Financial Analysis, Modeling, and Forecasting Techniques

433 Pages·2007·3.32 MB·English

Financial
Analysis,
Modeling, and
Forecasting
Techniques
Course #5710A/QAS-5710A
Course Material
Financial Analysis, Modeling, and Forecasting Techniques
(Course #5710A/QAS-5710A)

Table of Contents
Page
PART I: TOOLS AND TECHNIQUES FOR FINANCIAL ANALYSIS

Chapter 1: Break-Even and Contribution Margin Analysis
I. What is Cost-Volume-Profit Analysis? 1-1
A. Applications of the CVP Model 1-1
B. What and Why of Break-Even Sales 1-2
C. Break-Even Point 1-3
D. The Formula Approach 1-6
E. What is Margin of Safety? 1-7
F. Cash Break-Even Point 1-7
II. What is Operating Leverage? 1-8
III. Sales Mix Analysis 1-10
IV. Contribution Margin Analysis 1-11
A. Accepting or Rejecting a Special Offer 1-12
B. Analyzing the Make-or-Buy Decision 1-13
C. Determining Whether to Sell or Process Further 1-14
D. Adding or Dropping a Product Line 1-15
E. Utilizing Scarce Resources 1-16
F. Don’t Forget the Qualitative Factors 1-17
V. Conclusion 1-17
Review Questions & Solutions 1-18

Chapter 2: Understanding and Applying the Time Value of Money
Concept
I. Assumptions of Present Value and Future Value Techniques 2-1
II. Present Value Table 2-1
III. Future Value Table 2-2
IV. Both Present Value and Future Value Tables 2-2
A. Future Value of $1 (Table 2.1) 2-2
B. Future Value of An Annuity of $1 (Table 2.2) 2-4
C. Future Value of An Annuity Due of $1 (Table 2.2 Adjusted) 2-6
D. Present Value of $1 (Table 2.3) 2-9
E. Present Value of An Annuity of $1 (Table 2.4) 2-9
F. Present Value of An Annuity Due of $1 (Table 2.4 Adjusted) 2-12
V. Perpetuities 2-15
VI. Conclusion 2-15
Review Questions & Solutions 2-16

Table of Contents 1
Table of Contents (cont.)
Page
Chapter 3: How to Assess Capital Expenditure Proposals for
Strategic Decision Making
I. Factors to Consider in Determining Capital Expenditure 3-3
II. Type of Capital Budgeting Decisions to Be Made 3-3
III. Capital Budgeting Methods 3-3
A. Payback Period 3-3
B. Discounted Payback Period 3-4
C. Accounting Rate of Return 3-5
D. Net Present Value 3-6
E. Internal Rate of Return 3-6
F. Profitability Index 3-8
IV. How to Select the Best Mix of Projects with a Limited Budget 3-8
V. How to Handle Mutually Exclusive Investments 3-9
VI. Risk Analysis in Capital Budgeting 3-10
A. Probability Distributions 3-10
B. Risk-Adjusted Discount Rate 3-11
C. Certainty Equivalent Approach 3-12
D. Simulation 3-13
E. Sensitivity Analysis 3-13
F. Decision Trees 3-13
VII. Conclusion 3-14
Review Questions & Solutions 3-15

Chapter 4: Analyzing Financial Statements for Financial Fitness
I. Who Uses Financial Analysis 4-1
A. Internal Managers 4-1
B. External Users 4-1
C. Horizontal and Vertical Analysis 4-2
II. Financial Statement Analysis 4-2
A. Trend Analysis 4-2
B. Horizontal Analysis 4-3
C. Vertical Analysis 4-5
III. Ratio Analysis 4-8
A. Liquidity Analysis 4-8
B. Measuring a Company’s Ability to Pay its Long-Term Debt 4-14
C. Profitability Ratios 4-16
D. Evaluating Stock as an Investment 4-18
IV. Limitations of Ratio Analysis 4-20
Review Questions & Solutions 4-21

Chapter 5: Analyzing Quality of Earnings
I. Quality of Earnings 5-1
II. Analysis of Discretionary Costs 5-3
III. Accounting Estimates 5-3
IV. Internal Control and Management Honesty 5-4
V. Auditor Relations and Reports 5-5
VI. Conclusion 5-5
Review Questions & Solutions 5-6
Table of Contents 2
Table of Contents (cont.)
Page
Chapter 6: Analysis of Variance Analysis for Cost Control
I. Responsibility Accounting and Responsibility Center 6-1
II. Standard Costs and Variance Analysis 6-2
III. General Model for Variance Analysis 6-4
A. Materials Variances 6-4
B. Labor Variances 6-5
C. Variable Overhead Variances 6-6
IV. Flexible Budgets and Performance Reports 6-7
V. Nonfinancial Performance Measures 6-9
VI. Conclusion 6-10
Review Questions & Solutions 6-11

Chapter 7: Analysis of Segmental Performance and Profit Variance
I. Segmental Reporting for Profit Centers 7-1
II. Profit Variance Analysis 7-3
A. Types of Standards in Profit Variance Analysis 7-3
B. Single Product Firms 7-4
C. Multi-Product Firms 7-4
D. Managerial Planning and Decision Making 7-9
III. Sales Mix Analysis 7-10
IV. Conclusion 7-10
Review Questions & Solutions 7-12

PART II: MANAGING AND CONTROLLING FINANCIAL ASSETS,
INVESTING, AND POTENTIAL ACQUISITIONS

Chapter 8: Evaluating Divisional Performance
I. Rate of Return on Investment (ROI) 8-1
A. The Breakdown of ROI – Du Pont Formula 8-2
II. ROI and Profit Planning 8-3
III. Residual Income (RI) 8-5
A. Residual Income and Economic Value Added 8-6
IV. Investment Decisions Under ROI and RI 8-6
V. Conclusion 8-7
Review Questions & Solutions 8-8

Chapter 9: Analyzing Working Capital
I. Evaluating Working Capital 9-1
II. Cash Management 9-2
A. Acceleration of Cash Inflow 9-2
B. Delay of Cash Outlay 9-6
C. Cash Models 9-7
III. Management of Accounts Receivable 9-9
A. Credit Policies 9-10
B. Monitoring Receivables 9-10
C. Credit Policy 9-11
D. Determining the Investment in Accounts Receivable 9-12
E. Discount Policy 9-13
Table of Contents 3
Table of Contents (cont.)
Page
IV. Inventory Management 9-17
A. Quantity Discount 9-18
B. Investment in Inventory 9-18
C. Determining Carrying and Ordering Costs 9-19
D. The Reorder Point 9-21
E. Control of Stockouts 9-22
V. Conclusion 9-23
Review Questions & Solutions 9-24

Chapter 10: Corporate Investments
I. Accounting Aspects 10-1
II. Analytical Implications 10-2
III. Obtaining Information 10-3
A. Market Information and Indexes 10-3
B. Economic and Political Events 10-4
C. Industry and Company Analysis 10-4
D. Microcomputers and Electronic Data Bases 10-4
IV. Risk Versus Return 10-5
V. Financial Assets 10-6
A. Common Stock 10-7
B. Preferred Stock 10-7
C. Bonds 10-8
D. Convertible Securities 10-8
E. Warrants 10-8
F. Options 10-9
G. Futures Contracts 10-11
VI. Real Assets 10-13
A. Real Estate 10-13
B. Precious Metals 10-14
VII. Portfolio Analysis 10-14
VIII. Mutual Funds 10-14
IX. Fundamental Analysis 10-16
X. Technical Analysis 10-16
A. Key Indicators 10-16
B. Charting 10-21
XI. Conclusion 10-24
Review Questions & Solutions 10-25

Chapter 11: Obtaining Funds: Short-Term and Long-Term Financing
I. Financial Planning 11-1
II. Short-Term Financing 11-1
A. Using Trade Credit 11-2
B. Bank Loans 11-2
C. Interest 11-4
D. Commercial Finance Loans 11-4
E. Commercial Paper 11-5
F. Using Receivables for Financing 11-5
G. Using Inventories for Financing 11-7
H. Financing with Other Assets 11-7
Table of Contents 4
Table of Contents (cont.)
Page
III. Intermediate-Term Financing: Term Loans and Leasing 11-7
A. Purposes of Intermediate-Term Bank Loans 11-8
IV. Types of Long-Term Debt 11-8
A. Mortgages 11-8
B. Bonds 11-9
C. Interest 11-9
V. Cost of Capital 11-9
A. Computing Individual Costs of Capital 11-10
B. Cost of Debt 11-10
C. Cost of Preferred Stock 11-11
D. Cost of Equity Capital 11-11
E. Cost of Retained Earnings 11-13
F. Measuring the Overall Cost of Capital 11-13
G. Historical Weights 11-13
VI. Conclusion 11-15
Review Questions & Solutions 11-16

Chapter 12: Analyzing Mergers and Acquisitions
I. Mergers 12-2
II. Deciding on Acquisition Terms 12-4
A. Earnings 12-4
B. Dividends 12-4
C. Market Price of Stock 12-4
D. Book Value Per Share 12-5
E. Net Working Capital Per Share 12-5
III. Acquisition of Another Business 12-5
IV. Impact of Merger on Earnings Per Share and Market Price Per Share 12-8
V. Risk 12-10
VI. Holding Company 12-11
VII. Conclusion 12-12
Review Questions & Solutions 12-13

Chapter 13: Forecasting and Financial Planning 13-1
I. Who Uses Forecasts? 13-2
II. Forecasting Methods 13-3
III. Selection of Forecasting Method 13-4
IV. The Qualitative Approach 13-4
A. Executive Opinions 13-5
B. The Delphi Method 13-5
C. Sales-Force Polling 13-7
D. Consumer Surveys 13-7
E. Pert-Derived Forecasts 13-7
V. Common Features and Assumptions Inherent in Forecasting 13-8
VI. Steps in the Forecasting Process 13-9
Review Questions & Solutions 13-10

Table of Contents 5
Table of Contents (cont.)
Page
Chapter 14: Forecasting Methodology
I. Naïve Models 14-1
II. Smoothing Techniques 14-2
A. Moving Averages 14-2
B. Advantages and Disadvantages 14-4
C. Exponential Smoothing 14-5
D. The Model 14-5
E. The Computer and Exponential Smoothing 14-7
III. Forecasting Using Decomposition of Time Series 14-7
IV. Conclusion 14-13
Review Questions & Solutions 14-14

Chapter 15: Forecasting with Regression and Markov Methods
I. The Least-Squares Method 15-1
II. Trend Analysis 15-4
III. Regression Statistics 15-8
IV. Statistics to Look for in Multiple Regressions 15-12
A. T-Statistics 15-13
2
B. R-Bar Squared (R ) and F-Statistic 15-13
C. Multicollinearity 15-13
D. Autocorrelation (Serial Correlation) 15-14
V. Checklists – How to Choose the Best Forecasting Equation 15-14
A. How to Eliminate Losers 15-14
B. How to Choose the Best Equation 15-15
VI. Use of a Computer Statistical Package for Multiple Regression 15-15
VII. Measuring Accuracy of Forecasts 15-24
A. MAD and MSE 15-24
B. The U Statistic and Turning Point Errors 15-24
C. Control of Forecasts 15-25
VIII. Forecasting Sales with the Markov Model 15-26
IX. Conclusion 15-29
Review Questions & Solutions 15-30

Chapter 16: Financial Forecasting and Budgeting Tools
I. Forecasting External Financing Needs – The Percent-of-Sales Method 16-1
II. Budgeting and Financial Planning 16-3
III. How the Budget Works: An Example 16-7
A. The Sales Budget 16-7
B. Monthly Cash Collections from Customers 16-8
C. The Production Budget 16-8
D. Inventory Purchases – Merchandising Firm 16-9
E. The Direct Material Budget 16-10
F. The Direct Labor Budget 16-11
G. The Factory Overhead Budget 16-12
H. The Ending Finished Goods Inventory Budget 16-13
I. The Selling and Administrative Expense Budget 16-14
J. The Cash Budget 16-15
K. The Budgeted Income Statement 16-18
Table of Contents 6
Table of Contents (cont.)
Page
L. The Budgeted Balance Sheet 16-18
M. Some Financial Calculations 16-21
N. Computer-Based and Spreadsheet Models for Budgeting 16-21
IV. Zero Base Budgeting 16-21
V. The Certified Public Accountant’s Involvement and Responsibility
With Prospective Financial Statements 16-22
VI. Conclusion 16-26
Review Questions & Solutions 16-27

Chapter 17: Forecasting Cash Flows
I. Markov Approach 17-1
A. Simple Average 17-4
II. Lagged Regression Approach 17-5
A. Is Cash Flow Software Available? 17-8
III. Conclusion 17-9
Review Questions & Solutions 17-11

PART III: BUILDING FINANCIAL MODELS FOR BUDGETING AND PLANNING

Chapter 18: How to Use Corporate Planning Models
I. Types of Analysis 18-2
I. Typical Questions Addressed Via Corporate Modeling 18-2
III. Types of Models 18-3
A. History of Models 18-3
IV. Current Trends in Modeling 18-4
A. Attitudes and Problems 18-5
B. State-of-the-Art and Recommended Practice 18-6
V. MIS, DSS, EIS, and Personal Computers 18-8
VI. The Future of Corporate Planning Models 18-9
VII. Conclusion 18-10
Review Questions & Solutions 18-11

Chapter 19: Financial Modeling for “What-if” Analysis
I. A Financial Model 19-1
A. Types of Financial Models 19-1
II. Applications and Uses of Financial Modeling 19-2
III. Putting Financial Modeling into Practice 19-2
IV. Quantitative Methods Used in Financial Models 19-3
V. Developing Financial Models 19-4
A. Definition of Variables and Input Parameters 19-4
VI. Model Specification 19-5
A. Definitional Equations 19-6
B. Behavioral Equations 19-6
C. Model Structure 19-7
D. Decision Rules 19-8
E. Lagged Model Structure 19-9
VII. Comprehensive Financial Model 19-9
VIII. Conclusion 19-12
Review Questions & Solutions 19-13
Table of Contents 7
Table of Contents (cont.)
Page
Chapter 20: Using Optimization Techniques to Build Optimal Budgets
I. Use of Linear Programming 20-1
A. Applications of LP 20-1
B. Formulation of the LP Model 20-2
C. Generations of Budgets on the Basis of Optimal Mix 20-5
II. Use of Goal Programming (GP) 20-7
III. Conclusion 20-11
Review Questions & Solutions 20-12

Chapter 21: Using Spreadsheet and Financial Modeling Packages
I. Using Spreadsheet Programs 21-1
II. Forecasting Financial Distress with Z Score 21-6
A. Z-Score Model 21-6
B. More Applications of the Z Score 21-10
C. Words of Caution 21-10
III. Budgeting and Planning Software 21-10
A. Adaytum Planning 21-10
B. Budget Maestro V5.8 21-11
C. Microsoft Business Solutions for Analytics-Forecaster 21-12
D. Host Budget V3.2 21-12
E. SRC Systems 21-13
IV. Conclusion 21-14
Review Questions & Solutions 21-15

Chapter 22: Using Management Games for Executive Training
I. Executive Management Games 22-5
A. Advantages and Disadvantages of Executive Games 22-12
II. Validating the Game 22-13
III. A New Role for Computerized Executive Games 22-14
IV. Conclusion 22-14
V. References and Additional Readings 22-14
Review Questions & Solutions 22-18

Glossary

Index

Table of Contents 8
PART I.

TOOLS AND TECHNIQUES
FOR FINANCIAL ANALYSIS