2. What is it for…
• Comprehensive financial analysis accentuate
the strengths and weaknesses of a company.
Communicating the company’s strengths and
weaknesses in an accurate and honest manner
is helpful in convincing the investors to invest
in your business
3. What is a firm’s 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. Let’s 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 firm’s net assets
can generate profit by increasing the firm’s 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 firm’s 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 firm’s 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 firm’s past or current
performance, ratios can be used to forecast a
firm’s 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 firm’s 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 firm’s past or
current performance or about a firm’s future prospects.
Following this analysis, a manager can evaluate the impact of
the firm’s overall business and financial strategy on
shareholders’ profits, or can determine whether a strategy
under consideration is likely to add to such profi ts.
