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MGCR 211 - Chapter 12 .docx

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Management Core
MGCR 211
Julia Scott

CHAPTER 12 Purpose of Analysis - Trying to predict future performance and risk of the company (i.e. will they repay the loan?) from past data. o Looking for trends o Hoping that the past is a predictor of the future - Trying to assess past performance (i.e. management decisions) - Types of Comparisons: o Time series  Company’s previous numbers o Cross sectional  Other companies in the industry o Economic data Objective of the Analysis - Analysis can be done for many reasons - Different users/analysts are interested in different things – will do different type of analysis - Creditors/Lenders o Care about future cash flows to see if debt will be repaid o Wants the company to be solvent in the long run - Shareholders/Investors o Want to earn dividends and see share price go up o Willing to take them more risk if its going to give them a higher rate of return Getting Started on the Analysis by Understanding the Business - What businesses & segments does the corporation operate in? - Risks, returns, expectations vary by business. - What strategy do they follow? - Common Strategies: o Low-Cost Producer (selling in low price but low profit margin) o Product Differentiator (operating at the high end, where people are willing to pay high prices) - Affects how you interpret the results of the analysis Overview - Read Auditors’ Report - Review MD&A - management’s explanation of company’s results - Look for unusual accounts or large amounts in the F/S. o Is it going to recur in the future? Or was it a one time expense? - Read the notes o Review accounting policy choices o Look for more detailed information Time Series Analysis: Company data across time - Comparing changes in a company’s accounts over time (5 or 10 years; must be a long enough period to see a trend) - Can do it in absolute numbers $ - Or as a percentage % o Common Size Analysis:  Vertical Analysis  Horizontal Analysis (growth) - Helps in looking for changes or patterns Ratios - Most common analysis tool - Looks at relationship between 2 items (needs to be a logical relationship between them) - Easy to do & compare - Ratios tell you WHAT happened but not WHY. Your job is to interpret the ratios. Types of Ratios - Short-term Liquidity o Can company meet its short-term obligations? - Activity o How efficiently are they using their assets? - Solvency (Long-term) o What is the long-term risk? - Profitability o How well are they performing? Financial Position (Assessing risk) - Use liquidity ratios to assess risk. - Liquidity: ease of conversion into cash o Short Term: periods less than a year o Ability to generate cash & pay debts - Solvency (Long Term): relative mix of debt and equity and the ability to meet the interest and principal payments o Ability to meet long-term obligations o Example: Property Financial Position (Risk) Short term Liquidity Ratios - Look at ability to meet short-term obligations (current liabilities) and assess the quality of the current assets & liabilities. - Current Ratio = Current assets Current liabilities o Higher ratio is better (1 or more) in order to be more sure and conservative; however, the size of the ration depends on the business and the types of current assets and liabilities that are considered o Looks at using current assets to pay current debts. o Current assets is defined as assets that will be used in the next year - Quick Ratio = Cash + Accounts Receivable + Short-term investments Current liabilities o Higher ratio is better o Represent the most liquid (easily made liquid) assets that can pay of liabilities - Operating Cash Flow to Short-term Debt = Operating cash flow Current ST debt + Current portion of LT debt (Current liabilities) Activity Ratios - Provide information about the efficiency of asset use and more information about short-term liquidity - ST Activity Ratios tell you about the Quality of Current Assets & Liabilities (or Is there too much tied up in them?) o A/R turnover, Inventory turnover & A/P turnover - LT Activity ratio (Total Asset turnover) tells you about efficiency of total asset use Short term Activity Ratios - Accounts receivable turnover = Sales on credit Average A/R o Is company collecting their accounts receivable in a timely manner? o How long does it take the company to collect cash? o Converting into days: 365/(sales on credit/average A/R) - Inventory turnover = Cost of Goods Sold Average Inventory o How quickly is the company selling goods? o Converting into days: 365/(COGS/average inventory) - Accounts Payable Turnover = Cost of Goods Sold Average A/P o Is the company falling behind in its payments? o Converting into days: 3
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