Financial Analysis

Market Value of Equity* + Interest-Bearing Liabilities** - Cash

Measure of the economic value of a company. Frequently used to determine the value of a business if it is acquired. Considered to be a better valuation measure for M&A than market cap. Takes into account the debt an acquirer would have to assume and the cash they would receive. EV can be interpreted as the cost to take over a business. Therefore, it would cost # to buy all of the firm's equity and pay off its debts #, but because we would also take over the firm's cash #, the net cost of the business is only #.

*Market Cap // **All liabilities except Accounts Payable

Amphi 1

Market Price per Share x Number of Shares Outstanding

A firm's market capitalization measures the market value of the firm's equity.

Amphi 1

Financial analysts often use the information in the firm's balance sheet to assess its liquidity. Assesses whether the firm has sufficient working capital to meet its short-term needs.

Liquidity = company's ability to meet its short-term obligations. Debitors' ability to pay off current debt obligations without raising external capital. One can be solvent but can lack liquidity: Assets are liquid if they are either immediately accessible or easily converted into usable funds; Cash is considered the most liquid payment vehicle.

Amphi 1

Total Current Assets / Total Current Liabilities

The range of acceptable current ratios varies depending on the specific industry. But overall...

• A ratio value lower than 1: potential liquidity problems for the company unless the firm is able to secure other forms of financing.
• A ratio between 1.5 and 3: healthy. Company is able to pay off all its debts once they become due.
• A ratio over 3: not using its current assets efficiently or is not managing its working capital properly.

Amphi 1

(Cash and Equivalents + Marketable Securities + Accounts Receivable) / Current Liabilities

Compares only cash and "near-cash" assets, such as short-term investments and accounts receivable, to current liabilities. A reason to exclude inventory is that it may not be that liquid.

The firm may have a risk of experiencing a cash shortfall in the near future if under 1.

Amphi 1

Quick Ratio excludes inventory and other current assets (such as prepaid expenses); because they are generally more difficult to turn into cash.

The Current Ratio considers inventory and prepaid expenses assets.

Inventory takes time to liquidate, although a few rare companies can turn their inventory fast enough to consider it a quick asset.

Prepaid expenses, though an asset, cannot be used to pay for current liabilities.

Amphi 1

Cash / Total Current Liabilities

The most stringent liquidity ratio. Under 1, means poor liquidity.

Amphi 1

Enterprise value / EBITDA

(Earnings Before Interest, Taxes,  Depreciation, and Amortization = Net Income + Taxes + Interest Expense + Depreciation and Amortization)

Valuation metric to compare the relative value of different businesses. A lower value is better than a higher value. As an acquirer, you will want to buy a company with a low ratio. A firm's higher profit leads to a lower Enterprise Value.

Comment: The enterprise multiple for Company A is # and that for Company B is #. According to the above results, we may conclude that Company A's valuation is on the lower side, while Company B has a higher valuation. As a result, Company A becomes an easier target for acquisition.

Long-term Debt / Equity

Measure of how much of a company's operations are funded using debt versus the funding received from shareholders as equity. Excessive gearing may present a significant risk of bankruptcy.

Long term financing:

• Internal: Equity
• External: Long-term Debt

1. No standard method but the most commonly used approach is when "gearing" is a percentage of long-term debt relative to equity. Long-term Debt / Equity.
    
2. Another approach is when "gearing" is a percentage of long-term debt relative to capital employed. Long-term Debt / Capital Employed. Capital Employed = Long-term Financing = Equity + Long-term Debt. Also computed as "TALCL" = Total Assets - Current Liabilities.

Often considered that anything over 50% is a high level of gearing. May be true in some cases, but not always. Example: High levels of gearing BUT enough profit to service that debt without adversely affecting the returns of shareholders. If 0% -> "all-equity company" or "ungeared company". If higher than 0% -> "geared company".

Because of different approaches, always state how gearing has been calculated when quoting the ratio for a company.

Refers to the total amount of debt a business can incur and repay. Incurring too much debt or taking on the wrong type can result in damaging consequences.

• EBITDA
  Companies with higher levels can generate more earnings to repay their debt. The higher the EBITDA, the higher the debt capacity. Companies with stable levels are preferred because unlikely to default. Factors that contribute to stability: cyclicality and barriers to entry.
  • Cyclical businesses inherently have less debt capacity than non-cyclical businesses. From a lender's point of view, volatile EBITDA has a much higher default risk.
  • Industries with low barriers to entry also have less debt capacity compared to industries with high barriers to entry. Indeed, companies that have low barriers to entry can easily be disrupted as competition enters.
     
• Debt / Equity
  No standard method. Long-term Debt / Equity. Financial Gearing.
   
• Total Debt / EBITDA
  Most common cash flow metric to evaluate debt capacity. Demonstrates a company's ability to pay off its incurred debt.  Provides investment bankers with information on the amount of time required to clear all debt, ignoring interest, taxes, depreciation, and amortization.
   
• Interest Cover: EBIT / Interest Payable
  Measures the ability of a company to meet interest payments. An "interest cover" of 2 or less is seen as a problem. Indicates that more than half of the profits earned would be going to interest payments.

The ability of a company to meet its long-term financial obligations. Reflects the ability of a company to honor its commitments in the event of liquidation. Refers to a company's ability to meet long-term debts and continue operating into the future.

Example: Total amount of debts EUR 200'000. Total net value of assets EUR 300'000. If the company has to close, we can sell the assets to repay the debts.

The higher the "Total Net Value of Assets" in comparison with "Total Debts", the better the solvency.

Measuring Solvency:

1. Financial Gearing Ratios = Long-term Debts / Equity or Long-term Debt / Capital Employed
    
2. Interest Cover = EBIT / Interest Payable
    
3. Book Value of Equity = Total Assets - Total Liabilities

Refers to both an enterprise's ability to pay short-term bills and debts and a company's capability to sell assets quickly to raise cash.

• Current Ratio
• Quick Ratio
• Cash Ratio
• Working Capital