today’s topic: more on financial measurements
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Today’s Topic: More on Financial Measurements. Types, Definitions and Uses and “Typical Patterns” for High-tech Businesses. - PowerPoint PPT PresentationTRANSCRIPT
Today’s Topic:Today’s Topic: More on Financial More on Financial
MeasurementsMeasurements
Types, Definitions and Uses Types, Definitions and Uses andand
“ “Typical Patterns” Typical Patterns”
for High-tech Businessesfor High-tech Businesses
This class is not required;This class is not required;you can take E421 or TG401Byou can take E421 or TG401B
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especially Senior Designespecially Senior Design
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CC: good attendance and attention, but little/no active: good attendance and attention, but little/no active class participationclass participation
BB: 2-4 active contributions per class (answers,: 2-4 active contributions per class (answers, comments, questions, stories, disagreements, comments, questions, stories, disagreements, challenges, …)challenges, …)
AA: particularly insightful or useful contributions : particularly insightful or useful contributions (not necessarily more frequent!)(not necessarily more frequent!)
You will receive an interim cp grade at mid-term;You will receive an interim cp grade at mid-term; If you want to know how you’re doing……ASK MEIf you want to know how you’re doing……ASK ME
So far……….So far……….
Companies try to maximize the wealth of their owners Companies try to maximize the wealth of their owners --- --- market cap (stock price) plus dividendsmarket cap (stock price) plus dividends
Stock price and the ability to pay dividends are driven Stock price and the ability to pay dividends are driven by by earnings, and beliefs about future earnings earnings, and beliefs about future earnings growthgrowth
Individual Individual products and services are expected to products and services are expected to contributecontribute targeted amountstargeted amounts to earnings/growth to earnings/growth
Earnings growth (ultimately) requires Earnings growth (ultimately) requires revenue revenue growthgrowth
Firms use Firms use financial statementsfinancial statements to develop plans, to develop plans, and measure/analyze/report on their performanceand measure/analyze/report on their performance
……..therefore, in terms of ..therefore, in terms of business objectives…..business objectives…..
A A company’scompany’s basic financial objective is basic financial objective is to to grow its earningsgrow its earnings quickly and quickly and sustainably, in order to raise its stock sustainably, in order to raise its stock price and have the ability to pay its price and have the ability to pay its owners dividendsowners dividends
ProductsProducts are successful if and only if are successful if and only if they attain their they attain their targeted contribution to targeted contribution to corporate earningscorporate earnings
But…..But…..howhow do companies do companies maximize earnings/growth?maximize earnings/growth?
By providing potentialBy providing potential customerscustomers
a better a better (value - price) (value - price) propositionproposition
than than competitorscompetitors
while managing while managing costs and costs and expensesexpenses
so as to so as to make profits make profits (earnings)(earnings)
(these are the topics for upcoming (these are the topics for upcoming classes)classes)
Financial Financial MeasurementsMeasurements
(can apply to company, product, project, …)(can apply to company, product, project, …)
Types (items):Types (items): revenues, costs, revenues, costs, expenses, earnings, assets, expenses, earnings, assets, depreciation, liabilities, cash, depreciation, liabilities, cash, investments, …. investments, ….
Reports (formats):Reports (formats): income statement, income statement, balance sheet, cash flow statement, …balance sheet, cash flow statement, …
Financial Statement Financial Statement ObjectivesObjectives
Income statementIncome statement
(for a time period)(for a time period)
Balance sheetBalance sheet
(at a point in time)(at a point in time)
Cash Flow statementCash Flow statement
(for a time period)(for a time period)
revenues, costs, revenues, costs, expenses, & earningsexpenses, & earnings
assets, liabilities and assets, liabilities and net capitalnet capital
cash ($$) in and out , cash ($$) in and out , and uses of cashand uses of cash
Financial Statement Financial Statement UsesUses
Historical/currentHistorical/current:: financial financial reporting, competitive analysis, reporting, competitive analysis, performance measurement, performance measurement, performance analysis, compensationperformance analysis, compensation
Future (projected)Future (projected):: goal setting, goal setting, goal achievement analysis goal achievement analysis (planning), financing requirements, (planning), financing requirements, stock price assessmentstock price assessment
Financial Statement Financial Statement TimingTiming
For external and internal reporting: annual For external and internal reporting: annual & quarterly (10Q and 10K; required for & quarterly (10Q and 10K; required for public companies; see public companies; see www.sec.govwww.sec.gov))
For internal operations: monthly, weekly For internal operations: monthly, weekly and (sometimes, e.g. sales) dailyand (sometimes, e.g. sales) daily
May be historical, current or projectedMay be historical, current or projected
Key ConceptsKey Concepts
Operations vs. total (e.g., OI vs. NI)Operations vs. total (e.g., OI vs. NI)
Normalizing results: return measures (e.g., OI Normalizing results: return measures (e.g., OI as % of revenue; operating return on assets)as % of revenue; operating return on assets)
Knowing what “good” results are: competitive Knowing what “good” results are: competitive (industry) analogs/benchmarks (industry) analogs/benchmarks --- today--- today
Cash vs. non-cashCash vs. non-cash
The Income StatementThe Income Statement
Revenues - Cost of Goods Sold (COGS) = Gross Margin (gross profit)
- M&S expense - R&D expense
- G&A expense = Operating income (EBIT)
- Interest - Taxes = Net income (earnings)
Method:Method: How to analyze an How to analyze an
Income StatementIncome Statement (First, “calculate the percentages”)(First, “calculate the percentages”) Operating income vs. net income Operating income vs. net income In-period operating performance: costs, In-period operating performance: costs,
expenses and earnings as a % of revenue; expenses and earnings as a % of revenue; compare to benchmark(s)compare to benchmark(s)
Cross-period performance (trends): relative Cross-period performance (trends): relative change in rev, costs, expenses, earnings… change in rev, costs, expenses, earnings… improvements vs. deteriorations, and whyimprovements vs. deteriorations, and why
And…?And…?
Assignment Question #1Assignment Question #1understanding that technical people affect understanding that technical people affect
income statement resultsincome statement results
How can technologists impact the How can technologists impact the line items of the line items of the income statementincome statement??
(cite (cite two examples for two examples for eacheach line item line item: : revenues, COGS, M&S expense, R&D revenues, COGS, M&S expense, R&D expense, G&A expense, interest, and expense, G&A expense, interest, and
taxes)taxes)
Assignment Question #2Assignment Question #2analyzing Google’s (GOOG) income statementanalyzing Google’s (GOOG) income statement
For For FY10 (calendar 2010)FY10 (calendar 2010), what were GOOG’s revenues ($), , what were GOOG’s revenues ($), and and relative (%revrelative (%rev) gross margin, operating income, and net ) gross margin, operating income, and net income?income?
How did How did operating incomeoperating income change change from FY09 to FY10 from FY09 to FY10 (on both (on both a a total $total $ and and relativerelative basis)? What were the major financial basis)? What were the major financial determinants of the total $ change (revenues? COGS? R&D determinants of the total $ change (revenues? COGS? R&D exp? SG&A exp?)? Of the relative (%rev) change?exp? SG&A exp?)? Of the relative (%rev) change?
Why did relative operating income and relative net income Why did relative operating income and relative net income change differently change differently from FY09 to FY10from FY09 to FY10? Taxes? Interest? Other?? Taxes? Interest? Other?
For For FY10 FY10 what % of revenue came from each of GOOG’s what % of revenue came from each of GOOG’s product categories? Which products had the highest and product categories? Which products had the highest and lowest gross margin %? lowest gross margin %?
How has GOOG stock performed compared to the Nasdaq How has GOOG stock performed compared to the Nasdaq index over the last year? Speculate as to why.index over the last year? Speculate as to why.
Google Income StatementGoogle Income Statement
year ending; $M Dec-10%revenu
e %growth Dec-09 %revenueRevenues 29,321 100 24.0 23,651 100COGS 10,417 35.5 17.8 8,844 37.4Gross margin 18,904 64.5 27.7 14,807 62.6R&D expense 3,762 12.8 32.3 2,843 12.0M&S expense 2,799 9.5 41.1 1,984 8.4G&A expense 1,962 6.8 17.6 1,668 7.0Operating income 10,381 35.4 24.8 8,321 35.2Interest rec'd 415 1.4 501.4 69 0.3Taxes 2,291 7.8 23.1 1,861 7.9Net income 8,505 29.0 30.4 6,520 27.6
Financial Statement Financial Statement ObjectivesObjectives
Income statementIncome statement
(for a time period)(for a time period)
Balance sheetBalance sheet
(at a point in time)(at a point in time)
Cash Flow statementCash Flow statement
(for a time period)(for a time period)
revenues, costs, revenues, costs, expenses, & earningsexpenses, & earnings
assets, liabilities and assets, liabilities and net capitalnet capital
cash ($$) in and out , cash ($$) in and out , and uses of cashand uses of cash
The Balance Sheet The Balance Sheet EquationEquation
Net worth = what you own - what you owe
Net Capital = Assets - Liabilities
orAssets = Liabilities + Net Capital
The Balance SheetThe Balance Sheet
AssetsCurrent Assets:
Cash +Accts Rec.+Inventory
+Prepaid expenses
+ Net PP&E: PP&E at cost
- Depreciation Total Assets
Liabilities & Capital
Current Liabilities: Accounts Payable
+Accrued taxes +Accrued expenses
+ Short term debt+ Long term debt Total liabilities + Retained earnings/loss+ Owners’ equity
Total liabilities&capital
Cash Flow StatementCash Flow StatementNet operating cash flow(cash from operations)
+ Net cash from investingactivities:
capital expenditures +short term investments +securities (long term)
+ Net cash from financing
activities: debt financing
+stock financing Net change in cash
Net Net OperatingOperating Cash Flow Cash Flow
Net operating cash inflows: revenues
- change in accts rec- Net operating cash outflows:
COGS - depreciation + operating expenses
+ change in prepaid exp - change in accrued exp
+ change in inventory - change in accts payable
Net operating cash flow (NOCF)
Key ConceptsKey Concepts
Operations vs. total (e.g., OI vs. NI)Operations vs. total (e.g., OI vs. NI)
Normalizing results: return measures (e.g., OI Normalizing results: return measures (e.g., OI as % of revenue; operating return on assets)as % of revenue; operating return on assets)
Knowing what “good” results are: competitive Knowing what “good” results are: competitive (industry) analogs/benchmarks (industry) analogs/benchmarks --- today/now--- today/now
Cash vs. non-cashCash vs. non-cash
Typical Patterns: Typical Patterns: Financial Results Vary by Financial Results Vary by
….…. Product typeProduct type: hardware vs. software vs. : hardware vs. software vs.
servicesservices
CustomerCustomer: business/government vs. : business/government vs. consumerconsumer
Method of sellingMethod of selling: direct vs. indirect sales: direct vs. indirect sales
… …. so we’ll need 12 (3x2x2) benchmarks. so we’ll need 12 (3x2x2) benchmarks
Impact of Product Type: Impact of Product Type: IBM, prior to sale of PC IBM, prior to sale of PC
divisiondivision
2002 2004 % of Revenue % of OI GM%
Hardware 34% 23% 31%
Software 16% 37% 87%
Services 50% 40% 25%
Direct SellingDirect Selling
Company
Sales-force
Customers
bus/govtor
consumer
Indirect Selling ThroughIndirect Selling Through“Channel Partner(s)”“Channel Partner(s)”
Company Customers
bus/govt or
consumers
Sales-force
Sales-force
Company profit
Total (full-stream) profit
Channel profit
Impact of Customer Type: Impact of Customer Type: Business/gov’t.Business/gov’t. compared to compared to
consumerconsumer higher selling price higher selling price (higher value products)(higher value products) higher gross margin % higher gross margin % (less price competition)(less price competition) higher R&D % higher R&D % (more complex products)(more complex products) lower marketing % lower marketing % (fewer customers)(fewer customers) higher selling expense % higher selling expense % (more direct selling)(more direct selling) net: higher operating return on sales (OI/rev)net: higher operating return on sales (OI/rev) in bus/hw market: OROS of 12-20% is “good”in bus/hw market: OROS of 12-20% is “good” in consumer/hw market: OROS = 8-13% “good”in consumer/hw market: OROS = 8-13% “good”
““Good” Operating Return Good” Operating Return (OI/Rev)…(OI/Rev)…
Higher in business markets (12-25%)Higher in business markets (12-25%) … …compared to consumer markets (4-15%)compared to consumer markets (4-15%) (higher value products, less competition)(higher value products, less competition)
Highest with software products (5-10% higher)Highest with software products (5-10% higher) … …compared to hardware or services compared to hardware or services (volume leverage from very high (volume leverage from very high gross margin %) gross margin %)
Higher when selling direct (4-8% higher)Higher when selling direct (4-8% higher) … …compared to selling through otherscompared to selling through others (don’t have to share the total profit)(don’t have to share the total profit)
Typical Financial Typical Financial Structure: Structure: “Hardware” for “Hardware” for
Business/Gov’tBusiness/Gov’t
List price 100List price 100 Average selling price 80 (60-90 range)Average selling price 80 (60-90 range) Distributors’ price 60 (45-70 range)Distributors’ price 60 (45-70 range) COGS 40 (20-60 range)COGS 40 (20-60 range)
Direct-sale gross margin = 50% (40/80)Direct-sale gross margin = 50% (40/80) Indirect-sale gross margin = 33% (20/60)Indirect-sale gross margin = 33% (20/60)
Distributor’s gross margin = 25% (20/80)Distributor’s gross margin = 25% (20/80)
Typical Financial Typical Financial Structure:Structure:
“Hardware” for Consumers“Hardware” for Consumers List price 100List price 100 Average selling price 90 (70-100 range)Average selling price 90 (70-100 range) Distributor’s price 75 (70-80 range)Distributor’s price 75 (70-80 range) COGS 60 (50-70 range)COGS 60 (50-70 range)
Direct-sale gross margin = 33% (30/90)Direct-sale gross margin = 33% (30/90) Indirect-sale gross margin = 20% (15/75)Indirect-sale gross margin = 20% (15/75)
Distributor’s gross margin = 17% (15/90)Distributor’s gross margin = 17% (15/90)
So, for indirect sales….So, for indirect sales….
Price per unit (to producer) is lowerPrice per unit (to producer) is lower Revenues are lower for a given volume of Revenues are lower for a given volume of
salessales Gross margin % is lowerGross margin % is lower
Given that companies are trying to Given that companies are trying to maximize earnings/growth….why does maximize earnings/growth….why does anyany company choose to sell indirectly ????company choose to sell indirectly ????
Software is Software is different…..different…..
Cost of Cost of producing copiesproducing copies and and deliveringdelivering software to customers are lower than for software to customers are lower than for “physical” goods (hardware)“physical” goods (hardware)
Normally, Normally, sw sw COGSCOGS are 10-20% are 10-20% of revenues of revenues (when sold indirectly; even lower when direct)(when sold indirectly; even lower when direct)
So, manufacturer’s So, manufacturer’s indirect-sale gross indirect-sale gross marginsmargins are are 80% to 90%80% to 90% …..very high!! …..very high!!
Conversely, Conversely, development (R&D) expensedevelopment (R&D) expense is is typically higher than many other products, typically higher than many other products, often often 20-35%20-35% compared to 10-20% for compared to 10-20% for hardwarehardware
And, so are And, so are Services…...Services…...
May be managed “for profit,” May be managed “for profit,” oror to support to support the sale of hardware/softwarethe sale of hardware/software
If “for profit,” If “for profit,” gross marginsgross margins are typically are typically 35 - 55%35 - 55% (salaries of people who provide (salaries of people who provide the services are included in COGS, as is the the services are included in COGS, as is the depreciation on capital equipment used)depreciation on capital equipment used)
R&D expenseR&D expense usually much lower usually much lower (as % of (as % of sales), often approaching zerosales), often approaching zero
Asset requirementsAsset requirements to deliver service (and to deliver service (and associated depreciation) can be largeassociated depreciation) can be large
““Good” Operating ReturnsGood” Operating Returnsin the Business Marketin the Business Market
OI/Rev OI/Rev (%)(%)
Sold Sold directdirect
Sold Sold indirectindirect
SoftwareSoftware 27%27% 23%23%
HardwarHardwaree
18%18% 12%12%
ServiceService 15%15% --
Lower GM %Lower M&S %
Higher GM %Higher R&D %
……and compared to and compared to Business markets, Business markets,
Consumer markets…Consumer markets… Typically have Typically have 5-10% lower5-10% lower operating operating
returns, because…returns, because… Selling is mostly indirect (ex: internet)Selling is mostly indirect (ex: internet) GM% is lower (indirect selling, price GM% is lower (indirect selling, price
comp)comp) Lower R&D%Lower R&D% Higher Marketing%Higher Marketing%
““Good” Operating ReturnsGood” Operating Returnsin the Consumer Marketin the Consumer Market
OI/Rev OI/Rev (%)(%)
Sold Sold directdirect
Sold Sold indirectindirect
SoftwareSoftware 20%20% 16%16%
HardwarHardwaree
11%11% 7%7%
ServiceService 9%9% --
Lower GM %Lower M&S %
Higher GM %Higher R&D %
The Income StatementThe Income Statement
Revenues - Cost of Goods Sold (COGS) = Gross Margin (gross profit)
- M&S expense - R&D expense
- G&A expense = Operating income (EBIT)
- Interest - Taxes = Net income (earnings)
So, Successful Companies So, Successful Companies Have High Levels of Have High Levels of
Earnings and Earnings Earnings and Earnings Growth via…….Growth via…….
High revenuesHigh revenues……better products and/or ……better products and/or better sales/marketing than competitorsbetter sales/marketing than competitors
High gross margins (%)High gross margins (%) …..low costs to …..low costs to produce and deliver productsproduce and deliver products
““Low” expensesLow” expenses …..right-sized and …..right-sized and efficient M&S, R&D, and G&Aefficient M&S, R&D, and G&A
Low tax paymentsLow tax payments; ; low interest low interest paymentspayments or or high interest receiptshigh interest receipts
But…..But…..howhow do companies do companies make these things happen?make these things happen?
By providing potentialBy providing potential customerscustomersa better a better (value - price) proposition(value - price) proposition
than than competitorscompetitorswhile managing while managing costs and expensescosts and expensesso as to so as to make profits (earnings)make profits (earnings) ;;
thereby maximizing shareowner wealththereby maximizing shareowner wealth(company valuation)(company valuation)
(these are the topics for upcoming classes)(these are the topics for upcoming classes)
Customers assess “value” Customers assess “value” compared to competitorscompared to competitors
in multiple dimensions…….in multiple dimensions…….
Product performance/features (fit to market)Product performance/features (fit to market) Price/performance vs. competitorsPrice/performance vs. competitors Availability (time to market)Availability (time to market) ““Info” on product/uses/benefits (marketing)Info” on product/uses/benefits (marketing) Reliability/maintainabilityReliability/maintainability Sold the way customers want to buy (channels)Sold the way customers want to buy (channels) Customer service and supportCustomer service and support Costs to use (life-cycle cost)Costs to use (life-cycle cost)
The Income StatementThe Income Statement
Revenues - Cost of Goods Sold (COGS) = Gross Margin (gross profit)
- M&S expense - R&D expense
- G&A expense = Operating income (EBIT)
- Interest - Taxes = Net income (earnings)
Assignment for Next Week:Assignment for Next Week:Analyzing a Company Analyzing a Company
MedtronicMedtronic
Medical technologyMedical technology
-Founded in 1949Founded in 1949-$16.4 B annual revenue and OI%=29.4% (last 12 $16.4 B annual revenue and OI%=29.4% (last 12
months)months)- $41.8 B market cap, current P/E = 12.5$41.8 B market cap, current P/E = 12.5
-Market share leader in several product categoriesMarket share leader in several product categories
Getting Info on Getting Info on MedtronicMedtronic
Company website: Company website: www.medtronic.comwww.medtronic.com
- especially “Investor Relations” section- especially “Investor Relations” section
Yahoo: Yahoo: finance.yahoo.comfinance.yahoo.com
- enter “MDT” (Medtronic’s stock ticker - enter “MDT” (Medtronic’s stock ticker symbol)symbol)
Securities Exchange Commission: Securities Exchange Commission: ww.sec.govww.sec.gov
- - select “search for company filings,” enter select “search for company filings,” enter MDT, MDT,
see esp. the 10K annual report filed 6/28/11see esp. the 10K annual report filed 6/28/11
Medtronic Stock Price: last five yearsMedtronic Stock Price: last five years
Assignment Questions -- Assignment Questions -- 11
What What businessbusiness is Medtronic in? is Medtronic in? What What product categoriesproduct categories does it compete in? does it compete in? Who are its Who are its customerscustomers?? How does itHow does it sell sell its products? its products? Who are its Who are its competitorscompetitors?? Is its Is its financial performancefinancial performance good? good?
(use the annual income statement for YE Apr11 (use the annual income statement for YE Apr11 (FY11); (FY11);
suggestion: use the version in the SEC 10K suggestion: use the version in the SEC 10K report)report)
Is it Is it improving or deterioratingimproving or deteriorating? In absolute ? In absolute terms? In relative (% revenue) terms? Why?terms? In relative (% revenue) terms? Why?
What were the What were the major determinantsmajor determinants of the change of the change in relative operating income from FY10 to FY11? in relative operating income from FY10 to FY11?
Assignment Questions -- Assignment Questions -- 22
Why did MDT stock price fall significantly during Why did MDT stock price fall significantly during Aug 2011? (suggestion: see Associated Press (AP) Aug 2011? (suggestion: see Associated Press (AP) news item, Aug 23, 2011)news item, Aug 23, 2011)
How has MDT’s stock price fared vs. the overall How has MDT’s stock price fared vs. the overall stock market (use the Nasdaq index) in the last stock market (use the Nasdaq index) in the last year? Why?year? Why?
What What opportunities & challengesopportunities & challenges does Medtronic does Medtronic face in accelerating its revenue and profit growth in face in accelerating its revenue and profit growth in the future? the future?
(see esp. 10K data, “management’s discussion…”)(see esp. 10K data, “management’s discussion…”)
If you owned MDT stock, would you sell it right now?If you owned MDT stock, would you sell it right now?
Method:Method: How to analyze How to analyze an income statementan income statement
(First, “calculate the percentages”)(First, “calculate the percentages”) Operating income vs. net income Operating income vs. net income In-period operating performance: costs and In-period operating performance: costs and
expenses as a % of revenue; compare to expenses as a % of revenue; compare to benchmarksbenchmarks
Cross-period performance (trends): relative Cross-period performance (trends): relative change in rev, costs, expenses, earnings… change in rev, costs, expenses, earnings… improvements vs. deteriorations, and whyimprovements vs. deteriorations, and why
Going-forward opportunities and challenges/Going-forward opportunities and challenges/
risks for each line item (esp. rev and op inc)risks for each line item (esp. rev and op inc)
Topics for Next ClassTopics for Next Class
Finish financial measurements topicFinish financial measurements topic
……and…and…
Functions within a company: growth and Functions within a company: growth and profit responsibilities, how technical profit responsibilities, how technical
people “fit,” compensation in high-tech people “fit,” compensation in high-tech industriesindustries