Comprehensive financial analysis
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This document outlines a comprehensive financial analysis method using ratios to evaluate a company's performance. It examines ratios related to operating efficiency, financial leverage, liquidity, and profitability to identify strengths and weaknesses. Specifically, it analyzes return on net assets (RONA), weighted average cost of capital (WACC), earnings before interest and taxes (EBIT), gross and operating margins, asset turnover, operating ratios, and how ratios can forecast future prospects. The conclusion reiterates that this method allows for a thorough analysis of a company's past and current performance or the potential impact of strategies being considered.
Comprehensive financial analysis
- 2. What is it for Comprehensive financial analysis accentuate the strengths and weaknesses of a company. Communicating the companys strengths and weaknesses in an accurate and honest manner is helpful in convincing the investors to invest in your business
- 3. What is a firms return? RONA= net assets represents the return on each dollar of net assets invested in the firm. WACC (weighted average cost of capital) spontaneous financing (e.g., payables, accrued taxes, wages due, etc.) RONA>WACC
- 4. Lets increase our profit To do better, we should increase the operating result or reduce net assets. That is, leaving taxes aside for the moment EBIT= Earnings before interest and taxes
- 5. Components of RONA If we take the definition of RONA and multiply and divide by sales, we obtain the following expression (still omitting taxes): That is, each dollar invested in the firms net assets can generate profit by increasing the firms margin or turnover
- 6. Evolution of margin We may obtain some relevant conclusions by simply comparing the evolution of gross margin and operating margin. Example, if gross margin is exhibiting the expected progress but operating margin is getting behind (or falling), then we could conclude that there may be problems in the firms fixed cost structure (or, at least, that there is some cost associated with the chosen strategy).
- 7. Asset turnover What actually has to turn over are the components included in net operating investment: cash holdings, account receivables, inventory, and/or, as part of the net effect, payables. So, to analyze a firms potential success or failure in turning assets over, we could look at the operating ratios; namely, days of cash, days of receivables, days of inventory, and days of payables. In this way, we can uncover where our assets may be gaining weight and we can determine if the extra investment is being productive
- 9. A forecast In addition to helping an investor, analyst, or manager understand a firms past or current performance, ratios can be used to forecast a firms prospects. For example, ratios can be used by a manager who is considering whether to adopt a new growth strategy
- 10. Conclusion This chapter presented a method for conducting a comprehensive analysis of a firms financial performance based on traditional financial ratios. We first introduced the primary ratios related to operating efficiency, financial leverage, liquidity, and profitability. We then showed how these ratios and their components can be used to answer important questions about a firms past or current performance or about a firms future prospects. Following this analysis, a manager can evaluate the impact of the firms overall business and financial strategy on shareholders profits, or can determine whether a strategy under consideration is likely to add to such profi ts.