RSM219H1 Chapter Notes -Quick Ratio, Market Price, Corporate Finance
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Ch 12 15/04/2013 12:04:00 PM
Understanding the business
1. Operating activities
2. Underlying economics and risks in the industry
3. Overall strategy followed by the company
Low Cost producer
-They need to have a high volume of goods at the lower prices
Product/ Service differentiation
- Specializing to make a higher profit margin; they can success with
a low volume
Recent achievements and future goals/expectations can be found in the
a. Description of the company; highlights of the year; letter to the
b. Management Discussion and Analysis; many aspects of the
company’s financial performance in detail.
c. Financial statement & the Auditor’s report (second half of the A.P.);
pay attention to the accounting policies
Reading the Financial Statements
- Auditor’s Report: the financial statement gives a true and fair view of
the company’s financial position and the results of its operations in
accordance with accounting principles. It is presented before the financial
- Three parts
1. Opinions on the financial statements
2. State their justifications
3. Outline the specific procedures they use
Retrospective vs. Prospective Analysis
• Prospective analysis (forward-looking): use the past trends and operations
stated in a financial statement to forecast future outcomes
• Retrospective analysis: analysis that are used to determine past trends;
this method may be less reliable when something fundamental has changed
in the economic environment to make it unlikely that past results will predict
the future. *Economic environment must also be understood.
1. • Time Series Analysis: the analyst examines information from different
time periods; to look for any patterns in the data over time.
- Many companies provide five- or ten- year summaries to assist in
making this analysis
-Then the analyst will further analyze the performance and the reasons
for the low level of net income and assess whether the company will be
able to repay the additional debt
2. • Cross-sectional analysis compares the data from one company with
- Different industries might have different accounting principles; gives
industry trends of how well a company performs relative to its
- It is common for investment analysts to consider the return versus risk
trade-off across companies from different industries and countries.
Data to be used
1. • Raw Financial Data: data that appear directly in the financial
- Useful in a time-series analysis
2. • Common Size Data: Elements of the raw data are compared with other
elements using percentages
- Relationships between numbers can be easily understood. Ex. Compare
the cost of goods sold expressed as a proportion of the sales revenue.
Common Size statement of earnings:
- All line items are expressed as percentages of net revenues
- If sales are rising proportionately to the increase in cost?
- Common size analysis can also be used with the balance sheet and the
cash flow statement
- Useful in cross-sectional analysis; it allows you to compare companies in
3. Ratio Data
-Ratios compare a data element from one statement with another. It can
be used in bot time-series or cross-sectional analysis
- They reveal the relationships between the financial statements.
- Often several ways to calculate a given ratio
Ratios can be divided into 4 general categories:
1. Performance Ratio
• Net Profit Margin measures the company’s profitability relative to
its revenues, it provides information about the company’s ability to
control all costs.
= Net Earnings/ Revenues
- The current sources and types of earnings are important
• Gross Profit Margin measures the proportion of sales revenue
available to pay all other operating costs after the costs of goods
sold. The more the company retains on each dollar of sales to
service its other costs and obligations.
= Gross Profit / Revenue
= Revenue – Costs of Goods Sold/ Revenue
= (Money for other costs)/ Revenue
- The costs of goods sold is usually grouped with other operating
- Profit margin and cost of goods sold are reciprocal figures
- If ∆GP> ∆NP: the company has less money available after
producing its goods to pay other costs . Thus the company is doing
a better job of controlling its other costs
- Poor cost controls?
• Return on Equity (ROE): measures the return to shareholders; the
performance of their investment
• Return on Assets (ROA): measures the profitability of the
investment in assets.
a. 2 fundamental business decision
The type of assets in which should the company invest?
Should it seek more financing to increase the amount
that it can invest in assets? Financing decision.
b. ROA excludes the effects of the financing decision & focuses on
the investment decision.
c. What type of return is earned on assets?
d. Since net earnings is obtained by after deducting the interest
expense paid to debt holders, it must be adjusted so the
Understanding the business: operating activities, underlying economics and risks in the industry, overall strategy followed by the company. They need to have a high volume of goods at the lower prices. Specializing to make a higher profit margin; they can success with a low volume. Auditor"s report: the financial statement gives a true and fair view of the company"s financial position and the results of its operations in accordance with accounting principles. Three parts: opinions on the financial statements, state their justifications, outline the specific procedures they use. *economic environment must also be understood: time series analysis: the analyst examines information from different time periods; to look for any patterns in the data over time. Many companies provide five- or ten- year summaries to assist in making this analysis. Different industries might have different accounting principles; gives industry trends of how well a company performs relative to its competitors.