Week 2 - Profit Analysis Flashcards
Parts of SWOT analysis
Strengths
Weaknesses
Opportunities
Threats
Achieving Competitive Advantage
Barriers to entry: patents and copyrights, regulatory barriers, scarce resources
Product/service differentiation: technological innovation, marketing distribution and after scale support, market segmentation
Cost leader: access to low cost materials or labor, manufacturing efficiency, manufacturing scale efficiencies, greater bargaining power with suppliers, sophisticated IT systems
Two types of ratio comparison
time series comparison (horizontal analysis) - compare to prior periods, normal vs abnormal, triangulate with structural changes
Cross-sectional comparison - compare with competitors, triangulate ratios with corporate strategy
Ratio forecasting
mean revert:
unusually high -> tend to fall
unusually low -> tend to rise
What is a Common-size (vertical analysis)
- Allows meaningful comparisons over time while “controlling”
for changes in firm size (measured as either sales or total assets). - Allows meaningful comparisons for firms using different
currencies - Allows meaningful comparisons between firms
Caution – changes in expenses may not be directly
related to changes in sales
Percentage Change (horizontal statements)
- Amounts are expressed as a percentage of a base year (fixed or rolling)
- Focus is on growth in each item over time
Caution – small (immaterial) accounts, especially on the
balance sheet, can often be associated with huge percentage
changes
Caveats to ration analysis
No “correct” way to compute many ratios
- How to calculate ROE? Leverage?
Ratios do not provide answers – just tell you where to look
for answers
- Rule of thumbs do not always work
Managers know that investors use ratios.
- “Window-dressing”
What is the forecasting order
- income statement
- balance sheet
- statement of cash flows
What is non-controlling interest
portion of ownership in a subsidiary that is not owned by the parent company
what are the two methods to calculate ROE
DuPont Analysis
Operating Focus
DuPont Analysis: how to calculate ROE
ROE = NI / Avg Stockholder’s equity
= ROA * FL
ROA = NI / Avg Total Assets
~ represents company performance
FL = Avg total assets / Avg stockholder’s equity
~how assets are financed
What is Financial Leverage
= Avg Total Assets / Avg Stockholders Equity
- Financial leverage measures the relative
use of debt versus equity to finance the
company’s assets. - Financial leverage is important because
debt is a contractual obligation and a company’s failure to repay principal or interest can result in legal repercussions
or even bankruptcy. - Higher financial leverage means higher debt and interest payments.
- All else equal, higher financial leverage increases the probability of default and possible bankruptcy.
What is ROA
= NI / Avg Total Assets
= PM * AT
PM = NI / Sales
AT = Sales / Avg Total Assets
How to increase ROA:
1. Increase PM - increase profitability for a given level of assets
2. increase AT - reduce assets while still generating same profit
What is Gross Profit Margin
= Gross Profit / sales
high margin is better
low margin could mean:
- competition increased
- product lost appeal
- product costs have increased
- product mix changed
- volume has declined and fixed costs have not
what is Operating Expense Margin
measures operating costs / sales dollar
considers expense
lower is better
What is Asset Turnover
= sales / avg total assets
what is AR turnover
= sales / average AR
what is inventory turnover
= COGS / average inventory
what is AP turnover
= purchases or COGS / average AP
what is PPE turnover
= sales / average PPE
how to improve PPE turnover:
- divest unproductive assets
- joint ventures
- sell facilities with agreements to purchase finished goods from new facility owners
- sale and leaseback of administrative buildings
how do you analyze financial leverage
total liabilities to equity = total liabilities / total equity
times interest earned = EBIT / gross interest expense
financial leverage is the degree to the company uses borrowed money
(increases risk but also increases rate or return)
what is RNOA
Return on Net Operating Assets
= NOPAT / average NOA
what is NOA
Net Operating Assets
= Operating Assets - Operating Liabilities
What is NOPAT
Net Operating Profit After Tax
= EBIT - (tax expense + (nonoperating expense before tax * tax rate)
note: tax shield = nonoperating expense before tax * tax rate
