Company performance is affected by:
1. Economic environment
2. Government policy
3. Accounting rules & regulation (which numbers do they show)
4. Corporate law
Financial statements provide information on:
- Assets and liabilities at a point in time
- Measures of performance for a period of time – profits and cash flows
Companies’ reported accounting information is affected by:
- Rules (Accounting standards or GAAP)
- Forecast errors
- Managers’ accounting choices
o Bonus schemes
o Potential take-over
In analysis:
1. Identify key accounting policies
2. Assess accounting flexibility
3. Evaluate accounting strategy
4. Evaluate quality of disclosure
5. Identify potential “red flags” – under/overestimating liabilities
6. Undo accounting distortions
Balance sheet:
- Working capital = liquidity (current assets – current liabilities)
- Non-current liabilities = solvency
Balance sheet Reserves:
- Share premium account reserve: the difference between the price that the investors
paid and the actual value of the share
- Retained earnings
- Capital redemption reserve: when a company repurchases their own shares, they
are cancelled. Amount transferred to capital redemption reserve
Accounting Policies affect:
- Revenue – what is considered revenue and how is it measured
- Inventory – what is considered as inventory
- Property, plant and equipment (PPE) – method of depreciation – how is it valued
Industry Structure and Profitability:
- Business Strategy Analysis:
o Understanding of what company is trying to do
o Understanding the factors which facilitate or limit it in so doing
, Industry Analysis - Porter’s Five forces:
- What determines the profitability of an industry and whether it is worth being in
that industry
- Degree of actual and potential competitors:
o Rivalry among existing firms
Ability of competitors to steal market share by:
Entering price wars
Improving service e.g. new apps
Advertising
What potential is there for growth in industry?
How concentrated is the industry?
What product differentiation is there?
Are there any economies of scale?
o Threat of new entrants
More competition leads to lower prices
Are new entrants able to benefit from economies of scale?
o Threat of substitute products
Is it easy for customers to switch to substitutes?
How willing are customers to switch to substitutes?
What is the firm doing to prevent competition from substitutes?
- Bargaining power in input and output markets:
o Bargaining power of buyers
How price sensitive are our buyers?
How much power do the buyers have?
o Bargaining power of suppliers
What price sensitivity is there?
How much bargaining power do suppliers have?
Competitive Strategy Analysis:
- Strategy 1: Cost leadership
- Strategy 2: Differentiation
Accounting Ratios:
- Performance measurement
- Solvency and Liquidity measurement
- Working capital measurement
- Return on investment and risk measurement
Ratios comparison:
- Cross-sectionally – different firms at the same time
- Across time – same firm at different times
Operating profit (before interest ∧tax )
Return on Capital Employed (%) = × 100
Net capital employed
1. Economic environment
2. Government policy
3. Accounting rules & regulation (which numbers do they show)
4. Corporate law
Financial statements provide information on:
- Assets and liabilities at a point in time
- Measures of performance for a period of time – profits and cash flows
Companies’ reported accounting information is affected by:
- Rules (Accounting standards or GAAP)
- Forecast errors
- Managers’ accounting choices
o Bonus schemes
o Potential take-over
In analysis:
1. Identify key accounting policies
2. Assess accounting flexibility
3. Evaluate accounting strategy
4. Evaluate quality of disclosure
5. Identify potential “red flags” – under/overestimating liabilities
6. Undo accounting distortions
Balance sheet:
- Working capital = liquidity (current assets – current liabilities)
- Non-current liabilities = solvency
Balance sheet Reserves:
- Share premium account reserve: the difference between the price that the investors
paid and the actual value of the share
- Retained earnings
- Capital redemption reserve: when a company repurchases their own shares, they
are cancelled. Amount transferred to capital redemption reserve
Accounting Policies affect:
- Revenue – what is considered revenue and how is it measured
- Inventory – what is considered as inventory
- Property, plant and equipment (PPE) – method of depreciation – how is it valued
Industry Structure and Profitability:
- Business Strategy Analysis:
o Understanding of what company is trying to do
o Understanding the factors which facilitate or limit it in so doing
, Industry Analysis - Porter’s Five forces:
- What determines the profitability of an industry and whether it is worth being in
that industry
- Degree of actual and potential competitors:
o Rivalry among existing firms
Ability of competitors to steal market share by:
Entering price wars
Improving service e.g. new apps
Advertising
What potential is there for growth in industry?
How concentrated is the industry?
What product differentiation is there?
Are there any economies of scale?
o Threat of new entrants
More competition leads to lower prices
Are new entrants able to benefit from economies of scale?
o Threat of substitute products
Is it easy for customers to switch to substitutes?
How willing are customers to switch to substitutes?
What is the firm doing to prevent competition from substitutes?
- Bargaining power in input and output markets:
o Bargaining power of buyers
How price sensitive are our buyers?
How much power do the buyers have?
o Bargaining power of suppliers
What price sensitivity is there?
How much bargaining power do suppliers have?
Competitive Strategy Analysis:
- Strategy 1: Cost leadership
- Strategy 2: Differentiation
Accounting Ratios:
- Performance measurement
- Solvency and Liquidity measurement
- Working capital measurement
- Return on investment and risk measurement
Ratios comparison:
- Cross-sectionally – different firms at the same time
- Across time – same firm at different times
Operating profit (before interest ∧tax )
Return on Capital Employed (%) = × 100
Net capital employed
