BAV T1 Slides

Business Analysis And Valuation
Module 1: Framework for Business

Analysis and Valuation
Ritika Jaiswal, Department of Economics

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BITS Pilani K K Birla Goa Campus
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BITS Pilani K K Birla Goa Campus 2
What is Business?
• An entity for profit (commercial) or not for profit (non-commercial: not for profit or
charitable).
• Business entities are formed to produce or sell a product or services.
• Run by people or need other resources as well such as materials, finance etc.
• Achieve a desired output.
• Output for public or private benefits.

What is Business?
These business entities exists with a certain ‘Vision-Goals-Strategies’.
Vision: Future road map
Goals: very specific, attainable and time bound. future plans ofachievement
Strategies: are designed to achieve the goals.
Missions Current plans which the business is to achieve

Moltoof the company

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What is Business?
Vision: Tesla Motors:

“ To create the most compelling car company of the 21s century by driving the world’s
transition to electric vehicles.”
-Most compelling
-Car company
21st Century
The world’s transition to electric vehicles
Vision : Amazon
“ To be earth’s most customer centric company where customers can find and discover
anything they might want to buy online”
-Global Reach
-Customer prioritization
-Anything they might want to buy online.
Vision: P&G
“Be & Be recognized as the best consumer products and service company in the world”
-Be & Be Recognized
-Best consumer products & services
-Company in the world Ritika Jaiswal, Department of Economics
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What is Business?
Mission: Google: Organizing the world’s information
Mission: Tesla Motors: To accelerate the world’s transition to sustainable transport
Mission: Amazon: We strive to offer our customers the lowest possible prices, the best
available selection &the utmost convenience

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Business Ecosystems
Business Ecosystem consist of following components:

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Business Ecosystems
• If there is any disruption in business ecosystem it results in :

a) problems or b) opportunity
for an organization.
• This disruption causes mis-alignment in vision-goal-strategy chain.
• Organization need solution to help them to solve the problem or exploit opportunity.

IMP Why Business analysis
What is Solution?
Key components of a solution includes:

• Organization restructuring
• Business process reengineering
• Business process improvement initiative
• Information technology to support business

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Why Business analysis
Success of a solution lies in
• Understanding the ‘Current –State’ of an organization such as pain-points, bottleneck,

issues etc.
• Mapping out the ‘Future-State’ of an organization.
• Eliciting, analyzing, documenting and validating the business, system/technical

requirements
• Re-aligning the organization’s ‘Vision-Goal-Strategy’.

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Domains of Business Analysis

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What is Business Analysis?
• The BA is the linchpin of the company and is focused on solving all sorts of
business problems, whether through IT or other means.
• Business Analysis is similar to need analysis especially in the sense that it is used to
determine the needs (requirements) of the business, and is centred on
understanding the issues and opportunities faced by the business with the
objective of finding resolutions, defining approaches to resolving issues and
exploiting opportunities.
• According to the International Institute of Business Analysis (IIBA), Business

Analysis is “the practice of enabling change in an organizational context, by
defining needs and recommending solutions that deliver value to stakeholders.”

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Business Analysis
Business analysis is the evaluation of a company’s prospects & risks

for the purpose of making business decision
Business Decision Makers include:

•Equity Investors
•Creditors
•Managers
•Merger and Acquisition Analysis
•External Auditors
•Directors
•Regulators
•Employees and Unions

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IMP 3 C’s of Business Analysis
• Code (Accounting- language of business)
• Conduct (Strategic certificate which defines the path way of these businesses).
• Climate (Environmental factors)

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Steps of Business Analysis
• Strategic Analysis: identify key profit drivers and business risks and assess a firm’s
profit potential at a qualitative level. It helps to evaluate if current profitability is
sustainable.
• Accounting Analysis: evaluate the degree to which a firm’s accounting captures the
underlying reality. Evaluate the firm’s accounting policies and estimate. Undo the
accounting distortions by recasting accounting numbers to create unbiased accounting
data.
• Financial Analysis: evaluate current and past performance and assess its sustainability
by doing ratio analysis and cash flow analysis. Ratio analysis evaluates market
performance and financial policies while cash flow assesses a firm’s liquidity and
financial flexibility.
• Prospective analysis: forecasting a firm’s value using financial statements forecasting

and valuation.

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Business analysis of a firm before investing in it
Benjamin Graham once quoted: “The individual investor should act consistently as an
investor and not as a speculator”
• Understanding the Business Model of the Company

• Industry Analysis
• Competitive Advantage
• Management
• Corporate Governance (leadership, Accountability, Fairness, Compliance)
“Good corporate governance is about maximizing shareholder value on a sustainable
basis while ensuring fairness to all stakeholders: customers, vendor partners,
investors, employees, government and society.” – Mr. N R Narayan Murthy, Co-
Founder Infosys.
• Analyse Company’s annual and quarterly report
• Evaluate Balance Sheet
• Review the financial performance through ratio Analysis
(Benjamin Graham said “ Buy not on optimism, but on arithmetic”
• Quality of Earnings
ofearnings through the primary business should be
more Qualityof earnings is more
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Business
Environment &
Strategy Analysis
Industry Strategy
Analysis Analysis
Financial
Analysis
Analysis
Accounting of Sources Prospective
Analysis Profitability
&Uses of Risk Analysis
Funds Analysis
Analysis

Cost of Capital Estimate
BITS Pilani K K Birla Goa Campus Intrinsic Value
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Business Strategy Analysis
The process of conducting research on the business environment within

which an organization operates and on the organization itself, in order to
formulate strategy.
The purpose of Business Strategy Analysis identify key profit drives and
business risks. Assess company’s profit potential at a qualitative level.
Why Use it?

To take advantage of the path of least resistance to achieve your goal.
When to use it?

When you are planning to make a change in your organization, and you need
to determine the best path to take.
Tools of Strategic Analysis
A number of tools are used in the process of strategic analysis including PEST,
SWOT analysis, Michael Porter's five force mode, SPACE, Blind spot analysis,
value chain analysis etc.

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Strategy Analysis involves
• Industry analysis
• Competitive strategy analysis
• Corporate strategy analysis

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Module 1
Role of Financial Reporting in Capital

Market

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WARNING


What is Financial Reporting?
Financial Reporting involves the disclosure of financial information to the various

stakeholders about the financial performance and financial position of the
organization over a specified period of time.
These stakeholders include –

Investors,
Creditors,
Government and Government agencies
Suppliers
Customers
Employees
Management
Independent Auditor

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Objective of Financial Reporting
According to International Accounting Standard Board (IASB), the objective of financial

reporting is “to provide information about the financial position, performance and changes
in financial position of an enterprise that is useful to a wide range of users in making
economic decisions.”
The following points sum up the objectives & purposes of financial reporting –
• Providing information to management of an organization which is used for the purpose

of planning, analysis, benchmarking and decision making.
• Providing information to investors, promoters, debt provider and creditors which is used
to enable them to make rational and prudent decisions regarding investment, credit etc.
• Providing information to shareholders & public at large in case of listed companies about
various aspects of an organization.
• Providing information to various stakeholders regarding performance management of an
organization as to how diligently & ethically they are discharging their fiduciary duties &
responsibilities.
• Providing information to the statutory auditors which in turn facilitates audit.

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Components of Financial Reporting
Financial Reporting is usually considered as end product of Accounting.
Financial reporting is essentially a way of following standard practices to give the world
an accurate depiction of a company’s finances, including their:
• Revenues
• Expenses
• Profits
• Capital
• Cashflow Key Performance Indicators
All of these financial KPIs are important, because they show the “health” of a company –
at least when it comes to money.

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Components of Financial Reporting Cont..
The typical components of financial reporting are:

• The financial statements – Balance Sheet, Profit & loss account, Cash flow
statement& Statement of changes in stock holder’s equity
• The notes to financial statements
• Quarterly & Annual reports (in case of listed companies)
• Prospectus (In case of companies going for IPOs)
• Management Discussion & Analysis (In case of public companies)

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IMP Importance of Financial Reporting
The importance of financial reporting cannot be over emphasized. It is required by

each and every stakeholder for multiple reasons & purposes. The following points
highlights why financial reporting framework is important –
• To comply with Regulatory requirements.
• It facilitates statutory audit. Audit mandated by some law
• It helps in financial planning, analysis, bench marking and decision making.
• To raise capital
• To meet the tax compliances
• Performance indicator of the organization as well as of its management.
• To facilitate the purpose of bidding, labor contract, government supplies etc.,

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Importance of Financial Reporting
Financial statement analysis is a valuable activity when managers have

complete information on a firm’s strategies and more importantly, the
managers like the information reflected in the financial statement. In reality,
this is not often true. It enables the outside analysts create ‘inside
information’ from analyzing financial statement and thereby gaining valuable
insights about current performance and future prospects of the firm.

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Imp
The role of financial reporting in capital markets
Capital markets use wealth from

sa ers Public markets
put it to use
for those who need companies sell
Savings
the financing Shores to general
population
Net Savers
Financial Information
Intermediaries Intermediaries
Trading occurs
Long term debt Business stocks bonds shares
eyed or equity
backed
Ideas etc
Net Borrowers
Eu Companies making
long term investments

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IMP
What is the problem?

Matching savings to business ideas is complicated..
Entrepreneurs have better information
Entrepreneurs lack credibility because they have the incentives to be over
optimistic
These two reasons result in a classic “lemons” problem,* e.g., bad ideas “crowd out”
good ideas and investors lose confidence in this market. Suppose, initially there are
50% good firms and 50% bad firms. Both the types claim high prospect for the next
year. Investors fail to distinguish the two types and give them average credibility. For
example, 50% credibility turns up correct because 50% told lies. This demotivates the
good firms and they quit the market. The market now becomes full of ‘bad firms’. In
turn, among the bad firms, relatively good ones lose credibility because of bad firms,
and quit the market. At the end, it turns up that firms do not deserve perfect
credibility, that essentially leads to market break-down.
* “The market for Lemons: Quality Uncertainty and the market mechanism” is a well-known 1970 paper
by economist George Akerlof.

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Objectives of Lemon law:
• Explain what adverse selection and moral hazards are.
• Provide examples of real-world markets affected by incomplete information
• Set up and solve models of decision-making in the presence of incomplete

information.
• Predict the effects of policies to address incomplete information on market

outcomes.

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MP
Types of Information Asymmetries
Hidden Information Problem : One side of the market cannot observe the
quality of the good being bought or sold in the market.
Hidden Action Problem : One side of the market cannot observe the
actions of the other side of the market.

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Hidden Information Problem - Adverse Selection
Adverse selection occurs when, as a result of the hidden information problem, the only
products available on the market are low quality products.
Example:
Insurance Markets: If only people who engage in risky behavior buy insurance, there is
an adverse selection problem.
Labor Market: If the only workers available do not have the skills for the jobs available,
there is an adverse selection problem.
Stock Market: If the only stocks available in the market are of low quality, there is a
adverse selection problem.

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Solution to Adverse Selection:
1. Mandate purchase or mandatory disclosure: In most US states, drivers are

required to provide proof of automobile insurance in order to register their
vehicle.
2. Signaling: a way to indicate that your product is high quality.
Example: Owners of high quality cars purchase warranties.
Mandatory auditing of the financial statement, ratings
given by rating agencies.
As long as the cost of warranty is such that owners of high quality cars will buy
it, but owners of low quality cars won’t, the signal will effective at solving the
hidden information problem. It is called as separating equilibrium.
If the cost of the warranty is such that owners of all cars buy it, the signal will
be ineffective at solving the hidden information problem. It is called as pooling
equilibrium.
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Hidden Action Problem
Principal-Agent Problem:
Principal = owner(s) of a company (stockholders)
Agent = manager of day-to-day operations of the company
Principal’s goal is to incentivize the agent to work in such a way that the company’s
profits are maximized.
Problem: The principal cannot observe the agent’s effort, only the results (output or
profit) of the effort.
Sometimes, profits or output will be high, even if the agent’s effort is low.

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Principal-Agent Problem:
Moral Hazards: Moral hazard results when, as a result of the hidden action problem, the
agent engages in behavior that is damaging to the principal.
Examples: Drivers engage in more risky driving practices because they are insured.
Employees of investment firms make trades that ultimately, cause financial damage to the
firm. (PNB fraud case, Yes bank case)

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Solution to Moral Hazards
1. Incentive Compatible Payment Scheme
If the principal can design a way to reward the agent that incentivizes the agent to engage
in the type of behavior that the principal desires, we say that the reward system is
Incentive Compatible.
2. Monitoring
Mutual monitoring, in which member of a group monitor each other’s performance, is

often used in microfinance to ensure loan repayment.

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IMP The role of financial Intermediaries in capital markets
Intermediaries can prevent the market breakdown which resulted from the lemons
problem since they provide independent certification.
Intermediaries can be:

Financial Intermediaries: Venture capital firms, investment banks, merchant banks,
banks, mutual funds, and insurance companies. These institutions rely on information
of financial statements and supplement this with other sources of information to
analyze investment opportunities.
Information Intermediaries: Auditors, financial analysts, bond rating agencies and

financial press. These firms add value by enhancing the credibility of financial reports
(as audit firms do) and by analyzing the information in the financial statements (as
analysts do).
Both types add value by distinguishing bad ideas from good ones

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Intermediaries in the Market

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Meaning of Intermediaries
• Firm or person (such as broker or consultant) who acts as a mediator on a link

between parties to a business deal, investment decision, negotiation etc. In money
markets, for example, banks act as intermediaries between depositors seeking
interest income and borrowers seeking debt capital.
• Intermediaries usually specialize in specific areas and serve as a conduit for market
and other types of information.
• Intermediaries are service providers in the market including stock brokers, sub-
brokers, financiers, merchant bankers, underwriters, depository participants ,
registrar and transfer agents, FII/sub accounts, mutual funds, venture capital funds,
portfolio managers, custodians etc.

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Stock Brokers : A stockbroker is a regulated professional individual, usually associated with

a brokerage firm or broker-dealer, who buys and sells stocks and other securities for both
retail and institutional clients, through a stock exchange or over the counter in return for a
fee or commission. Such as initiate the process of block deal and bulk deal.
Financiers : is a person or a business entity who makes their money from investments,
typically involving large sums of money and usually involving private equity and venture
capital, leveraged buyouts, corporate finance, investment banking and/or large scale asset
management.
Merchant bank: A merchant banker usually refers to a firm or organization involved in all
aspects of issue management. Their services include providing consultancy or advisory
services to corporates for issue management, making arrangements for buying, selling or
subscribing to shares in an issue or any other consultancy or services such as underwriting,
analysis and advice related to mergers and acquisitions, arranging offshore funding or
venture capital, credit syndication and portfolio management.
Example: SBI capital markets Ltd., PNB, BOM, ICICI securities Ltd., Axis Bank Ltd.

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Underwriting: Underwriting is a guarantee given by the underwriters to take up whole
or part of the issue of securities not subscribed by the public. The two most common
types of underwriting are bought deals and best effort deals.
Depository participant: A depository is an organisation which holds securities (like

shares ,debentures, bonds, government securities, mutual fund units etc.) of investors
in electronic form at the request of the investors through a registered depository
participant. It also provides services related to transaction in securities.
Example: NSDL, CDSL
Registrar and Transfer Agent (RTA): An RTA is an agent of the issuer. RTA acts as an
intermediary between the issuer and depository for providing services such as
dematerialization, rematerializationn, IPO and corporate actions.
Mutual Funds: A mutual fund is a type of professionally managed collective investment

scheme that pools money from many investors to purchase securities.
Venture Capital : VC is financial capital provided to early-stage, high-potential, high risk,

growth start-up companies. The VC fund makes money by owning equity in the
companies it invests in. Venture capital is a subset of private equity. Therefore, all VC is
private equity, but not all privateRitika
equity is venture capital.
Jaiswal, Department of Economics
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Portfolio Manager: Is either a person who makes investment decisions using money
other people have placed under his or her control or a person who manages a
financial institution’s asset and liability (loan and deposit) portfolios. On the
investment side, they work with a team of analysts and researchers and are
ultimately responsible for establishing an investment strategy.
(Discussion in class: Role of financial intermediaries in dot com bubble 2000

Role of financial intermediaries in sub-prime crisis 2008
Role of financial intermediaries in ILFS crisis 2018)

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From Business activities to financial statements
IMP
Business Environment Business Strategy

Labor markets Scope of business:
Capital Markets Degree of diversification
Business Activities
Product Markets:
Operating Types of diversification
Suppliers Investing Competitive positioning:
Customers Financing
Cost leadership
Competitors
Product Differentiation
Business regulations
Accounting system Key success factors and
risks
Measures and reports
Accounting economic consequences of
environment business activities
Capital market structure Accounting strategy
Contracting and governance Financial statements Choice of accounting policies
Accounting conventions and Managers’ superior information Choice of accounting
regulations on business activities estimates
Tax and financial accounting Estimation errors Choice of reporting formats
Third-party auditing Distortion from managers’ Choice of supplementary
accounting choices disclosures
Legal system for accounting Ritika Jaiswal, Department of Economics
disputes BITS Pilani K K Birla Goa Campus
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IMP
A firm’s business activities are influenced by its business or

economic environment and its own business strategy
The business or economic environment includes the firm’s
industry, its input and output markets, and regulations.
Business strategy determines how the firm positions itself in
its environment to achieve competitive advantage.
The firm’s accounting system provides a mechanism through
which business activities are selected, measured, and aggregated
into financial statement data. Thus, in its turn depends on
accounting environment and accounting strategy.

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IMP
A firm’s financial statements summarize the economic

consequence of its business activities. However, the firm
cannot report everything either because they are too
numerous or because they fear losing competitive
advantage.
Thus Financial Statement data are influenced by both the
firm’s business activities and by its accounting system.
Understanding the Accounting system is therefore very
important!

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IMP A Critical Approach to
Institutional Features of Accounting System
Accounting System (AS) Feature 1: Accrual system

• Accrual system against cash based one
• Investors’ preference for calendar based performance
against function based one
Accounting System (AS) Feature 2 (a): Delegation to

corporate management
• Regarding future consequence of current activities
(expected realization of credit sales). This might be
realistic (benefit) or fabricated (cost)

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Institutional Features of Accounting System (Contd)
AS Feature 2 (b): Conservatism and Uniform accounting

standard
• Accounting standard limits the freedom of
management by cost and conservatism principle
• Accounting standards ( GAAPs like FASB, IAS, BAS for
example) limit the freedom through uniform
accounting standard for different organizations.
AS Feature 2 (c): Role of auditing and law
• External auditing may curtail the freedom
• Legal environment may curtail the freedom

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Institutional Features of Accounting System (Cont)
AS Feature 3: Managers’ reporting strategy

• The strategy may be to make either more or less difficult for
external users
• Makes voluntary disclosure when accounting regulation
restricts certain disclosure
• Competitive dynamic might hinder superior disclosure
• Optimistic assessment of performances or hiding the
weakness of the firm may be necessary to influence
investors’ perceptions.
• Information content of Financial Statements about the
business varies across firms and time, which provides for
both opportunity and challenge in business analysis.

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Business Analysis using Financial Statements
Financial Statements Business Application context
Influenced by managers’ superior information on Credit analysis, Securities

business activities, noise from estimating errors, and analysis, Merger & Acquisition
Distortions from managers’ accounting choices analysis, Debt/Dividend
analysis, Corporate
Other Public Data communication strategy
Like Industry and Firm data outside Financial analysis, and General business
Statements analysis
ANALYSIS TOOLS
Accounting Generate performance expectations
Analysis through industry analysis and Prospective
Evaluate accounting competitive strategy analysis Analysis
quality by assessing Financial Analysis Make forecasts and
accounting policies value business
and estimates Evaluate performance using
ratios and cash flow analysis
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Steps of Business Analysis
Step 1: Business Strategy Analysis
Identifies the key profit drivers and business risks, and makes an
Assessment of profit potentials at a qualitative level
Industry analysis to evaluate the sustainability of competitive advantage
Step 2: Accounting Analysis
Evaluates the degree to which a firm’s accounting captures the underlying
business reality
Identifies the sources of distortion in accounting data, and makes a
revision
Step 3: Financial Analysis
Systematic and efficient analysis of sustainability of current performances
by using financial data
Ratio analysis makes time series and cross section study, and Cash flow
analysis evaluates the cash management and liquidity
Step 4: Prospective Analysis:
Synthesis of all 3 above to predict future

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Module 2
Strategic Analytical Techniques :

Industry Analysis

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WARNING


Strategy Analysis as a guide to Financial Analysis
Business Survival
There are two key factors for business survival:

Profitability
Solvency
Profitability is important if the business is to generate revenue (income) in excess

of the expenses incurred in operating that business.
The solvency of a business is important because it looks at the ability of the
business in meeting its financial obligations.
Financial Statement Analysis
Financial Statement Analysis will help business owners and other interested people
to analyse the data in financial statements to provide them with better information
about such key factors for decision making and ultimate business survival.

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Financial Statement Analysis
Purpose:
To use financial statements to evaluate an organisation’s
Financial performance
Financial position.
To have a means of comparative analysis across time in terms of:
Intra-company basis (within the company itself)
Intercompany basis (between companies)
Industry Averages (against that particular industry’s averages)
To apply analytical tools and techniques to financial statements to obtain useful
information to aid decision making.
Financial statement analysis involves analysing the information provided in the financial
statements to:
Provide information about the organisation’s:
Past performance
Present condition
Future performance
Assess the organisation’s:
Earnings in terms of power, persistence, quality and growth
Solvency Ritika Jaiswal, Department of Economics
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Effective Financial Statement Analysis
• Strategy analysis is an important starting point for the analysis of financial

statements. Strategy analysis allows the analyst to probe the economics of the firm
at a qualitative level so that the subsequent accounting and financial analysis is
grounded in business reality.
• To perform an effective financial statement analysis, you need to be aware of the
organisation’s:
• business strategy
• objectives
• annual report and other documents like articles about the organisation in
newspapers and business reviews.
• These are called individual organisational factors.
• It Requires that you:

• Understand the nature of the industry in which the organisation works. This is an
industry factor.
• Understand that the overall state of the economy may also have an impact on the
performance of the organisation.

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• Financial statement analysis is more than just “crunching numbers”, it involves

obtaining a broader picture of the organisation in order to evaluate appropriately
how that organisation is performing
• Strategy analysis also allows the identification of the firm’s profit drivers and key
risks. This, in turn, enables the analyst to assess the sustainability of the firm’s
current performance and make realistic forecasts of future performance.
• Hence, firm’s profit potential is determined by its own strategic choices of :

1. Industry choice
2. Competitive positioning
3. Corporate strategy

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IMP Industry Analysis
1. Identify the business unit and its geographic and product boundaries
2. Define the industry
3. Determine whether ROA, ROS, ROE or another measure of operating profitability is
appropriate
4. Estimate the industry average profitability
5. Compare the industry average profitability with the global average provided in class to
determine if the industry is attractive or unattractive
6. Do a five-forces analysis to explain why the industry is attractive or unattractive.

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Industry Analysis: Porter’ Five Force Model
IMP
Figure 1 – Porter's Five Forces

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IMP
Existing rivalry
Industry gro Hr rate
Rapid no need to grab share from each other
Stagnant piece wars to capture market share
conc of competitors
only few monopolies Hey can set pricing other competitive
moves
En Pepsi Coke
Fragmented industry price wars
Degree
of differentiation switching costs
More diff avoid head as competition

how switching costs possibility of substitutes
Capacity evict barriers

Price slashing tf capacity s stock produced 1 to be sold
Arcee slashing also possible
if erect barriers are high
Economies of scale 1 scope

Incentives to engage in aggressive production
Fined cost Variable cost high Incentive to slash pieces to

utilize installed capacity
Buyer’s and Supplier’s Power
Bargaining Bargaining
Rivalry among existing
power of power of
competitors
Suppliers buyers
Design the cost Design the

structure of the revenue structure
industry of the industry
Analysis of Buyers and suppliers across the industry

• Price Sensitivity
• Intrinsic bargaining strength

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Analysis of Buyer’s and Supplier’s Power in Pharmaceutical Industry
Patients, insurance
Scientists companies, doctors
Bargaining Bargaining
Rivalry among existing
power of power of
competitors
Suppliers buyers
Price Sensitivity: Price sensitivity

• Motivated by concerns • Decision maker separated
other than wealth from payer
Intrinsic Bargaining Intrinsic bargaining strength

Strength • Payers uninformed and
• Few careers attractive fragmented relative to
to top scientists pharmaceutical company
• Prestige associated
with accomplished
groups
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IMP Industry Analysis: Porter’ Five Force Model
Power of buyers
1. Price sensitivity
• Product cost vs. total cost
• Product differentiation
• Impact on quality performance
• Buyer strategy
• Buyer profitability
2. Intrinsic Bargaining strength

• Buyer concentration more conc lesserpower fewbuyers don't buy it doesn't
• Volume of purchases more rot more power affectthe company
• Switching costs
• Alternative products
• Buyer Information
• Threat of backward integration
buy your supplier to gaincontrol over
costs

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IMP
Power of Supplier
Intrinsic Bargaining strength
Supplier Concentration cess conc more powerbecausethey can pretty much

Supplier Volume more uolsupply dictate the price
Substitute Inputs more power tobuyer less
power to supplier
Product differentiation But thisalsodependson suppliercone
Switching costs
Buyer information
Threat of forward integration manufacturer purchases a retailer to
Pull-through gain control
produce only when
yougetorder

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IMP
Threat of Substitution
Substitute create:
• Cap on the prices that buyers will pay

• Floor on the prices that suppliers will require (i.e. on the average costs
paid by firms in our industry)
• The level of the threat depends on relative price/performance including
switching costs.
• Judge substitutes by their functional equivalence
Buyers doing without
Suppliers shutting down production

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Degree of Rivalry
Do structural conditions create potential for market power among firms in the
industry?
• Concentration and balance of competitors

• Industry growth
• Scale and learning economies
• Switching costs
• Fixed-Variable costs
• Excess capacity
• Exit barriers
• Corporate stake

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Threat of New Entrants
Does an outsider have to pay more to get in now than incumbents did when
they entered (adjusting the inflation)?
• Economies of scale-units with respect to market size entrants will

high new
• Brand Image infer initially if they don't
have high capacity
• Switching Costs
• Capital requirements with respect to collateral
• Access to distribution
• Government Policy Patents etc
copyrights
first mover advantage can signearly deals getcheap new materials
set industry standards

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Industry Analysis: Motorcycle Industry (Porter’ Five Force Model)
Threat of new entrance
• Entry Barriers are high

• Huge investment
• Capital investment is very huge in two wheeler industry
• The biggest challenge is setting up sales and services which is very hard for a new
entrants
• Well established players are already existing
• Industry is consolidated
Threat of new entrance is very low

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Threat of Substitute
• Faces direct competition from the automobile sector.

• Substitute products for two wheeler industries are:
Bus, Auto, Cars and other public transport.
• Reasons for choosing substitutes may:
Relative quality of substitutes is higher
Switching costs is lower.
Threat of substitute is high.

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Rivalry among Competitors
Price, quality of the products plays an important role for rivalry among
competitors.
Methods adopted to attract customers- Discounts, availability of loans, low rate

of interest and long-term warranties to attract customers.
Each company in industry change the model on going basis to show

differentiation in their competitors.
Rivalry among competitors are high.

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Bargaining power of suppliers
Since they change their model on going basis they create good relationship between their
suppliers.
Some of the components in two wheeler industry sellers have bargaining power:
Steel
Batteries
tyre and tube etc.
The automobile supply business is quite fragmented
Bargaining power of suppliers are low.

19
Bargaining power of Buyers
There are 5 to 6 big popular brands of two wheelers are available.

Nowadays, people go to unique brands because of good service they provide after
purchase.
Bargaining power of buyers are high.
(Do the industry analysis of eyeglass industry and textile industry.)

20
Module 2
Strategic Analytical Techniques :

Competitive Strategy Analysis

1
WARNING


A competitive advantage is what makes an entity's goods or services superior to all of a

customer's other choices.
To create a competitive advantage, you've got to be clear about these

three determinants.
• Benefit
• Target Market
• Competition
To be successful, you need to be able to articulate the benefit you provide to

your target market that's better than the competition. That's your competitive
advantage.
Such as competitive advantage of backloader truck of CASE is

Mileage
Low maintenance
Low fuel consumption

3
How to design a strategy to achieve the competitive advantage
1. Identify the Critical Success Factor of your customer

2. Identify the Critical Success Factor of your customer’s customer
3. Identify the Critical Success Factor of your customer’s competitor also
4. Where to focus
5. Customer’s Centric organisation
Customer’s Critical Success Factor should be the foundation of your competitive

strategy
Critical Success Factor
John F. Rockart, of MIT's Sloan School of Management defined CSFs as: "The
limited number of areas in which results, if they are satisfactory, will ensure
successful competitive performance for the organization. They are the few key
areas where things must go right for the business to flourish. If results in these
areas are not adequate, the organization's efforts for the period will be less than
desired."

4
Consider a produce store “Farm Fresh Produce”
Mission of Farm Fresh Produce is :
To become the number one produce store in main street.
Strategic objectives of Farm Fresh are to:
• Gain market share locally of 25%

• Sustain a customer satisfaction rate of 98%
• Expand product range to attract more customers.
• Sufficient store space to accommodate the range of products.

5

To identify possible CSFs, we must examine the mission and objectives:
Objectives Critical Success Factors

Gain market share locally of 25% Increase competitiveness vs. local stores
Sustain a customer satisfaction rate of 98% Retain staff

Keep up customer-focused training
Expand product range Source new products locally

Secure financing for expansion
Accommodate the range of products Manage building works

6
IMP Competitive Strategy Analysis
Source of Competitive Advantages:
Porter outlined the three primary ways companies achieve a sustainable advantage.
They are cost leadership, differentiation, and focus. Porter called the generic strategies
"Cost Leadership" (no frills), "Differentiation" (creating uniquely desirable products
and services) and "Focus" (offering a specialized service in a niche market). He then
subdivided the Focus strategy into two parts: "Cost Focus" and "Differentiation Focus."
These are shown in Figure 2 below.
Overall uniqueness
premiumprice Addresses
customerneeds properly
offer diff product at price
Become cost leader belowwhatcustomeris willingto
target segment pay premium for
Seekdiff n'starget
segment
Ritika
Figure2 : Source of Jaiswal, Department
Competitive of Economics
Advantages 7
Cost Leadership Differentiation

Supply same product or services at a Supply a unique product or service at a cost lower
lower cost than the price premium customers will pay.
• Economies of scale and scope • Superior product quality
• Efficient Production • Superior product variety
• Simpler product design • Superior customer services
• Lower input cost • More flexible delivery
• Low-cost distribution • Investment in brand image
• Little research and development • Investment in research and development
or brand advertising • Control system focus on creativity and innovation
• Tight cost control system
Competitive Advantage
Match between firm’s core competencies and key success factors to execute strategy
Match between firm’s value chain and activities required to execute strategy
Sustainability of competitive advantage

8
Differentiation Strategy:
• Distinguished product or services from other similar products offered by the

competitors in the market.
• Products are distinguished based on product design, features, brand image,
quality or customer service.
How to achieve the product differentiation:
• To identify one or more attributes of a product or service that customer value.

• To position itself to meet the chosen customer need in a unique manner.
• To achieve differentiation at a cost that is lower than the price the customer is
willing to pay for the differentiated product or service.

9
Differentiation Strategy
Different ways to achieve the differentiation of your product:

• Innovation/ Invention: to become the market leader by innovation such as Apple,
Google
• Product-level differentiation: to incorporate product differentiation strategy at
product level. Such as tourism industry.
• Price differentiation: to incorporate price differentiation at product level. Such as
Samsung and Apple target the cream segment whereas companies like Micromax and
Xolo target the price sensitive segment.
• Branding: to create brand image by promotion mix and marketing strategy. Such as
Pepsi, Coke, Thums up and Fanta.

10
Different ways to achieve the differentiation of your product:
• Packaging: Packaging of a product, as a tool of differentiation strategy. Such as top

cover of book.
• Service pre sale and post sale: to provide service beyond customers expectation. Such
as service and ambiance of a restaurant.
• Point of customer interaction: to provide a good experience to the customers when
they interact with the company. Such as banks and retail showrooms.
• User convenience: to take care of user convenience to achieve the differentiation. Such
as banks and smaller shops vs. big retail store.
• Offer variety of products: to understand the psychology of the customers. Such as
invest in product line in order to provide more variety of products.

11
Business Strategy Analysis Cont….
Differentiation Strategy By McDonald
• Format and method of business (Franchisee owner is my first and last

customer)
• QSCV Quality ServiceCleanliness Value
• Employees are our customer
• Product innovation (Happy meal offered by McDonald)
• Fast food restaurant
• Localization of product line India are beef vegmly in GT
• Cross selling strategy
Fries Coke extra Rs So

12
IMP Business Strategy Analysis Cont….
Blue Ocean Strategy (Entry Barrier to create monopoly)
• Intellectual Property Protection

• Patent and Licenses Marketof co competition high
• Distribution Network potential for higherprofits
• Exclusive Right capture new demand
• Economies of Scale
• High Capital Investment Ex when Apple launchedipod
• Proprietary Technology for music on thego co poet
• Excellent Customer Services form
• Brand Equity
• Loyalty beyond logic
Red ocean cutthroat competition

13
Cost Leadership:
Cost leadership = High volume and low margin per unit
Cost Leadership can be designed for
• Serve broad market (no segmentation)

• Capitalizes on efficient production
• Effective controls on manufacturing and overhead costs
• Distribution costs also remain low and tightly monitored
Cost leadership can be achieved by
Economies of scale
Economies of scope
Process design
Lower input cost
Example : Cost leadership strategy of WalMart, Micromax, McDonald, IKEA, Amazon,

Dell, ZARA, South-west airlines etc.
14
Benefits of Cost Leadership Strategy

High Return on investments
Production facilities
Distribution channels
High profit margins
High market share
Disadvantage of Cost Leadership Strategy

• New Technology
• Price wars
• Consumers lose diversity
• Companies lose margin
Examples of Cost Leadership
McDonald’s has been extremely successful with this strategy by offering basic fast food
meals at low prices. They are able to keep prices low through a division of labor that
allows it to hire and train inexperienced employees rather than trained cooks.
Why Tata Nano fails though it adopted the cost leadership strategy!
15
Sustainable Competitive Advantages
• To become successful it is essential that firm should achieve sustainable competitive

advantage based on the combination of both cost leadership and differentiation
strategies.
• A sustainable competitive advantage is the key to business success,
• It enables a business to have greater focus, more sales, better profit margins, and
higher customers and staff retention than its competitors.
• Firms need to acquire the uniqueness of a firm’s core competencies and its value chain
in order to achieve the sustainable competitive advantages.
Every Competitive advantage has limited Time Span!

16
Steps to achieve the Sustainable Competitive Advantages:
• To identify the key success factors and risks.

• To identify the resources and capabilities require to deal with the key success
factors and risks.
• To identify the set of actions require to bridge the gap between its current
capabilities and the requirements.
• To restructure its key process or activities such as R&D, manufacturing, marketing
and distribution in such a way that is consistent with its competitive strategy.
• To create the barriers that make imitation of firm’s strategy difficult.
• To make a flexible company structure in order to incorporate the potential changes
in the firm’s industry structure.

17
Dell uses both generic strategies of Porter's model to achieve competitive advantage:
Cost leadership strategy of Dell:
• Firstly, with 'cost leadership', Dell's direct business model involves purchasing
standardised components which ultimately minimises the need for expensive
research and development.
• Dell's customisation policy of tailoring technological solutions to satisfy individual or
company needs also reduces inventory costs.
• Sales are then made direct over the Internet to customers thus eliminating retailers
that add necessary time and cost, or/who can diminish Dell's understanding of
customer expectations.
• Consequently, Dell have lower manufacturing and distribution costs than most of
their competitors, thus they have achieved a cost leadership strategy over their rivals.

18
Dell uses both generic strategy of Porter's model to achieve competitive advantage:
Differentiation strategy of Dell:
• Dell's direct sales model has allowed it to differentiate its PC products by allowing
"customers to design their own computer system and offering complementary
services such as online customer support, three-year-on-site warranty, web hosting,
installation and configuration of customers' hardware and software“.
• Hence, hybrid strategy of Dell not only helps it to produce cost effective
manufacturing policies and customised products but also overcame the barrier of
having access to new suppliers or distributors.

19
Hybrid strategies adopted by IKEA, one of the most successful and largest furniture retailers
in the world.
Cost Leadership Strategy

• IKEA buys well-designed subassemblies at the lowest costs from suppliers and
customers need to assemble the products themselves. This method could save delivery
costs for both producers and customers.
• It allows manufacturers reducing a lot of costs as soon as customers could pay for the
products on a much lower price with high quality and therefore, to receive different
segments of customers. This is also IKEA’s “Focus Strategy” on low costs.

20
Hybrid strategies adopted by IKEA, one of the most successful and largest furniture retailers
in the world.
• Basically, the company innovated the way people purchase furniture. Every IKEA stores
is a unique building with the noted brand symbol and style.
• Compared to other furnishing retailers, IKEA shows their products in prototype rooms
which are miscellaneous and stylish. It provides various choices and suggestions for
customers to decorate their rooms.
• As a result, IKEA could easily receive their potential customers. Meanwhile, the company
focus on producing high-quality products with competitive price, which is another
differentiation compared to most of the firms in the industry.
Focus Strategy
• Moreover, IKEA obeys the “Focus Strategy” on differentiation. For instance, in IKEA
stores in China, customers can find lots of Chinese traditional designed furniture, which
is well-satisfied for Chinese customers’ decoration demand.
21
Module 2
Corporate Strategy Analysis, BCG

Matrix

1
WARNING


Corporate Strategy Analysis
What is Corporate strategy?
• Corporate Strategy takes a portfolio approach to strategic decision making by looking

across all of a firm’s businesses to determine how to create the most value.
• In order to develop a corporate strategy, firms must look at how the various business
they own fit together, how they impact each other, and how the parent company is
structured in order to optimize human capital, processes, and governance.
• Corporate Strategy builds on top of business strategy, which is concerned with the
strategic decision making for an individual business.
• Delloite says “corporate strategy is about enabling an organization to achieve and

sustain superior performance by overcoming business challenges.” It is also about
understanding industry trends and linking tangible actions to a corporation’s vision.

3
Transaction cost economies of multibusiness organization
• Economic theory suggests that the optimal activity scope of a firm depends on
the relative transaction cost of performing a set of activities inside the firm versus
using the market mechanism.
• Transaction cost economic implies that the multiproduct firm is an efficient

choice of organizational form when coordinating among independent, focused
firms is costly due to market transaction costs.
• Transaction costs can arise out of several sources such as specialized assets
involved in production process, market imperfection due to information
asymmetry and incentive problems.

4
Business Strategy vs. Corporate Strategy
According to the University at Albany, business-level strategies:

“Detail actions taken to provide value to customers and gain a competitive advantage by
exploiting core competencies in specific, individual product or service markets.”
A business-level strategy is a business objective.
Harvard professors Davis J. Collis and Cynthia A. Montogomery described corporate

strategies as “the way a company creates value through the configuration and
coordination of its multi market activities.”

5
IMP
Components of corporate strategy
A good corporate strategy consists of four components that together promote a

corporate advantage. The main tasks of corporate strategy are:
1. Allocation of resources
2. Organizational design
3. Portfolio Management
4. Strategic tradeoff
6
Corporate Strategy Analysis of Amazon ( Jeff Bezos )
• Timely Build good product: amazon.com, amazon Prime, amazon consumer

electronics, amazon game studio, amazon prime instant video, amazon music, amazon
go, amazon kindle, amazon web services
• Timely purchased new companies: companies purchased by Amazon are WholeFoods,

Twitch, Audible, Zappos.com, IMDb, The Washington post and GoodReads etc.
• Timely investment in companies: Jeff Bezos invested in Google, UBER, Business inside,
Twitter, Workday, Grai, Lookout. Amazon invested in HomeGrocer.com, bankbazar.com,
Easybar and wine.com etc.
• Net worth company: Second largest company in the world in terms of market
capitalization.

7
Corporate Strategy Analysis of Amazon ( Jeff Bezos )
• Customer is the king and I am the servant (Delay, Defect and out of stock)
• Expect more from his employees
• Long term vision
Our Vision is to use this platform to build earth’s most customer centric company. A
place where customer can come to find and discover anything and everything they might
want to buy online.
• Simplify the complex process.
• Every employee has a hidden owner within
• Take quick decision with 70% information (First product is never the final product)
• Value imitation vs Value Innovation
Amazon. Com Prime has given him recurring revenue, loyal customer and customer
retention.
• Don’t let the process kill the progress
(new ideas, new test, new innovation, new method, alternate method, creativity, new
solution)
• 80% product and 20% promotion
• Master of failure

8
Corporate strategy analysis of the Tata Group, a diversified global company
At the end of 2010, Tata Group was organized into seven business sectors:
Information Technology and Communications (16% of Tata revenue)

Engineering Product and services (33% of Tata revenue)
Materials (32% of Tata revenue)
Services (4% of Tata revenue)
Energy (6% of Tata revenue)
Consumer products (4% of Tata revenue)
Chemicals (3% of Tata revenue)

9
Key elements of the success of Tata group as a multi-industry conglomerate are:
• The primary connection between the Tata group companies and perhaps their
biggest collective source of strength is the Tata brand , which in 2011 was named one
of the top 50 global brands by Brand Finance.
• The Tata Group exploits its scale and the diversity of its collective companies in order
to foster learning, leadership development and the sharing of best practices across
the group. Such as TAS, TMTC.
• Tata Group companies operate with a significant degree of independence, they have
the financial, intellectual and other resources of the broader group behind them.

10
Corporate Strategy of Apple
Apple Inc. is one of the most successful companies in the world and their corporate strategy
is most of the reason why Apple is successful.
• Originally, they were simply a computer store, but then they expanded to be both
software and hardware products. Products offered currently: home computers, personal
computers, phones, music devices, software and applications.
• Products of the future: AppleTV and upgraded versions of the iPhone and iPad.
• One of the only computer manufacturers who own their own retail stores.
• Company promotes the integrated value of their products; Apple may cost more initially,
but the way they integrate their hardware and software creates value for the consumer.
• Their platform strategy makes it beneficial to a consumer to use all Apple products
because all their products run on the same platform .
• Their products all use a very similar design and can all run Apple applications, which
means that Apple uses constrained diversification

11
Corporate Strategy of Apple Cont…
• Apple utilizes economies of scope to increase efficiency; use many of the same
resources for their many products (standard inputs in the industry).
• Apple is also well known for diversifying their products once they've hit the market (ex.
iPod classic turned into iPod shuffle, nano, video etc.).
• Well known for their excellent customer support.
• Their PC and home computer sales are in the mature stage, but most of their other
products are still in the growth stage.
• Products like iTunes and the iPod are cash cows because they are still popular, but don't
require too much investment from Apple
• Products like the iPhone and the iPad are stars because they are currently successful,
but Apple is trying to update the current version for even more sales.
• Apple is lucky because most of their products that are question marks quickly turn to
stars because of Apple's popularity as a brand.

12
Corporate Strategy of Aditya Birla Group
• Birla’s diversification strategies include operational relatedness when they

formed Grasim industry. Birla textile and Grasim could share resources like
plant, R&D facilities, distribution centers etc. thereby saved cost.
• Diversification into metal business and formation of Hindalco was a good

example of growth motive and risk spreading across businesses. Hindalco’s
diversification in the upstream and downstream was to have synergies due to
operational relatedness.
• Diversification into cellular & insurance business gave Birla group entry into
markets which were attractive and had low cost of entry.
• Thus it shows strategic relatedness in all the Birla group business which has
made a US $35 billion corporation and in the league of Fortune 500.

13
IMP BCG Growth-Share Matrix
• In the early 1970’s the Boston Consulting Group (BCG) developed a model for managing
a portfolio of different business units or major product lines.
• The BCG growth-share matrix displays the various business units on a graph of the
growth rate vs. market share relative to competitors.
Require huge
investments
growth Introduction largeinvestment
highly competitive needed to grow
huge return gainmarketshare
new products
if ignored becomedog
hugereturns
Require Low Maturity Decline
investment cowinvestment
follow stability required Rlow revenue
strategies generation
Deteriorate pulled showed mostly be
out of
market liquidated
Ritika
Figure:Jaiswal, Department of Economics
BCG Matrix
14
BCG Growth-Share Matrix
Stars-
• Stars represent business units having large market share in a fast growing industry.
• They may generate cash but because of fast growing market, stars require huge
investments to maintain their lead.
• Net cash flow is usually modest.
• Business unit located in this cell are attractive as they are located in a robust industry
and these business units are highly competitive in the industry.
• If successful, a star will become a cash cow when the industry matures.
Cash Cows-
• Cash Cows represents business units having a large market share in a mature, slow
growing industry.
• Cash cows require little investment and generate cash that can be utilized for
investment in other business units.
• These SBU’s are the corporation’s key source of cash, and are specifically the core
business. They are the base of an organization.
• These businesses usually follow stability strategies. When cash cows loose their
appeal and move towards deterioration, then a retrenchment policy may be pursued.

15
Question Marks-
• Question marks represent business units having low relative market share and located in a
high growth industry.
• They require huge amount of cash to maintain or gain market share.
• Question marks are generally new goods and services which have a good commercial
prospective.
• Most businesses start as question marks as the company tries to enter a high growth
market in which there is already a market-share.
• If ignored, then question marks may become dogs, while if huge investment is made, then
they have potential of becoming stars.
Dogs-
• Dogs represent businesses having weak market shares in low-growth markets. They
neither generate cash nor require huge amount of cash.
• Due to low market share, these business units face cost disadvantages.
• Generally retrenchment strategies are adopted because these firms can gain market share
only at the expense of competitor’s/rival firms.
• These business firms have weak market share because of high costs, poor quality,
ineffective marketing, etc.
• Unless a dog has some other strategic aim, it should be liquidated if there is fewer
prospects for it to gain market Ritika
share. Number
Jaiswal, Departmentof ofdogs should be avoided and minimized in
Economics
16
an organization. BITS Pilani K K Birla Goa Campus
BCG Product Life Cycle

17
BCG Growth-Share Matrix Analysis of Apple
Market Share
High Low
High Star Question Mark

Iphone -Hold Macbook- Analyse
Market
Growth
Cash Dog
Low
Cows Ipod- divest
Ipad Harvest

18
BCG Growth-Share Matrix Analysis of Coca-Cola
Market Share
High Low
Star Question Mark

High
Thumbs Up, Maaza, Fanta, Sprite- Analyse
Market Kinley-Hold
Growth
Cash
Dog
Cows
Diet Coke, Minute
Coca-cola, Limca
Maid- Divest
Harvest

19
BCG Growth-Share Matrix Analysis of Coca-Cola

20
BCG Growth-Share Matrix Analysis of Media Channel
Market Share
High Low
Star Question Mark

High
Mobile Application - Digital- Analyse
Market Hold
Growth
Cash
Dog
Low Cows
divest
Media Industry and
News Industry-Harvest

21
Why Kodac camera fails?
Market Share
High Low
High Star Question Mark

Digital Camera -Hold Digital- Analyse
Market
Growth
Cash Dog
Low
Cows Film
Film Camera-Harvest

22
Module 2
Blind Spot Analysis, SPACE Analysis

and Value Chain Analysis

1
WARNING


Blind Spot Analysis
Why Yahoo fails?

Why Nokia fails? Inability or willful decision of management to identify
Why Kodac fails ? the “Blind Spot”.
Why Videocon Fails?
Why JP Infratech becomes bankrupt?
• The Blind spot Analysis uncovers dangerous, incomplete, incorrect and

outdated assumptions that can inhibit decision making within an organisation.
• American economist Michael Porter first used the term to detect old-fashioned
wisdoms and assumptions within companies, that support the business strategy and
prevented new, modern ideas from having a chance of succeeding. Such as mistake
which was done by Nokia and Kodac.
used
ymbian didnotgetandroid 2 did not includedigitalphotographs atnighttime
• Businesses can use this to replace ingrained and old-fashioned convictions and
assumptions with modern reality, thoughts, and convictions. This ensures their
decisions will be more effective.

3
IMP Blind Spot Analysis
“Patterns That Gave Success In the Past Can Delay Your Progress In The Future”
Especially a Blind spot Analysis can uncover shortcomings and make it easier to abandon
old-fashioned ideas. Blind spots can manifest in three ways:
• The (top) management is completely ignorant of strategically important issues.

• The (top) management is aware of strategically important issues, but does not interpret
them correctly.
• The (top) management is aware of problems being caused by outdated assumptions
and interpretations, but discovers this too late and as a result also acts too late.
Identifying and removing blind spots is of crucial importance for effective strategic
decision making to minimise the chance of making wrong decisions.
Apart from the fact that blind spots are mostly caused by old-fashioned ideas, it also has
to do with the mindset of the supervisor.

4
Steps to uncover the blind spot in an organisation
In the end, it was the Israeli-born American psychologist and philosopher Benjamin
Gilad who developed a 3-step method to uncover blind spots in his book ‘Business blind
spots‘.
Step 1: Identify the historical organisational perspective based on which previous strategic
decision has been taken. Such as what are the arguments, factors and context are
considered to arrive at these strategic decisions?
Step 2: To identify the perspective and viewpoint of external public about the organisation.
Using public information, it is researched how an organisation has profiled itself and what
outsiders thought of this. Think of interviews with important decision makers within the
organisation, assumptions by top managers, information for stock holders, interviews in the
media, public appearances and speeches, telephone meetings and maybe even
autobiographies by directors.
Step 3: The results of step 2 are then compared with those of step 1. Every contradiction
with the results from step 1 is a potential blind spot.
Top Management lacks inJaiswal,

Ritika reflective listening
Department about their blind spot.
of Economics
5
Blind Spot Analysis
A simplifies framework of Blind Spot Analysis
Misjudging industry boundaries & trends, misjudging customers’ changing needs, poor
identification of the competitors & their strategies and weak organisational structure &
culture are the broad reasons that lead to blind spots in the competitive analysis of a
firm.
Cases of Yahoo, Nokia, Kodac,
Vodafone etc.
Cases of Yahoo, Nokia, Kodac,

JP Infratech etc.
Cases of Motorola, Blackberry,

Kodac etc.
Cases of Lehman Brother, IBM,
Delta Airlines etc.
Culture and leadership in Intel, Apple and Google are the example where they are very
much alive to the danger and reminded his staff constantly to be wary of complacency. They
believe they are working for other people, not just to make money for themselves or hit
targets for their companies. 6
Following sections describe all of the aspects of blind spot analysis:

7
How to overcome the problem of blind spot:
• Always keep in touch with environment externally and internally
• Perform regular competitive intelligence program
• Perform benchmark testing regularly
Culture and leadership in Intel, Apple and Google are the example where they are very
much alive to the danger and reminded his staff constantly to be wary of complacency. They
believe they are working for other people, not just to make money for themselves or hit
targets for their companies.

8
SPACE Analysis
• Strategic Position and Action Evaluation (SPACE) analysis is an analytical technique used
in strategic management and planning.
• SPACE matrix was developed by H. Rowe, Mason and Dickel in their book “Strategic
management and business policy: A methodological Approach”.
• It analyzes the company’s strategic position in comparison to the strategic position of the
industry.
• It can be used a basis for other analysis such as SWOT analysis, BCG matrix model,
Industry analysis or assessing strategic alternatives.
• The analysis assesses the internal and external environment and allow to design an
appropriate strategy for the enterprise.

9
IMP SPACE Analysis
SPACE matrix has four quadrant which basically determine the strategic positioning of the
organisation.
The first two quadrant describes the external positioning of an organisation:

• Environmental Stability (ES): it is influenced by the following subfactors: technological
change, inflation rate, demand volatility, price range of competitive products, price
elasticity of demand, pressure from the substitutes.
• Industry Attractiveness (IA): it is influenced by the following subfactors: growth

potential, profit potential, financial stability, resource utilization, complexity of
entering the industry, labor productivity, capacity utilization, bargaining power of
manufacturers.
The other two quadrant of the matrix represents the internal strength of an organisation:
• Competitive advantage (CA) - it is influenced by the following factors: market
share, product quality, product lifecycle, innovation cycle, customer loyalty, vertical
integration.
• Financial strength (FS) - it is influenced by the following indicators: return on

investment, liquidity, debt ratio, available versus required capital, cash flow, inventory
turnover.
10
SPACE Analysis
IMP
Internal Strategic Position:
Financial Strength (FS): Competitive Advantage (CA)

ROI Market Share
Leverage Product Quality
Liquidity Product Life Cycle
Working Capital Customer Loyalty
Cash Flow Competitors’ Capacity Utilization
Inventory Turnover Technology Knowhow
Earning per share Control over Suppliers and Distributors
Price Earning ratio

11
SPACE Analysis
External Strategic Position:
Environmental Stability (ES) Industry Strength(IS)

Technological Changes Growth Potential
Rate of Inflation Profit Potential
Demand Variability Financial Stability
Price range of competing products Technological Know How
Barrier to entry into market Resource Utilization
Competitive pressure Ease of Entry into Market
Ease of Exit from Market Productivity, Capacity Utilization
Price Elasticity
Risk

12
IMP SPACE Analysis
SPACE Matrix:
The following are a few model technical assumptions:
- By definition, the CA and IS values in the SPACE matrix are plotted on the X axis.
- CA values can range from -1 to -6.
- IS values can take +1 to +6.
- The FS and ES dimensions of the model are plotted on the Y axis.
- ES values can be between -1 and -6.
- FS values range from +1 to +6.

13
SPACE Analysis
Based on the SPACE matrix analysis following strategic position can be taken by the
company:
Aggressive Position - an attractive and relatively stable industry, the company has a
competitive advantage and it can protect it, a critical factor is the possible entry of
new competitors into the industry, it may be considered new acquisitions, increasing
market share, market integration (MI), Market Penetration(MP), Market Development
(MD) and focusing on competitive products through product development and
diversification.
Competitive Position- The Competitive position arises when a firm has strong
advantages in an attractive industry but its financial strength is insufficient to
compensate for environmental instability. The immediate strategy is to the solution is
the possibility of joining another company, increasing production efficiency and
strengthening cash flow, MI, MP,MD etc.

14
SPACE Analysis
Conservative position - a stable industry with low growth rate and financially stable
company, a critical factor is in the product competitiveness, company should protect its
successful products and develop new ones and think about the possibilities of the
penetration into the industry more attractive, reduce costs, PD and related diversification.
Defensive position - an unattractive industry, the company lacks competitive products

and financial resources, a critical factor is the competitiveness, the company should
reduce costs, reduce investment, retrenchment divestment and consider leaving the
industry.
Thus SPACE matrix is a framework that indicates whether aggressive, conservative,

defensive or competitive strategies are the most appropriated for a given organization.

15
IMP
SPACE Analysis
Steps to construct SPACE matrix:
• The SPACE matrix is constructed by plotting calculated values for the competitive
advantage (CA) and industry strength (IS) dimensions on the X axis.
• The Y axis is based on the environmental stability (ES) and financial strength (FS)
dimensions. The SPACE matrix can be created using the following seven steps:
Step 1: Choose a set of variables to be used to gauge the competitive advantage (CA),
industry strength (IS), environmental stability (ES), and financial strength (FS).
Step 2: Rate individual factors using rating system specific to each dimension. Rate
competitive advantage (CA) and environmental stability (ES) using rating scale from -6
(worst) to -1 (best). Rate industry strength (IS) and financial strength (FS) using rating scale
from +1 (worst) to +6 (best).
Step 3: Find the average scores for competitive advantage (CA), industry strength (IS),
environmental stability (ES), and financial strength (FS).
Step 4: Plot values from step 3 for each dimension on the SPACE matrix on the appropriate
axis.
Step 5: Add the average score for the competitive advantage (CA) and industry strength
(IS) dimensions. This will be yourRitika
final point
Jaiswal, on axis
Department X on the SPACE matrix.
of Economics
16
SPACE Analysis
Steps to construct SPACE matrix:
Step 6: Add the average score for the SPACE matrix environmental stability (ES) and
financial strength (FS) dimensions to find your final point on the axis Y.
Step 7: Find intersection of your X and Y points. Draw a line from the center of the SPACE
matrix to your point. This line reveals the type of strategy the company should pursue.
17
SPACE Analysis
Now the completed SPACE matrix looks like:

18
SPACE Analysis
Another example of SPACE matrix construction:
Coordinate (-2.15, -3) indicatesRitika

thatJaiswal,
vector pointsofare
Department in defensive quadrant.
Economics
19
Value Chain Analysis
What is Value Chain Analysis?
• Value chain analysis is the method for determining the critical path to enhance
customer value while reducing costs.
• A value chain is the full range of activities – including design, production, marketing and
distribution – businesses conduct to bring a product or service from conception to
delivery.
• Harvard Business School's Michael E. Porter was the first to introduce the concept of a
value chain. Porter, who also developed the Five Forces Model to show businesses
where they rank in competition in the current marketplace, discussed the value chain
concept in his book "Competitive Advantage: Creating and Sustaining Superior
Performance" (Free Press, 1998).
• Competitive advantage cannot be understood by looking at a firm as a whole," Porter

wrote. "It stems from the many discrete activities a firm performs in designing,
producing, marketing, delivering and supporting its product. Each of these activities can
contribute to a firm's relative cost position and create a basis for differentiation."

20

21
IMP
In his book, Porter splits a business's activities into two categories: Primary Activities and
support Activities.

22
IMP Value Chain Analysis
Cost Drivers of Value Chain Analysis
• Cost advantage results from a reduction in costs associated with activities in a value
chain.
• After the value chain has been defined, it’s important to associate costs to the activities
and then make adjustments for efficiency.
• Porter identifies 10 cost drivers in order to improve efficiency, add value, and
differentiate.
Economies of scale Learning and spillovers
Pattern of capacity utilization Linkages
Interrelationships Integration
Timing Organization policies
Location Institutional factors
• Value chain analysis is more than a straightforward cost-to-profit model. It expands on

the principles of economies of scale and capacity.
• Value chain analysis stresses that competitive differentiation can also focus on the
perceived value to the customer that justifies a product's price tag.
• Finding these perceived values could mean the difference between getting a consumer
to spend three dollars on a cup of Starbuck's coffee rather than one dollar on a
competitor's discount brand.Ritika Jaiswal, Department of Economics
23
Who uses Value Chain Analysis?
• A wide variety of industries such as enterprise, manufacturing, retail, service, and

technology, in addition to governments and their agencies, successfully adapt the basic
value chain concept, and understand that not all functions or activities need to receive
the same level of scrutiny.
• For example, the Department of Defense (DOD) has a design-chain operations reference
(DCOR) that cites little need to spend time or resources analyzing marketing and sales
activities in their overall value chain.
• Therefore, the first order of any value chain strategy is to identify the important tasks
and functions necessary to deliver your product or service. Once you identify value
activities, you can then focus analysis on where you can add value and discover areas for
optimization, differentiation, or cost efficiency.

24
Examples of Value Chain Analysis
• As one of the biggest purchasers of cocoa in the world, Nestlé has developed the
"Every Woman, Every Child Initiative." To improve company value, they have
committed to providing expertise, sustainable solutions, and social improvements,
especially in the area of child labor
• Selecting and sourcing high-quality coffee beans, developing loyalty through

excellent customer service, and aggressively marketing their brand were key
elements in Starbucks’ creation of a unique identity and a robust competitive
edge.
• Rather than focusing on premium pricing, Pizza Hut outpaced the competition by
offering fast delivery of a less expensive product.
• To increase market share and brand loyalty, FedEx's value chain emphasizes and
invests in employee development through excellent human resources initiatives
and infrastructure improvements.
• Walmart is constantly performing value chain analysis in order to keep costs low
for their customers. From regularly evaluating suppliers and integrating in-store
and online shopping experiences to remaining innovative in order to differentiate,
25
IMP Value Chain Analysis
Disadvantages of Value Chain Analysis
• Some of the difficulties involve gathering data (which can be labor and time-
intensive), identifying the tasks or functions that can add perceived or real value,
and developing and deploying the plan.
• Additionally, it is not always easy to find appropriate information in order to break
your value chain down into primary and supporting activities.

26
Module 3
Accounting Analysis: Institutional

Framework for Financial Reporting

1
WARNING


Accounting Analysis
Purpose of Accounting Analysis
• The purpose of accounting analysis is to evaluate the degree to which a firm's

accounting captures its underlying business reality.
• By identifying places where there is accounting flexibility, and by evaluating the

appropriateness of the firm's accounting policies and estimates, analysts can assess
the degree of distortion in a firm's accounting numbers.
• Having identified any accounting distortions, analysts can then adjust a firm’s
accounting numbers using cash flow and footnote information to “undo” the
distortion.

3
Accounting Analysis
Institutional Framework for Financial Reporting
• In United States, financial statements are prepared based on Generally Accepted

Accounting Principles (GAAP) which denotes the accounting standards, conventions
rules and procedures.
• The financial standards and principles denoted as GAAP have been set by the
Financial Accounting Standards Board (FASB).
• Due to globalization, need arises to develop a set of high quality global accounting
standards.
• Hence, in 1974, the International Accounting Standards Board (IASB) and its
predessor, the International Accounting Standards Committee (IASC) have promoted
worldwide accounting standards which is called as International Financial Reporting
Standards (IFRS).

4
Accounting Analysis
• In India , Indian Accounting Standard (abbreviated as Ind-AS) is the Accounting

standard adopted by companies and issued under the supervision of Accounting
Standards Board (ASB) which was constituted as a body in the year 1977.
• ASB is a committee under Institute of Chartered Accountants of India (ICAI) which

consists of representatives from government department, academicians, other
professional bodies viz. ICAI, representatives from ASSOCHAM, CII, FICCI, etc.

5
Accounting Analysis
Accounting Standards
• Accounting standards specify how transactions and other events are to be

recognized, measured, presented and disclosed in financial statements. The
objective of such standards is to provide financial information to investors, lenders,
creditors, contributors and others that is useful in making decisions about providing
resources to the entity. For example, measurement of deferred tax, valuation of
assets, intangibles and financial instruments etc. and presentation and disclosure of
such measurements and valuations.
• The Ind AS are named and numbered in the same way as the International Financial
Reporting Standards (IFRS). National Advisory Committee on Accounting
Standards (NACAS) recommend these standards to the Ministry of Corporate
Affairs (MCA).

6
Accounting Analysis
Accounting Principles
• Accounting principles are the general rules and guidelines that companies are required to
follow when reporting all accounts and financial data. Whilst there is currently no
universally standardized accepted accounting principles, there are various accounting
frameworks which set the standard body.
• The most common accounting principle frameworks used are IFRS, UK GAAP, and US
GAAP. The purpose of having - and following - accounting principles is to be able to
communicate economic information in a language that is acceptable and understandable
from one business to another.
• Companies that release their financial information to the public are required to follow
these principles in preparation of their statements.

7
Accounting Analysis
Accounting Principles Cont…
Accounting principles involve both accounting concepts and accounting conventions.
Accounting Concepts:
1. Business Entity Concept: The business and its owner(s) are two separate existence
entity. Any private and personal incomes and expenses of the owner(s) should not
be treated as the incomes and expenses of the business. Such as insurance premium
for the owner’s house should be excluded from the expense of the business, any
payments for the owner’s personal expenses by the business will be treated as
drawings from business.
2. Money Measurement Concepts: Only business transactions that can be expressed in

terms of money are recorded in accounting. Such as market conditions,
technological changes and the efficiency of management would not be disclosed in
the accounts.
3. Dual Aspect Concept: Every transaction should have a two-sided effect to the extent
of same amount i.e. for every debit , there is a credit. Such as Cash sales Rs. 10,000.
Debit: Cash A/c Rs. 10,000
Credit: Sales A/c Rs. 10,000 8
Accounting Analysis
4. Going Concern Concept: In accounting, a business is expected to continue for a fairly

long time and carry out its commitments and obligations. This assumes that the
business will not be forced to stop functioning and liquidate its assets.
5. Cost Concept: An asset acquired by a concern is recorded in the books of accounts at

historical cost i.e. at the price actually paid for acquiring the asset. The market price of
the asset is ignored.
6. Accounting Period Concept: For measuring the financial results of a business

periodically, the working life of an undertaking is split into convenient short periods
called accounting period.
7. Matching Concept: The matching principle ensures that revenues and all their
associated expenses are recorded in the same accounting period. The matching
principle is the basis on which the accrual accounting method of book-keeping is built.
Such as: Salary paid in 2012-13 relating to 2011-12. Such salary is treated as
expenditure for 2011-12 under Outstanding Salaries Account, not for the year 2012-13.

9
Accounting Analysis
8. Realisation Concept: Revenues should be recognized when the major economic

activities have been completed. Sales are recognized when the goods are sold and
delivered to customers or services are rendered. Thus it is incorrect to record profit
when order is received, or when the customer pays for the goods.
Accounting Conventions:
1. Conservatism: By this convention, profit should never be overestimated, and there

should always be a provision for losses. Accountant should always anticipate for all
losses rather than the profit. Such as making provision for bad and doubtful debts,
showing depreciation on fixed assets but not appreciation.
2. Consistency: The accounting practices and methods should remain consistent from
one accounting period to another. Whatever accounting practice is followed by the
business enterprise, should be followed on a consistent basis from year to year. Such as
Depreciation method of either straight line method or written down value method
should be followed in a consistent manner for all the accounting periods.
10
Accounting Analysis
3. Materiality: Only those transactions, important facts and items are shown which are useful
and material for the business. The firm need not record immaterial and insignificant items.
Such as Company XYZ Ltd. Bought 6 months supplies of stationary worth $600. Based on this
concept, as the amount is so small or immaterial, it can be expensed off in the next month
instead of tediously expensing it in the next 6 months.
A large company has a building in the hurricane zone during Hurricane Sandy. The company
building is destroyed and after a lengthy battle with the insurance company, the company
reports an extra ordinary loss of $10.00. The company has net income of $10,000,000. The
materiality concept states that this loss is immaterial because the average financial statement
user would not be concerned with something that is only .1% of net income.
4. Full Disclosure: Financial statements and their notes should present all information that is
relevant and material to the user’s understanding of the statements.

11
Accounting Analysis
Financial Reports
On a periodic basis, firms typically produce three primary financial reports:

1. Income Statement: It describes the operating performance during a time period.
2. Balance Sheet: It states the firm’s assets and how they are financed.
3. Cash Flow Statement: It summarizes the cash flows of the firm.
These statements are accompanied by footnotes that provide additional details on the
financial statement line items.

12
Accounting Analysis

13
Accounting Analysis

14
Accounting Analysis

15
Accounting Analysis

16
Accounting Analysis

17
Accounting Analysis

18
Accounting Analysis
Cost and Benefit associated with the Delegation of Reporting Discretion to Management
Benefits:
• Managers are entrusted with the primary task of making the appropriate decision
with respect to portraying the business transaction in accounting reports based on
accrual accounting framework.
• The accounting discretion granted to managers is potentially valuable because it
allows them to reflect inside information in reported financial statements.
Costs:
• However, since investors view profits as a measure of managers’ performance,

managers have an incentive to use their accounting discretion to distort reported
profits by making biased assumptions.
• Further, the use of accounting numbers in contracts between the firm and outsiders
provides motivation for management manipulation of accounting numbers.
• This willful distortion in financial accounting data divert the actual purpose of
financial statements to external users.
19
Accounting Analysis
Delegation of Reporting Discretion to Management
Accounting rules and auditing are mechanisms designed to reduce the cost and preserve
the benefit of delegating financial reporting to corporate managers.
• Accounting Rules: Accounting rules and regulations are defined by GAAP. These
accounting standards create a uniform accounting language and increase the
credibility of financial statements by limiting a firm’s ability to distort them. However
these rigid standards sometimes become dysfunctional when it prevent managers
from using their superior business knowledge in assessing a transaction’s economic
consequences.
• External Auditing: External auditing of the reported financial statements improves the
quality and credibility of accounting data by limiting a firm’s ability to distort financial
statements to suit its own purposes.
• Legal Libility: The threat of lawsuits and resulting penalties have the beneficial effect
of improving the accuracy of disclosure.

20
Accounting Analysis
Incidence of Accounting Fraud
Satyam Scandal (2009): Falsely boosted revenue by $1.5 billion. Falsified revenues,
margins and cash balances to the tune of 50 billion rupees.
Lehman Brothers Scandal (2008) : Hid over $50 billion in loans disguised as sales. It is
also called as Repo 105. Allegedly sold toxic assets to Cayman Island banks with the
understanding that they would be bought back eventually. Created the impression
Lehman had $50 billion more cash and $50 billion less in toxic assets than it really did.
Main players of this scandal was Lehman executives and the company’s auditors Ernst
and Young.
Bernie Madoff Scandal (2008): A Wall Street investment firm founded by Madoff,
tricked investors out of $64.8 billion through the largest Ponzi scheme ever. Investors
were paid returns out of their own money or that of other investors rather than profits.
Madoff told his sons about his scheme and his son reported him to the SEC. He was
arrested the next day.
Gupta Scandal (2018) :

KPMG has become central to the scandal over the Gupta family since the leaked emails
showed its South African office allowed a Gupta-owned company, Linkway Trading, to
treat spending on a 2013 Gupta family wedding
BITS Pilani asCampus
K K Birla Goa a business expense. 21
Accounting Analysis
Freddie Mac Scandal (2003) A federally backed mortgage-financing giant, misstated

earnings of $5 billion. They intentionally misstated and understated earnings. An SEC
investigator caught this fraud. Main players was president and chairman of the company.
The funny fact was one year later Fannie Mae, the other federally backed mortgage
financing company was caught in an equally stunning scandal.
American Insurance Group Scandal (2005): Massive accounting fraud to the tune of $3.9
billion was alleged. Created false accounting records writing loans as revenues , resulted
in mislead of investors to say that they did significantly better performance then they
really endured. One whistle-blower brings this fraud into the notice of SEC regulators.
WorldCom Scandal (2002): A telecommunication company, inflated assets by as much as $

11 billion, leading to 30,000 lost jobs and $180 billion in losses for investors. They
underreported line costs by capitalizing rather than expensing, and inflated revenues with
fake accounting entries. WorldCom’s internal auditing department uncovered $ 3.8 billion
in fraud.

22
Accounting Analysis
Enron Scandal (2001): They kept huge debts off the balance sheets. Andersen, the
company's auditor, has admitted to an “error of judgment” in its treatment of the debt
of one of Enron's off-balance-sheet vehicles; these vehicles led to an overstatement of
profits by almost $600m over the years 1997-2000. High stock prices fueled suspicion
which is noticed by internal whistle-blower .
Waste Management Scandal (1998). It was a massive fraud lasting over five years from
1992 to 1997 involving six top officers. The company’s revenue was not growing fast
enough to meet predetermined earnings target. So the executives falsified and
misrepresented the company’s financial results to make the official reports look good
and get money out of it. The company allegedly falsely increased the depreciation time
length and salvage values of garbage trucks. Similarly expenses were not recorded for
decrease in value of landfills and cost of unsuccessful landfill development projects.
Main players was the company’s CEO and company’s auditor, Arthur Andersen. A new
CEO and management team caught the misrepresentation.

23
IMP Accounting Analysis
Factors Influencing the Accounting Quality
• Information in corporate financial reports is noisy and biased, even in the presence
of accounting regulation and external auditing.
• The objective of accounting analysis is to evaluate the degree to which a firm’s
accounting captures its underlying business reality and to “undo” any accounting
distortions.
• There are three potential sources of noise and bias in accounting data
1. the noise and bias introduced by rigidity in accounting rules
2. random forecast errors
3. systematic reporting choices made by corporate managers to achieve specific
objectives

24
IMP
Accounting Analysis
Accounting Rules: Accounting distortions are not necessarily a deliberate attempt by

management to misrepresent the true operating picture of the company. They may
occur because of the accounting process in which the true economic profit of a
business is not visible. Such as R & D outlay, merger expenses, Inventory cost flows,
depreciation method.
Forecast Errors: Another source of noise in accounting data arises from forecast error,
because managers cannot predict future consequences of current transactions
perfectly. For example provision of bad debts.
Manager’s Accounting Choices: Managers have a variety of incentives to exercise

their accounting discretion to achieve certain objectives, leading to systematic
inﬂuences on their ﬁrms’ reporting.
• Accounting Based Debt Covenants Regulatory Consideration
• Management Compensation Capital market consideration
• Corporate Control contest Stakeholders consideration
• Tax Consideration Competitive Consideration
• Disclosure Policy
25
Module 3
Steps of Accounting Analysis

1
WARNING


Imp Steps in Performing Accounting Analysis
Step 1: Identify Principal Accounting Policies
• One of the major goal of financial statement analysis is to evaluate how well the key
success factors and risks such as firm's industry characteristics and its own competitive
strategy are being managed by the firm.
• Such as a significant success factor in the leasing business is to make accurate forecasts
of residual values of the leased equipment at the end of the lease terms.
• The analyst has to identify the

accounting measures the firm uses to capture these business constructs
the policies that determine how the measures are implemented
the important estimates embedded in these policies.

3
Step 2: Access Accounting Flexibility
• Firms do not have equal flexibility in choosing their accounting policies and estimates.
• Some firm’s accounting choice is severely constrained by accounting standards and

conventions. Such as R&D outlay for biotechnology firms, marketing and brand
building outlay of consumer goods firms, managing credit risk for banks etc.
• Regardless of the degree of accounting flexibility a firm’s managers have in measuring

their key success factors and risks, they have come flexibility with respect to other
accounting policies. Such as depreciation policies, inventory accounting policies etc.
• All these policy choices can have a significant impact on the reported performance of
a firm. Hence, analyst should focus on that how firms are managing its reported
numbers using these opportunities.

4
Step 3: Evaluate Accounting Strategy
Analyst has to evaluate that how managers are utilizing the accounting flexibility if they
have that facility. Following questions one should ask in examining how managers
exercise their accounting flexibility:
• How do the firm’s accounting policies compare to the norms in the industry?
• Do managers face strong incentives to use accounting discretion to manage earnings?
• Has the firm changed any of its policies or estimates?
• Have the company's policies and estimates been realistic in the past?
• Does the firm structure any significant business transactions so that it can achieve
certain accounting objectives?

5
Step 4: Evaluate the Quality of Disclosure
Disclosure quality is an important dimension of a firm’s accounting quality. Hence

accounting rules require a certain amount of minimum disclosure in which managers have
considerable choice. An analyst could ask the following questions, in assessing a firm’s
disclosure quality:
• Does the company provide adequate disclosures to assess the firm’s business strategy and
its economic consequences?
• Do the footnotes adequately explain the key accounting policies and assumptions and
their logic?
• Does the firm adequately explain its current performance? (Management Discussion and
Analysis (MD&A) section of the annual report helps the analyst to understand the reasons
behind a firm’s performance changes.)
• If accounting rules and conventions restrict the firm from measuring its key success
factors appropriately, does the firm provide adequate additional disclosure to help
outsiders understand how these factors are being managed?
• If a firm is in multiple business segments, what is the quality of segment disclosure?
• How forthcoming is the management with respect to bad news?
• How good is the firm’s investor relations program?
6
Step 5: Identify Potential Red Flags
A common approach to accounting quality analysis is to look for “red flags” pointing to
questionable accounting. Some of the red flags are as follows:
• Unexplained changes in accounting, especially when performance is poor
• Unexplained transactions that boost profits
• Unusual increase in accounts receivable in relation to sales increases
• Unusual increase in inventories in relation to sales increase. But this could also mean 1h
co is stocking up forfuture
• An increasing gap between a firm’s reported income and its cash flow from operating
activities.
• An increasing gap between a firm’s reported income and its tax income.
• A tendency to use financing mechanism such as research and development
partnerships, special-purpose entities and the sale of receivables with recourse.
• Unexpected large asset write-offs
• Large fourth-quarter adjustments
• Qualified audit opinions or changes in independent auditors that are not well justifies.
• Related party transactions or transactions between related entities.
• Unexplained increase in contingencies and off-balance sheet transactions.

7
Steps in Performing Accounting Analysis
Imp
Step 6: Undo Accounting Distortions
• If the accounting analysis suggests that the firm’s reported numbers are misleading,
analysts should attempt to restate the reported numbers to reduce the distortion to
the extent possible.
• A firm’s cash flow statement provides a reconciliation of its performance based on

accrual accounting and cash accounting.
• Financial statement footnotes also provide information that is potentially useful in

restating reported accounting numbers.

8
Accounting Analysis Pitfalls
There are several potential pitfalls and common misconceptions in accounting analysis
that an analyst should avoid. Such as
1. Conservative Accounting is not “Good” Accounting

Financial Statement users want to evaluate how well a firm’s accounting
captures business performance in an unbiased manner and conservative accounting can
be just as misleading as aggressive accounting in this respect.
2. Not all Unusual Accounting is Questionable
Unusual accounting choices might take a firm’s performance difficult to compare

with other firm’s performance, such an accounting choice might be justified if the
company’s business is unusual.

9
Value of Accounting Data and Accounting Analysis
• Analysts who are able to identify firms with misleading accounting are able to create
value for investors.
• The findings also indicate that the stock market ultimately sees through earnings
management.
• In most cases, earnings management is eventually uncovered and the stock price
responds negatively to evidence that firms have inflated price earnings through
misleading accounting.

10

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Business Analysis And Valuation

Module 1: Framework for Business

Ritika Jaiswal, Department of Economics

These slides are only for your personal

Ritika Jaiswal, Department of Economics

• Business entities are formed to produce or sell a product or services.

• Achieve a desired output.

• Output for public or private benefits.

Ritika Jaiswal, Department of Economics

These business entities exists with a certain ‘Vision-Goals-Strategies’.

Vision: Future road map

Missions Current plans which the business is to achieve

Ritika Jaiswal, Department of Economics

Vision: Tesla Motors:

Mission: Google: Organizing the world’s information

Mission: Tesla Motors: To accelerate the world’s transition to sustainable transport

Ritika Jaiswal, Department of Economics

Ritika Jaiswal, Department of Economics

• If there is any disruption in business ecosystem it results in :

• This disruption causes mis-alignment in vision-goal-strategy chain.

Ritika Jaiswal, Department of Economics

Key components of a solution includes:

Ritika Jaiswal, Department of Economics

Success of a solution lies in

• Understanding the ‘Current –State’ of an organization such as pain-points, bottleneck,

• Mapping out the ‘Future-State’ of an organization.

• Eliciting, analyzing, documenting and validating the business, system/technical

• Re-aligning the organization’s ‘Vision-Goal-Strategy’.

Ritika Jaiswal, Department of Economics

Ritika Jaiswal, Department of Economics

Ritika Jaiswal, Department of Economics

• According to the International Institute of Business Analysis (IIBA), Business

Ritika Jaiswal, Department of Economics

Business analysis is the evaluation of a company’s prospects & risks

Business Decision Makers include:

Ritika Jaiswal, Department of Economics

• Code (Accounting- language of business)

• Climate (Environmental factors)

Ritika Jaiswal, Department of Economics

• Prospective analysis: forecasting a firm’s value using financial statements forecasting

Ritika Jaiswal, Department of Economics

• Understanding the Business Model of the Company

Ritika Jaiswal, Department of Economics

The process of conducting research on the business environment within

Why Use it?

When to use it?

Tools of Strategic Analysis

Ritika Jaiswal, Department of Economics

Strategy Analysis involves

Ritika Jaiswal, Department of Economics

Role of Financial Reporting in Capital

Ritika Jaiswal, Department of Economics

These slides are only for your personal

Ritika Jaiswal, Department of Economics

Financial Reporting involves the disclosure of financial information to the various

These stakeholders include –

Ritika Jaiswal, Department of Economics

According to International Accounting Standard Board (IASB), the objective of financial

• Providing information to management of an organization which is used for the purpose

Ritika Jaiswal, Department of Economics

Financial Reporting is usually considered as end product of Accounting.

Ritika Jaiswal, Department of Economics

The typical components of financial reporting are: