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FSA in the Boardroom

FSA in the Boardroom. by Carlos A. Mello-e-Souza Seattle University. - What do I expect? - Can I trust these numbers? - What is really going on? - How can performance be improved?. Idea: Use FSA to generate questions such that the answers will enlighten and generate further questions.

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FSA in the Boardroom

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  1. FSA in the Boardroom by Carlos A. Mello-e-SouzaSeattle University Presentation to the Board of REI on 11-22-2004

  2. - What do I expect?- Can I trust these numbers?- What is really going on?- How can performance be improved? Presentation to the Board of REI on 11-22-2004

  3. Presentation to the Board of REI on 11-22-2004

  4. Idea: Use FSA to generate questions such that the answers will enlighten and generate further questions. Presentation to the Board of REI on 11-22-2004

  5. Stock prices: COST, WMT, SP-500 COST$47 WMT$55 Presentation to the Board of REI on 11-22-2004

  6. Question: Why has the return on Wal Mart’s stock between November 2002 and November 2004 been close to zero, while COSTCO has returned almost 50 % ? Presentation to the Board of REI on 11-22-2004

  7. Plan: • Exploratory Analysis • Analysis of Quality • Dupont Analysis • Analysis of Credit Risk • Financial Planning and Valuation • Conclusion Presentation to the Board of REI on 11-22-2004

  8. 1. Exploratory Analysis - Start with the raw statements; - Look for structure, structural changes; - Observe trends and cycles; - Compare with other companies. Example: ... Presentation to the Board of REI on 11-22-2004

  9. Costco Presentation to the Board of REI on 11-22-2004

  10. Costco Presentation to the Board of REI on 11-22-2004

  11. Wal-Mart Presentation to the Board of REI on 11-22-2004

  12. Wal-Mart Presentation to the Board of REI on 11-22-2004

  13. 2. Quality of Accounting Do financial reports and other means of communication provide relevant, reliable and transparent information to investors ? Is accounting being manipulated to convey an image that does not represent the business faithfully ? Presentation to the Board of REI on 11-22-2004

  14. Accounts most often subject to manipulation AAER-1 to AAER-1745 on 294 firms that manipulated 426 different accounts. (Dechow) Presentation to the Board of REI on 11-22-2004

  15. 3. Dupont Analysis  Return on Equity ROE = ROA + ( Leverage x Spread )  Return on Assets ROA = Profit Margin x Asset Turnover Presentation to the Board of REI on 11-22-2004

  16. Map of ROA breakdown for 248 3-digit SIC industry groups from 1970 to 2001 (medians) (Soliman 2003, Dechow) Presentation to the Board of REI on 11-22-2004

  17. Wal-Mart in 2003: Dupont analysis Presentation to the Board of REI on 11-22-2004

  18. WMT vs. COST ROA in 1999 Presentation to the Board of REI on 11-22-2004

  19. WMT vs. COST ROA in 2000 Presentation to the Board of REI on 11-22-2004

  20. WMT vs. COST ROA in 2001 Presentation to the Board of REI on 11-22-2004

  21. WMT vs. COST ROA in 2002 Presentation to the Board of REI on 11-22-2004

  22. WMT vs. COST ROA in 2003 Presentation to the Board of REI on 11-22-2004

  23. WMT vs. COST ROE in 1999 Presentation to the Board of REI on 11-22-2004

  24. WMT vs. COST ROE in 2000 Presentation to the Board of REI on 11-22-2004

  25. WMT vs. COST ROE in 2001 Presentation to the Board of REI on 11-22-2004

  26. WMT vs. COST ROE in 2002 Presentation to the Board of REI on 11-22-2004

  27. WMT vs. COST ROE in 2003 Presentation to the Board of REI on 11-22-2004

  28. Dupont conclusions: - WMT beats COST in ROA and ROE every year (99-03). - The ROA gap has shrunk. Therefore maintenance of the ROE gap has come at a higher level of debt and risk. - WMT has suffered a steady decline in ATO; PM recovers in 03 because of lower ETR and other transitory items. Presentation to the Board of REI on 11-22-2004

  29. Dupont questions: - Why are WMT’s asset turnover and profit margin falling? (ROA goes from 16.3% to 12.6%, before recovering) - Why is WMT’s effective tax rate falling? (37.4% to 35.3% of EBT) - Why is the investment in operating LT assets relatively so much higher? (67 to 86 days of sales!) Presentation to the Board of REI on 11-22-2004

  30. Wal-Mart’s business segments Presentation to the Board of REI on 11-22-2004

  31. Wal-Mart’s business segments Presentation to the Board of REI on 11-22-2004

  32. Wal-Mart’s business segments Presentation to the Board of REI on 11-22-2004

  33. Wal-Mart’s business segments Presentation to the Board of REI on 11-22-2004

  34. Wal-Mart’s business segments Presentation to the Board of REI on 11-22-2004

  35. Wal-Mart’s business segments Presentation to the Board of REI on 11-22-2004

  36. 4. Analysis of Credit Risk - Multivariate models of the association between p(default) and accounting and/or market-based measures. - OPM approach (e.g.: Moody’s KMV). Presentation to the Board of REI on 11-22-2004

  37. 5. Valuation  of equity, debt, or the “enterprise” Presentation to the Board of REI on 11-22-2004

  38.  ... and value can be based on CASH Presentation to the Board of REI on 11-22-2004

  39.  ... or on “RESIDUAL” EARNINGS Presentation to the Board of REI on 11-22-2004

  40. Valuation of WMT’s Equity market balance sheet cash earnings Presentation to the Board of REI on 11-22-2004

  41. Valuation of Costco’s Equity market balance sheet cash earnings Presentation to the Board of REI on 11-22-2004

  42. 6. Conclusion Analytical tools such as:- Dupont ratios - credit and manipulation risk models - corporate valuation modelsbased on spreadsheets can be used by senior management to assist in understanding and verifying financial reports. Presentation to the Board of REI on 11-22-2004

  43. Analytical tools are a helpful, but blunt instrument. Their biggest strength lies in guiding the investigation and thought processes:- Can I trust these figures? - How can we improve firm value? Presentation to the Board of REI on 11-22-2004

  44. Presentation to the Board of REI on 11-22-2004

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