AFM 101 - Final Exam Pkg.docx

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Accounting & Financial Management
AFM 101
Donna Psutka

Chapter 13 – Analyzing Financial Statements PAGE 701 for Ratios Investment Decision  Single largest group who use financial statements o Rely on advice of analysts and their reports – tracking their recommendations o Evaluate the future profit and growth potential of the business based on Economy- Economy Wide Factors: overall health of the economy has wide a direct impact on the performance of individual businesses Factors - 2007 economic downturn caused a decrease demand for g/s  bankruptcy of large corporations like GM Ifactors A Ifactors B - Unemployment, inflation, and changes in interest rates, Ex. High interest rate slows economic growth b/c people are Company 1 Company 2 Compnay 3 Company 4 less willing to borrow money & buy on credit  expensive factors factors factors factors o Industry Factors: certain events have major impacts on companies within the industry; minor impact on the others outside  Drought will devastate food-related industries but no effect on electronics o Individual Company Factors: good analysts don`t solely reply on financial information, but visit the company, buy its products and read about them in the newspapers  McDonald`s financial statements + quality of their products is equally important o Understand company`s business strategy when evaluating financial statements  Analysts are info. intermediaries who interpret audited financial info. and advise their clients on whether they should buy, hold or sell shares o Reach different conclusions despite access to same info., may affect their predictions of future performance based on analysis of company`s past is relevant to these predictions o Recommendations shift overtime as new info. is released and actual performance occurs o Good understanding of financial statements and the standards used for relevance and faithful representation o May disagree on how to interrupt the results based on company`s prior performance, showing that analysis is part art and part science o Consider other factors affecting operating performance and its position  Global, economic, industry which are not controllable by the company  Management’s ability to adapt its business plans to these uncertainties and risks o Management success at containing the effects of uncontrollable risks and managing uncertainties plays a role in analysts prediction of future economic health of the company o Predictions can be proven inaccurate Understanding Business Strategy  Each transaction  result of company`s operating decisions as it implements its business strategy  Useful to begin financial analysis with return on equity (ROE) profit driver analysis o ROE decomposition or DuPont analysis  understanding # of business strategies affect profitability o Logical relationship among the 3 ratios o Based on financial statement elements that are often called profit drivers/levers b/c they describe the 3 ways that management can improve ROE o Businesses can earn a high rate of return for owners by following different strategies  Product Differentiation – companies offer products with unique benefits (high quality or unusual features/styles) which allows for higher pricing  High Price = High Profit Margin = High return on Equity Ex. Cadillac, Mercedes, Lincoln, Cartier, Holt Renfrew  Cost Advantage - companies attempt to operate more efficiently than their competitors, allowing them to offer lower prices to attract consumers  Effects asset turnover ratio  High asset turnover = High return on investment Ex. Hyundai Accent, Toyota Yaris, Zellers, Walmart  Must know: o What managers are trying to do o Solid understanding of business strategy o Read annual report; letter from President o Articles about the company  Company can take different actions to try to affect each of its profit drivers o Analysts disaggregate each of the profit drivers into more detailed ratios  Break Asset Turnover to Receivable, Inventory, Fixed Assets Financial Statement Analysis  Need to compare data with other information o Cannot be evaluated in isolation o Properly analyze, must develop appropriate comparisons o Finding appropriate benchmarks requires judgment and is not an easy task  Analysis is a sophisticated skill, not mechanical  Time Series o Info. for a single company is compared over time o Retail company`s key measure of performance is the change in sales volume each year for its existing stores ( ) ( ) ( )  Comparison with Similar Companies o Financial results are often affected by industry and economy-wide factors o Comparison of similar companies allows for a better insight into performance o Profit margin comparison between RONA, Home Depot and Canadian Tire  Finding comparable companies is often difficult o Industry is general but the product(s) one sells is not exactly the same o Must be careful with selection process o Marriot & Intrawest  provide different levels of quality and target different types of customers  North American Industry Classification System o Mexico, United S
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