of a product 
Attract new customers to the market 
Average value creation 
Gain market share in fast-growing market 
Make bolt-on acquisitions to accelerate product growth 
Below average value creation 
Gain share from rivals through incremental innovation 
Gain share from rivals through product promotion and pricing 
Make large acquisitions
Categories
Financial Analysis and Valuation

General Notes

  • Intrinsic value: the value that WE THINK the company is worth. The actual worth of an investment or asset justified by information about its future cash flows. This is the ‘true’ value according to a model. 
  • Market value: the price determined by buyers and sellers on an open market. It’s the consensus value of all market participants. 
  • Is growth always good? It depends on the return on capital. Growth = IR (investment rate) * ROIC 
  • Invested Capital: the cumulative amount that the business has invested in its operations – primarily PP&E and working capital 
  • Guiding Principal of Value Creation 
    • Firms that grow and earn a return of capital that exceeds their cost of capital create value 
    • As long as the spread between ROIC and WACC is positive, new growth creates value. The faster the firm grows, the more value it creates. ROIC > WACC = VALUE CREATION! 
    • If the spread is equal to zero, the firm creates no value through growth. The firm is growing by taking on projects that have NPV of zero 
    • When the spread is negative, the firm destroys value by taking on new projects. If a company cannot earn the necessary return on a new project or acquisition, its market calue will drop. ROIC < WACC = VALUE DESTRUCTION! 

High ROIC companies should focus on growth. Low ROIC companies should focus on improving returns before growing. 

The amount of value they (the company) create is the difference between cash inflows and the cost of the investment made, adjusted to reflect the fact that tomorrow’s cash flows are worth less than today’s because of the time value of money and the riskiness of future cash flows. 

A combination of three primary financial metrics typically measure how well a company is delivering value to shareholders: earnings per share (EPS), return on invested capital (ROIC) or return on equity (ROE), and after-tax cash flow. 

Warren Buffet’s principles for an outstanding business: 

  • A high ROIC and is able to reinvest its earnings at a high rate 
  • A “moat”, a barrier against competition, something like a world-class brand or advantage of scale. Often it is the firms business in a particular market 
  • Either an outstanding management or is so powerfully positioned that it doesn’t need one 

A large established company might have a low return on capital as it might have lost its competitive advantage (it grew at first thanks to its good ROIC). A small company might have a low return on capital as it struggled to ever establish and source of competitive advantage 

Categories
Financial Analysis and Valuation

Private Equity and Venture Capital

Categories
Financial Analysis and Valuation

Industry Analysis Template

A suggested structure for an industry analysis memoSector overview and key players
  1. Industry overview and key players
    1. Breakdown of key sectors within the industry (by revenues) and their associated business models (i.e. – how do they make money?)
    2. For each sub-sector:
      1. Key players
      2. Key financial statistics: market cap, total sales, operating and net profit, margins, risk (beta), recent 5-year equity returns (ROE, ROIC), as well as valuations (P/E, P/S, P/B and EV/EBITDA ratios)
      3. Sector potential short and long term consensus growth rates
  2. Industry features
  3. Sensitivity of sales to the business cycle; Industry life-cycle stage
  4. Operating leverage
  5. Financial leverage
  6. Industry structure: threat to entry, rivalry between existing competitors, pressure from substitute products, bargaining power of buyers, and bargaining power of suppliers 
  7. Operating environment: regulatory, political, social, environmental and product risk, trade issues, exchange rate sensitivity, and impact of consolidation and globalization 
  8. Industry Trends & Market Outlook for the next 12-36 months? (e.g., how would strong dollar, rising rates, rising commodity costs, or increasing legislation impact the sector?)
  9. Key Financial & Valuation Metrics—Sector specific characteristics (e.g., same store sales for retailers)
  10. Recommendations—Should SIF 2021 overweight or underweight this sector in the next 12-36 months? 
Categories
Financial Analysis and Valuation

Useful Templates

Discounted Cash Flows (DCF) template

Leveraged By Out (LBO) template

Adjusted Present Value DCF (APV) template

Categories
Interpersonal Influence and Power

The Hero’s Journey Framework to Arguments and Storytelling

The below is a really nice framework to use when thinking about framing an argument, telling a story, or thinking about your short and long term goals. It can help ensure that arguments are solid, backed by evidence, and are compelling. The next time you need to make an argument, or need to get more clarity around a decision that you need to make.

This framework was introduced to us by Damon D’Amore. He’s an executive mentor and advisor to C-Suite executives and select entrepreneurs and public speakers. Here’s a list of his favorite professional development books:

https://damondamore.com/five-favorite-personal-development-books-time/

Categories
Corporate Strategy

Global Strategies

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A quick reminder.. When identifying a problem, we should ask ourselves: what’s going on here…what’s important… what’s less important.. what’s not really important?





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The first question strategists should ask is what is the firm trying to do? What do they want to do? From there, it’s important to identify the key sources of success (BTW – A lower price is not a sustainable competitive advantage.

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