FINANCIAL ANALYSIS BY

SHORT GLOSSARY






















Marc BERTONECHE
Visiting Professor of Finance at Harvard Business School
CONCEPT DEFINITION
Assets
Wealth of a company.

Constitute one of the two columns of the balance sheet. Comprise fixed assets and current assets.

Beta (B)
A measure of the extent to which the returns on a given stock move with the stock market.

When the beta is higher (lower) than 1, the share price will tend to amplify (tamper) the fluctuations of the
market. Beta is influenced by the industry (cyclical versus non-cyclical), and the amount of debt relative to
shareholders' investment.

In industrialized countries, most listed corporations have a Beta value between (0.5 and 1.5)

Breakeven Point Volume of sales for which total costs equal total revenues
Book Value of
Equity
That part of capital employed which is financed by shareholders. Is made up of paid in capital + retained
earnings - treasury stock (see definition of treasury stock)

Capital Assets
Pricing Model
Model based on the proposition that any stock's required rate of return is equal to the risk-free rate of
return plus a risk premium which reflects only the risk which cannot be eliminated through diversification of
shareholders' portfolios.

Capital Employed
(CE) = Invested
Capital (IC)
Level of investment required to have a business running: not only fixed assets but also working capital.

CE = Net Fixed Assets + Working Capital CE = NFA + WC

As a balance sheet is balanced(I), capital employed is also equal to:

CE = Book Value of Equity + Net Financial Debt CE = BE + NFD

Capital Employed
Management
Ratios
Inventory Turnover Ratio = Inventory / Cost of goods Sold * 360 days

Receivables collection period = Days of Sales Outstanding = Accounts Receivable / Sales * 360

Days Payables deferral period = Accounts Payable / Purchases * 360 days

Fixed Assets Turnover Ratio = Sales I Net fixed Assets

Capital Rationing
It occurs when management places a constraint on the size of the firm's capital budget during a given
period.

It is usually associated with regulated economies or asymmetry of information.

In ideal, well functioning, transparent capital markets, prices should adjust the equilibrium supply of capital
to the equilibrium demand.

Cash Flows
(accounting
definition)
Accounting Cash Flow = net income + depreciation & amortization

CONCEPT DEFINITION
Cash Flows
Statement
It shows the impact of a firm's operating, investing and financing activities on cash inflows and
outflows over an accounting period.

Cash flows from
operating
activities (CFO)
Operating cash flows = net income + depreciation & provisions - variation in working capital

A better definition of cash from operations exclude the impact of both interest and tax savings generated by
interest tax deductibility.

This amounts to replacing "Net Income" in the above computation, with NOPAT (see definition of NOPAT)

Cash Flows from
Investing
activities (CFI)
Net Capital Expenditures (Capex) = Capex-assets sales
CAGR Compounded Average Growth Rate
Cost of Capital
(COC)
The return expected by investors for the capital they supply to firms.

Also, the highest return on an alternative investment with the same risk as the investment under
consideration. (See also WACC)

Cost of Debt
(COD)
The cost of borrowing new funds.
Cost of Equity
(COE)
Rate of return required by the firm's owners on their equity capital used to finance the firm's assets or a
particular project.

Discounting The process of finding the present value for a cash inflow or outflow or a series of cash in( outflows
Earnings per
share (EPS)
Earnings after tax/ number of outstanding shares
EBT Earnings Before Tax, earnings before interest and tax minus net interest.
EBITDA
Earnings Before Interest, Tax, Depreciation and Amortization.

EBITDA = Sales - Cost of Goods Sold - Selling, General and Administrative Expenses

EBITDA = EBIT + depreciation & amortization

Also EBITDA-tax on EBIT =NOPAT +depreciation

EBIT
Earnings Before Interest and Tax.

EBIT = EBITDA-depreciation & amortization

Efficient Market
Hypothesis
The hypothesis that securities are fairly priced in the sense that the price reflects all publicly available
information on each security.

Economic Value
Added (EVA)
Value created during the period
CONCEPT DEFINITION
Economic Value
Added (EVA)
EVA = Net Operating Profit After Tax - (Capital Employed x WACC)
NB: NOPAT is also called: Economic profit

EVA= (RaCE-WACC) x Capital Employed

Spread between the return on capital and the cost of capital
multiplied by the level of capital employed.

Enterprise Value
(EV) or Firm
Value (FV)
The sum of shareholders/ investment (MVE), and debt holders/ investment (MVD) valued at market price.

Often book value of debt (BVD) is used as a proxy for market value of debt

Free Cash Flow to
the Firm (FCFF)
Cash generated (needed) during the period to meet; obligations to the financial stakeholders, assuming no
variation in cash position

Free Cash Flow to
Equity (FCFE)
Cash generated (needed) during the period to meet obligations to the shareholders, assuming no variation
in cash position

Financial
leverage
Proportion of debt in a firm's financing structure. Measured by the ratio BVD / BE (book leverage) or
MVD/MVE (market leverage)

Gross Margin Is equal to sales minus cost of goods sold

Internal Rate of
Return (IRR)
It is the discounting rate with which the NPV becomes equal to zero (see definition for NPV)

NPV: FCFF
t
/(1+TRI)
t
= 0

Caution is highly recommended when comparing two projects of different size or duration on the basis of
the IRR

Liabilities
Resources of a company.

Constitute one of the two columns of the balance sheet. Comprise Shareholders Equity (or Book Value of
Equity) and Debt

Market risk
premium (rp)
It corresponds to the risk premium required by funds suppliers to invest in a diversified portfolio made up of
all the shares of the market.

The risk premium depends of the respective market power of funds suppliers on one side, and investors in
risky projects in the other side.

The market risk is the part of a security's risk that cannot be eliminated by diversification. On the contrary,
the diversifiable risk is associated with random events and can be eliminated by proper diversification.




CONCEPT DEFINITION
Market Value
Added
Overall value creation at the firm level
MVA = Enterprise value-Capital Employed = EV-CE
When MVD =BVD,
then MVA =MVE-BE

Market to Book
ratio
It may refer to the Equity Market to Book: EV/CE
Or to the Firm Market to Book: MVE/BE

It's the same thing as the MVA, expressed as a ratio rather than a difference. It can be used to compare
corporations value creation capabilities.

Market Value of
Equity (MVE)
Is equal to the price of a share times the number of shares.
Net Income
Wealth generated for the shareholders during the period

NFD
Net Financial Debt

Net Operating
Profit After Tax
(NOPAT)
Represents the net income/earnings after tax that would have been obtained without extraordinary items
and without taking into account the impact of debt financing (equivalent to assuming capital employed is
financed only by shareholders).

NOPAT = EBIT (1-t)
t is the income tax rate.
NPV
Net present value of an investment project.

Difference between the present value of the cash flows generated by the project and the initial investment.
The present value of future cash flows is computed through the discounting technique

PV = IFCFF
t
/ (l+r)
t

FCFF
t
= Expected cash flow in year t
r = funds suppliers opportunity rate

The NPV can also-be obtained in discounting the forecasted EVAs

NPV = 2EVAtf{l+WACC)t

Operating
leverage
A firm with a high operating leverage will see a large change in operating income with a relatively small
change in sales.

The operating leverage depends on the level of fixed cost in a firm's cost structure.

Payback period
Length of time required for the net cash flows of a project to recover the initial investment.
"Discounted" payback is computed using the discounted value of the future cash flows.



CONCEPT DEFINITION
Present Value
The price investors would be ready to pay, today, for the rights to a future cash flow or of a series of cash
flows.

This price depends upon the opportunity rate of the investor, given the risk he is facing.
Such opportunity rate is reflected in the discount factor.

Price / Earning
Ratio (P/E)
P/E = price per share / Earnings per share
Return required
by shareholders
or Cost of Equity
(COE)
Is usually assessed by the following formula
COE = r
t
+ x r
p

Return on Equity
Earnings after tax (EAT)/ Owners equity

Risk-adjusted
discount rate or
project cost of
capital
When the risk of the project is different from the average risk of projects usually undertaken, the return k
e
,
has to be adjusted to take into account a specific to the project.

The WACC should also be adjusted. In multi-divisional companies, there is usually a WAC by division.

Risk Free Rate
Return (r
t
) provided by a risk free security.

Return On Equity
(ROE)
Return on Equity: earnings after tax divided by owner's equity.

A measure of the firm's profitability to shareholders.

Spin-off or
Demerger
Split of a company into two entities, each of them having their own shareholders.

This operation may create shareholder value through improved transparency and / or better focus on each
business entity.

Scenario analysis
A risk analysis technique in which the best-and worst- case NPVs are compared with the project's expected
NPV Scenario building implies that we are looking at alternative, views of the world, which have a
reasonable degree of profitability, and where the actions we would be taking might differ significantly

Sensitivity
analysis
A technique which shows how much a project's NPV or IRR will change in response to a given change in an
input variable (such as sales) other things held constant.

Stakeholders
All those who have an interest in the development of the firm: Employees, Customers, Suppliers, Funds
Suppliers, State.

Total
Shareholders
Return (TSR)
It consists of dividends plus capital gains.
Treasury Stock
Shares of the corporation acquired by the corporation from the shareholders, and kept as a negative
component of shareholders' equity until they are destroyed or floated back on the market



CONCEPT DEFINITION
Value Creation
Creation of wealth in excess of what is required by shareholders.

Depending on the perspective, value creation is measured by NPV or MVA (global value creation), or EVE
(value creation for a given period)

Weighted
Average Cost of
Capital (WACC)
Return that needs to be generated on the invested capital to just meet return requirements by the pool of
funds suppliers.

It combines the return required by shareholders (COE) and the return required by debt holders (COD), each
return requirement being associated to a weight proportional to the corresponding stakeholders' financial
investments.

WACC = COD x (1-t) x MVD/EV+ COE x MVE/EV, t is the income tax rate.

Working capital
(required)
Capital required to finance a firms operational cycle: current (operational) assets - current liabilities.

WC = Inventories + Accounts Receivable - Accounts Payable