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Times Interest Earned
Times interest earned (TIE) is a ratio that compares the company™s
EBIT to its interest expense. This ratio is important to the lending
decisions made by banks. If a company has a TIE of 3.0‚, this
means that its EBIT is enough to pay its interest expense three




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222




times over. Put another way, EBIT has to shrink more than two-
thirds before it defaults, or cannot pay its interest payments.
Lending banks want to see a high ratio because it means there
is less likelihood that a loan to the company will become a ˜˜non-
performing™™ loan.

EBITDA/Cash Interest Expense
EBITDA/cash interest expense is TIE on a cash basis. EBITDA is
the cash earnings that a company has. The denominator uses the
interest expense that is cash, as there are forms of debt where the
interest is not paid out in cash but instead added to the out-
standing debt. This kind of debt is called accreting debt. It is
also called payment-in-kind (or PIK, pronounced ˜˜Pick™™) debt.
Thus, the denominator is total interest (which may have both
cash and noncash interest) less noncash interest. This ratio
gives an extra measure of insight for coverage analysis, because
EBITDA is a more accurate measure of the cash earnings a
company has for paying its interest costs.

(EBITDA À Capital Expenditures)/Cash
Interest Expense
(EBITDA À capital expenditures)/cash interest expense is a
coverage measure of the ability to repay cash interest based on
cash earnings after what usually is a required expense: capital
expenditures. Capital expenditures do not appear in the income
statement by accounting convention. By subtracting these
expenditures from EBITDA, the ratio shows the company™s ability
to pay its cash interest expense. It may be that a company can
reduce or defer its capital expenditures in order to pay its interest.
But if it does so, it is likely to suffer diminished productivity in the
long run (as its fixed assets age and fall into increasing disrepair)
and, thus, interest-paying ability.


Fixed Charge Coverage
(EBIT þ rent expense)/(interest expense þ preferred dividends þ
rent expense). This ratio is more important in analyzing retail
companies.




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Ratios: Key Performance Indicators 223




Cash Fixed Charge Coverage
This is similar to the ratio above, but we use (EBITDA þ rent
expense)/(cash interest expense þ preferred dividends þ rent
expense). The cash interest expense makes a distinction between
interest payments that are cash and those that are noncash.


Operating Cash Flow Ratios
Operating cash flow is an item from the cash flow statement and
is the sum of net income (the first item on the statement) plus all
the addbacks of noncash expenses. Put another way, this is net
income on a cash basis and represents the cash earnings after
interest and taxes from operations.



COMMON-SIZE STATEMENTS
Common-size statements, which can be prepared for the in-
come statement, balance sheet, or the cash flow statement,
express a firm™s performance over time as a percentage of a base
number.
For the income statement, the typical base is each year™s
revenue number. All the other income and expense numbers
shown for each year are a percentage of that year™s revenue.
Revenue is shown as 100 percent. In effect, the whole income
statement becomes a ˜˜margin statement.™™ By expressing all the
accounts in this manner, we can see how well the company
maintains its margins, even if the underlying dollar numbers
have undergone sizable changes over time.
For the balance sheet, the usual base is total assets, which
are shown as 100 percent. Every other account on the balance
sheet, whether assets, liabilities, or equity, are then shown as
percentages of this total.
In addition to providing a yardstick for comparisons across
time within a company, common-size statements also provide
useful information for looking at the economic characteristics of
different companies in the same industry, as well as in different
industries.




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You can add this to the model we have developed by
adding an extra sheet for each financial statement you want to
show in common-size terms. An easy way to do this is to make a
copy of the sheet through the Excel commands. (Double-click on
the sheet tab you want to copy, right-click and select ˜˜Move or
copy. . .,™™ select a position among the sheets shown in the list
box, check the ˜˜Create Copy™™ check box, then click on OK.
You can then rename the duplicate sheet by clicking on the
sheet tab, and typing in a new name for the sheet). Then write
the formulas this way. Let™s say you have just made a duplicate
of the ˜˜IS™™ sheet, and you have renamed the duplicate sheet
˜˜ISCS™™ (for Income Statement Common Size.) On ˜˜ISCS,™™
create a formula that looks to its counterpart in ˜˜IS,™™ but with
a divisor of the Revenues line for that column. For example, in
ISCS cell B6 for the first year™s revenues, write the formula that
at its core is the calculation IS!B6/IS!B$6. Note the use of the
absolute reference for the row in B$6. Because some of the
rows in ˜˜IS™™ may be holding zeros, write the full formula as
¼ IF(B$6,IS!B6/IS!B$6,0) so that you do not get a #DIV/0! Error
when the formula encounters a zero.
In ˜˜ISCS,™™ copy this formula down the column and across
all the columns. As long as you have not made any changes
to the ˜˜IS™™ and ˜˜ISCS™™ after you made the duplicate”i.e.,
each sheet has the same layout in rows and columns”this copy-
ing sequence can be done quickly, as you can be assured that the
formula references from one sheet to the other are correct.
As you copy the formulas down, there may be some format-
ting that you want to keep, such as the underline before the
subtotals. Make use of Excel™s ability to copy only the contents
of a cell (which means that the formatting of the cell you are
pasting into is not affected). After the Edit>Copy command, use
the Edit>Paste Special>Formulas. Then, format all the cells with
the new formula in the Percent format.
As a final step, the original lines in ˜˜IS™™ had margin per-
centages. In ˜˜ISCS,™™ you can delete these rows. The final ˜˜ISCS™™
sheet will be a few lines shorter than ˜˜IS.™™
Go through the same steps for creating a common-size
balance sheet, but with the divisor for the formulas being the
total assets for each column.




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Ratios: Key Performance Indicators 225




This is what the ˜˜ISCS™™ sheet will look like:


Common-Size Income Statement

  A  B  C  D  E  F  G 
1  First Corporation             
2               
3    Proj  Proj  Proj 
     
4  INCOME STATEMENT  2000  2001  2002  2003  2004  2005 
5               
6  Revenues  100.0%  100.0%  100.0%  100.0%  100.0%  100.0% 
7  COGS  54.5%  54.5%  55.0%  55.0%  55.0%  55.0% 
8  Gross profit  45.5%  45.6%  45.0%  45.0%  45.0%  45.0% 
9               
10  SGA  15.2%  15.0%  15.0%  15.0%  15.0%  15.0% 
11  Operating expenses  3.0%  3.0%  3.0%  3.0%  3.0%  3.0% 
12  EBITDA  27.3%  27.4%  27.0%  27.0%  27.0%  27.0% 
13               
14  Depreciation  7.3%  8.3%  8.0%  7.7%  7.6%  7.7% 
15  Amort of intangibles  0.5%  0.4%  0.4%  0.4%  0.3%  0.3% 
16  EBIT  19.5%  18.7%  18.6%  18.9%  19.1%  19.0% 
17               
18  Non-oper  expenses  1.2%  1.1%  0.8%  0.9%  0.9%  0.9% 
19               
20  Interest income  0.4%  0.6%  0.6%  0.7%  0.8%  0.5% 
21  Interest expense  6.1%  5.6%  5.0%  4.3%  3.9%  3.7% 
22  EBT  12.6%  12.6%  13.4%  14.4%  15.0%  15.0% 
23               
24  Provision for taxes  4.4%  4.4%  4.7%  5.0%  5.2%  5.2% 
25  Net income  8.2%  8.1%  8.7%  9.3%  9.7%  9.7% 
26               
27  Dividends  1.2%  1.3%  1.1%  0.9%  1.0%  1.0% 
28  Net to retíd earnings  7.0%  6.8%  7.6%  8.4%  8.8%  8.8% 
29               
30               
ISCS 




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Here is the balance sheet common-size statements, based on total
assets:

Common-Size Balance Sheet

A B C D E F G
1 First Corporation
2 Proj Proj Proj
3 BALANCE SHEET 2000 2001 2002 2003 2004 2005
4 ASSETS
5 Surplus funds 0.0% 0.0% 0.0% 5.2% 2.8% 0.0%
6 Cash 4.6% 5.2% 5.1% 4.6% 4.3% 4.0%
7 St investments 2.3% 2.2% 2.1% 1.9% 1.9% 1.8%
8 Accounts receivable 4.6% 5.2% 5.8% 5.2% 5.3% 5.4%
9 Inventory 9.2% 9.3% 9.6% 9.3% 9.3% 9.4%
10 Other current assets 0.8% 0.7% 0.8% 0.6% 0.6% 0.7%
11 Current assets 21.5% 22.6% 23.3% 26.8% 24.2% 21.2%
12
13 Net PPE 66.9% 65.7% 63.9% 61.8% 64.5% 67.7%
14 Intangibles 4.5% 3.7% 3.2% 2.6% 2.2% 1.9%
15 Long-term assets 7.1% 8.0% 9.6% 8.8% 9.1% 9.2%
16 Total assets 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
17
18 LIABILITIES
19 Short-term notes 0.8% 0.8% 0.9% 0.8% 0.7% 0.7%
20 Accounts payable 4.6% 4.8% 5.1% 5.2% 5.4% 5.5%
21 Other current liabilities 0.8% 1.4% 1.3% 1.3% 1.3% 1.3%
22 Current liabilities 6.2% 7.0% 7.3% 7.3% 7.4% 7.5%
23
24 Necessary to finance 0.0% 0.0% 0.0% 0.0% 0.0% 1.0%
25 Debt 1 15.4% 15.5% 9.6% 8.6% 8.0% 7.4%
26 Debt 2 15.4% 13.8% 14.4% 12.9% 12.0% 11.1%
27 Debt 3 8.5% 7.6% 7.0% 6.3% 5.9% 5.4%
28 Long-term liabilities 3.1% 2.6% 2.4% 2.5% 2.6% 2.6%
29 Total liabilities 48.5% 46.6% 40.6% 37.5% 35.9% 35.0%
30
31 SHAREHOLDERS™ EQUITY
32 Common stock 35.4% 34.6% 37.1% 37.2% 34.8% 32.1%
33 Retained earnings 15.4% 18.0% 21.5% 24.6% 28.7% 32.2%
34 Other equity account 0.8% 0.8% 0.8% 0.7% 0.7% 0.6%
35 Total SH equity 51.5% 53.4% 59.4% 62.5% 64.1% 65.0%
36 Total liabs & SH equity 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
37
BSCS




TLFeBOOK
CHAPTER 13


Forecasting Guidelines




This chapter goes over the principles of good forecasting”the

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