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Today’s Topic: More on Financial Measurements. Types, Definitions and Uses and “Typical Patterns” for High-tech Businesses.

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today s topic more on financial measurements

Today’s Topic:More on Financial Measurements

Types, Definitions and Uses

and

“Typical Patterns”

for High-tech Businesses

slide2

This class is not required;you can take E421 or TG401BYou are responsible for managing conflicts with other courses,especially Senior DesignPick up your name cards and return them after class

reminders
Reminders
  • Send your completed homework to my AOL address:

carlpavarini@aol.com

  • Class presentation materials are on the course website:

stevens.edu/sse/tgcourse

  • Class participation is 25% of your grade
  • Inform me via email if you will be missing a class
  • Ongoing feedbackis requested and appreciated
class participation grades
Class Participation Grades
  • D,F: poor attendance and participation; inattention

(web surfing, texting, talking, sleeping, etc)

  • C: good attendance and attention, but little/no active

class participation

  • B: 2-4 active contributions per class (answers,

comments, questions, stories, disagreements,

challenges, …)

  • A: particularly insightful or useful contributions

(not necessarily more frequent!)

You will receive an interim cp grade at mid-term;

If you want to know how you’re doing……ASK ME

so far
So far……….
  • Companies try to maximize the wealth of their owners --- market cap (stock price) plus dividends
  • Stock price and the ability to pay dividends are driven by earnings, and beliefs about future earnings growth
  • Individual products and services are expected to contributetargeted amounts to earnings/growth
  • Earnings growth (ultimately) requires revenue growth
  • Firms use financial statements to develop plans, and measure/analyze/report on their performance
therefore in terms of business objectives
…..therefore, in terms of business objectives…..
  • A company’s basic financial objective is to grow its earnings quickly and sustainably, in order to raise its stock price and have the ability to pay its owners dividends
  • Products are successful if and only if they attain their targeted contribution to corporate earnings
but how do companies maximize earnings growth

But…..how do companies maximize earnings/growth?

By providing potentialcustomers

a better (value - price) proposition

than competitors

while managing costs and expenses

so as to make profits (earnings)

(these are the topics for upcoming classes)

financial measurements can apply to company product project
Financial Measurements(can apply to company, product, project, …)
  • Types (items): revenues, costs, expenses, earnings, assets, depreciation, liabilities, cash, investments, ….
  • Reports (formats):income statement, balance sheet, cash flow statement, …
financial statement objectives
Income statement

(for a time period)

Balance sheet

(at a point in time)

Cash Flow statement

(for a time period)

revenues, costs, expenses, & earnings

assets, liabilities and net capital

cash ($$) in and out , and uses of cash

Financial Statement Objectives
financial statement uses
Financial Statement Uses
  • Historical/current: financial reporting, competitive analysis, performance measurement, performance analysis, compensation
  • Future (projected): goal setting, goal achievement analysis (planning), financing requirements, stock price assessment
financial statement timing
Financial Statement Timing
  • For external and internal reporting: annual & quarterly (10Q and 10K; required for public companies; see www.sec.gov)
  • For internal operations: monthly, weekly and (sometimes, e.g. sales) daily
  • May be historical, current or projected
key concepts
Key Concepts
  • Operations vs. total (e.g., OI vs. NI)
  • Normalizing results: return measures (e.g., OI as % of revenue; operating return on assets)
  • Knowing what “good” results are: competitive (industry) analogs/benchmarks --- today
  • Cash vs. non-cash
the income statement
The 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 how to analyze an income statement
Method: How to analyze anIncome Statement
  • (First, “calculate the percentages”)
  • Operating income vs. net income
  • In-period operating performance: costs, expenses and earnings as a % of revenue; compare to benchmark(s)
  • Cross-period performance (trends): relative change in rev, costs, expenses, earnings… improvements vs. deteriorations, and why
  • And…?
assignment question 1 understanding that technical people affect income statement results

Assignment Question #1understanding that technical people affect income statement results

How can technologists impact the line items of the income statement?

(cite two examples for each line item: revenues, COGS, M&S expense, R&D expense, G&A expense, interest, and taxes)

assignment question 2 analyzing google s goog income statement
Assignment Question #2analyzing Google’s (GOOG) income statement
  • For FY10 (calendar 2010), what were GOOG’s revenues ($), and relative (%rev) gross margin, operating income, and net income?
  • How did operating income change from FY09 to FY10(on both a total $ and relative basis)? What were the major financial determinants of the total $ change (revenues? COGS? R&D exp? SG&A exp?)? Of the relative (%rev) change?
  • Why did relative operating income and relative net income change differently from FY09 to FY10? Taxes? Interest? Other?
  • For FY10what % of revenue came from each of GOOG’s product categories? Which products had the highest and lowest gross margin %?
  • How has GOOG stock performed compared to the Nasdaq index over the last year? Speculate as to why.
financial statement objectives1
Income statement

(for a time period)

Balance sheet

(at a point in time)

Cash Flow statement

(for a time period)

revenues, costs, expenses, & earnings

assets, liabilities and net capital

cash ($$) in and out , and uses of cash

Financial Statement Objectives
the balance sheet equation
The Balance Sheet Equation

Net worth = what you own - what you owe

Net Capital = Assets - Liabilities

or

Assets = Liabilities + Net Capital

the balance sheet
The Balance Sheet

Assets

Current 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 statement
Cash Flow Statement

Net operating cash flow

(cash from operations)

+ Net cash from investing

activities:

capital expenditures

+short term investments

+securities (long term)

+ Net cash from financing

activities:

debt financing

+stock financing

Net change in cash

net operating cash flow
Net Operating 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 concepts1
Key Concepts
  • Operations vs. total (e.g., OI vs. NI)
  • Normalizing results: return measures (e.g., OI as % of revenue; operating return on assets)
  • Knowing what “good” results are: competitive (industry) analogs/benchmarks --- today/now
  • Cash vs. non-cash
typical patterns financial results vary by
Typical Patterns: Financial Results Vary by ….
  • Product type: hardware vs. software vs. services
  • Customer: business/government vs. consumer
  • Method of selling: direct vs. indirect sales

…. so we’ll need 12 (3x2x2) benchmarks

impact of product type ibm prior to sale of pc division
Impact of Product Type: IBM, prior to sale of PC division

2002 2004

% of Revenue% of OIGM%

Hardware 34% 23% 31%

Software 16% 37% 87%

Services 50% 40% 25%

direct selling
Direct Selling

Company

Customers

bus/govt

or

consumer

Sales-

force

indirect selling through channel partner s
Indirect Selling Through“Channel Partner(s)”

Company

Customers

bus/govt

or

consumers

Sales-

force

Sales-

force

Company profit

Channel profit

Total (full-stream) profit

impact of customer type business gov t compared to consumer
Impact of Customer Type: Business/gov’t. compared to consumer
  • higher selling price (higher value products)
  • higher gross margin % (less price competition)
  • higher R&D % (more complex products)
  • lower marketing % (fewer customers)
  • higher selling expense % (more direct selling)
  • net: higher operating return on sales (OI/rev)
  • in bus/hw market: OROS of 12-20% is “good”
  • in consumer/hw market: OROS = 8-13% “good”
good operating return oi rev
“Good” Operating Return (OI/Rev)…
  • Higher in business markets (12-25%)

…compared to consumer markets (4-15%)

(higher value products, less competition)

  • Highest with software products (5-10% higher)

…compared to hardware or services

(volume leverage from very high

gross margin %)

  • Higher when selling direct (4-8% higher)

…compared to selling through others

(don’t have to share the total profit)

typical financial structure hardware for business gov t
Typical Financial Structure: “Hardware” for Business/Gov’t
  • List price 100
  • Average selling price 80 (60-90 range)
  • Distributors’ price 60 (45-70 range)
  • COGS 40 (20-60 range)
  • Direct-sale gross margin = 50% (40/80)
  • Indirect-sale gross margin = 33% (20/60)
  • Distributor’s gross margin = 25% (20/80)
typical financial structure hardware for consumers
Typical Financial Structure:“Hardware” for Consumers
  • List price 100
  • Average selling price 90 (70-100 range)
  • Distributor’s price 75 (70-80 range)
  • COGS 60 (50-70 range)
  • Direct-sale gross margin = 33% (30/90)
  • Indirect-sale gross margin = 20% (15/75)
  • Distributor’s gross margin = 17% (15/90)
so for indirect sales
So, for indirect sales….
  • Price per unit (to producer) is lower
  • Revenues are lower for a given volume of sales
  • Gross margin % is lower
  • Given that companies are trying to maximize earnings/growth….why does any company choose to sell indirectly ????
software is different
Software is different…..
  • Cost of producing copies and delivering software to customers are lower than for “physical” goods (hardware)
  • Normally, swCOGS are 10-20% of revenues (when sold indirectly; even lower when direct)
  • So, manufacturer’s indirect-sale gross margins are 80% to 90% …..very high!!
  • Conversely, development (R&D) expense is typically higher than many other products, often 20-35% compared to 10-20% for hardware
and so are services
And, so are Services…...
  • May be managed “for profit,” or to support the sale of hardware/software
  • If “for profit,” gross margins are typically 35 - 55% (salaries of people who provide the services are included in COGS, as is the depreciation on capital equipment used)
  • R&D expense usually much lower (as % of sales), often approaching zero
  • Asset requirements to deliver service (and associated depreciation) can be large
good operating returns in the business market
“Good” Operating Returnsin the Business Market

Higher GM %

Higher R&D %

Lower GM %

Lower M&S %

and compared to business markets consumer markets
…and compared to Business markets, Consumer markets…
  • Typically have 5-10% lower operating returns, because…
  • Selling is mostly indirect (ex: internet)
  • GM% is lower (indirect selling, price comp)
  • Lower R&D%
  • Higher Marketing%
good operating returns in the consumer market
“Good” Operating Returnsin the Consumer Market

Higher GM %

Higher R&D %

Lower GM %

Lower M&S %

the income statement1
The 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 have high levels of earnings and earnings growth via
So, Successful Companies Have High Levels of Earnings and Earnings Growth via…….
  • High revenues……better products and/or better sales/marketing than competitors
  • High gross margins (%)…..low costs to produce and deliver products
  • “Low” expenses…..right-sized and efficient M&S, R&D, and G&A
  • Low tax payments; low interest payments or high interest receipts
but how do companies make these things happen

But…..how do companies make these things happen?

By providing potentialcustomers

a better (value - price) proposition

than competitors

while managing costs and expenses

so as to make profits (earnings);

thereby maximizing shareowner wealth

(company valuation)

(these are the topics for upcoming classes)

customers assess value compared to competitors in multiple dimensions
Customers assess “value” compared to competitorsin multiple dimensions…….
  • Product performance/features (fit to market)
  • Price/performance vs. competitors
  • Availability (time to market)
  • “Info” on product/uses/benefits (marketing)
  • Reliability/maintainability
  • Sold the way customers want to buy (channels)
  • Customer service and support
  • Costs to use (life-cycle cost)
the income statement2
The 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 analyzing a company medtronic

Assignment for Next Week:Analyzing a Company Medtronic

Medical technology

Founded in 1949

$16.4 B annual revenue and OI%=29.4% (last 12 months)

$41.8 B market cap, current P/E = 12.5

Market share leader in several product categories

getting info on medtronic
Getting Info on Medtronic
  • Company website: www.medtronic.com

- especially “Investor Relations” section

  • Yahoo: finance.yahoo.com

- enter “MDT” (Medtronic’s stock ticker symbol)

  • Securities Exchange Commission: ww.sec.gov

- select “search for company filings,” enter MDT,

see esp. the 10K annual report filed 6/28/11

assignment questions 1
Assignment Questions -- 1
  • What business is Medtronic in?
  • What product categories does it compete in?
  • Who are its customers?
  • How does it sell its products?
  • Who are its competitors?
  • Is its financial performance good?

(use the annual income statement for YE Apr11 (FY11);

suggestion: use the version in the SEC 10K report)

  • Is it improving or deteriorating? In absolute terms? In relative (% revenue) terms? Why?
  • What were the major determinants of the change in relative operating income from FY10 to FY11?
assignment questions 2
Assignment Questions -- 2
  • Why did MDT stock price fall significantly during Aug 2011? (suggestion: see Associated Press (AP) news item, Aug 23, 2011)
  • How has MDT’s stock price fared vs. the overall stock market (use the Nasdaq index) in the last year? Why?
  • What opportunities & challenges does Medtronic face in accelerating its revenue and profit growth in the future?

(see esp. 10K data, “management’s discussion…”)

  • If you owned MDT stock, would you sell it right now?
method how to analyze an income statement1
Method: How to analyze an income statement
  • (First, “calculate the percentages”)
  • Operating income vs. net income
  • In-period operating performance: costs and expenses as a % of revenue; compare to benchmarks
  • Cross-period performance (trends): relative change in rev, costs, expenses, earnings… improvements vs. deteriorations, and why
  • Going-forward opportunities and challenges/

risks for each line item (esp. rev and op inc)

topics for next class

Topics for Next Class

Finish financial measurements topic

…and…

Functions within a company: growth and profit responsibilities, how technical people “fit,” compensation in high-tech industries