Managerial Financial Analysis

Class 2

2021
Financial Analysis
• Business Performance Review
• Ratio Analysis
Business Performance Review
• Main aims
- provide an understanding of the business
- provide an interpretation of the financial results
• Care must be taken in reviewing business performance,
primarily because of :
- lack of consistency in definitions
- changes in economic conditions
- regional variations.  
Business Performance Review
• Ratio analysis - important method used to analyse the
financial performance of a business
• Usual ratio categories are:

- profitability
- efficiency
- liquidity
- financial structure
- investment
Stages of Performance Review
1. SWOT Analysis
SWOT Analysis

Strengths Weaknesses

Opportunities Threats
Potential Internal Strengths
• Many product lines?
• Manufacturing competence?
• R&D skills and leadership?
• Cost or differentiation advantage?
• New-venture management expertise?
• Appropriate management style?
• Appropriate control systems?
• Ability to manage strategic change?
Potential Internal Weaknesses
• Obsolete, narrow product lines?
• Loss of customer goodwill?
• Inadequate information systems?
• Growth without direction?
• High conflict and politics?
• Industrial relations problems?
Potential Opportunities
• Expand core business?
• Exploit new market segments?
• Diversify into new growth businesses?
• Vertically integrate forwards or backwards?
• Overcome barriers to entry?
Potential Threats
• Increases in domestic or foreign competition?
• Rise in new or substitute products?
• Potential for take-over?
• Changes in demographic factors?
• Changes in economic factors?
• Rising labour costs?
Example SWOT analysis - Airline company
2. Other Key Features
PESTLE ANALYSIS
• Political
• Economic
• Social
• Technological
• Legal
• Environmental
In search of Competitive Advantage…..?

• Porter’s Five Forces (1985)

• Analytical model which:

- allows competitive dynamics to be assessed with regards to the

existing and future profitability of the firm
Porter’s Five Forces
Threat of
New
Entrants

Bargaining Rivalry Bargaining

Power of Among Power of
Suppliers Existing Buyers
firms

Threat of
Substitute
Products
3. Ratio Analysis
Ratio analysis
• Ratio analysis - applied to financial statements and
similar data to:
• Assess performance of a company
• Determine whether company is solvent and financially
healthy.
• Assess risk attached to its financial structure
• Analyse returns generated for shareholders and other
interested parties
Ratio analysis – why?
• Financial figures on their own are difficult to interpret -
need context
• Ratio analysis = relating one figure in FS to another –
drawing meaningful conclusion from the relationship
• Helps to examine and assess trends
• Ratio Analysis requires ‘like’ with ‘like’
• Comparison only possible if an identical basis of
compilation is used
• A Ratio on its own are meaningless….. Its value is as a
comparator
What do we evaluate against?

Competitors

Industry Past
norms performance
Evaluate
against

Rules of Budget
Thumb
Categorisation of ratios
Profitability ROCE, ROE, capital turnover,
Profits relative to Sales & Investment. Analyse Net & Gross margins
different levels of profits (gross, operating, after
tax)
Activity/Efficiency: Receivables, Inventory and
The efficiency with which management manage Payables days,
current assets Asset Turnover
Liquidity: Current & acid test
The ability to meet its short term cash obligations
Financing: Gearing ratios, Debt to equity,
Impact of company’s long term financing Interest cover
structure
Investment: EPS, PE, Dividend cover &
The return generated specifically to shareholders yield
Profitability Ratios
1. Profitability Ratios
• ROCE (Return on Capital Employed)
• ROE (Return on Equity/Shareholders Funds)
• Capital Turnover
• Net and Gross Margins
Ratio 1a – Return on Capital Employed
• But what is Capital Employed?
• It is the funds which company had at its disposal

Definitions vary
• Equity Plus Long term loans
• Equity only
• Equity Plus Long term loans plus short term debt (including trade creditors)
• Total assets (return on total assets)

• NB: Equity= share capital plus all the reserves (i.e. share premium,
revaluation reserve, retained earnings etc)
Ratio 1a – Return on Capital Employed

Operating profit X 100

Total equity+ Long-term debt

• Assesses how effectively funds have been deployed for all

providers of finance

• % of profit made from every €1 of capital invested

• The higher the rate of return the better!

Ratio 1B – Return on Equity

Net profit after interest and tax X 100

Total equity

• Assesses how effectively funds have been deployed specifically

for shareholders
• % of profit made from every €1 invested by shareholders
• The higher the rate of return the better!
Ratio 1C – Capital Turnover

Sales = X times
Capital employed

• Assesses how effectively funds have been deployed to

generate sales
• Higher the better!
• % of profit made from assets
Return on Capital Employed, Return on
Equity, Capital Turnover
• When analysing the above ratios:

• Useful to compare against:

• A target return
• The cost of borrowing or alternative investment
Ratio 1D – Gross Margin
• Gross Profit = Revenue - Cost of Goods Sold

Gross profit x 100

= Sales

• Rule of Thumb:
• 5% = Low Margin , 10% Healthy Margin, 20% High
Margin
• Should be stable and not fluctuate
Ratio 1E – Net Margin

• Net Margin =

Net profit x 100

Sales

• Can use different profit levels (operating profit,

profit before interest and tax (PBIT), profit after
interest and tax (PAIT) etc.
Gross Margin (GM) and Net Margin (NM)
• GM reflects a company’s trading policy and sector

• Reasons for change in GM over time

• Change in sales policy re selling price per unit or
product mix
• Change in purchase cost per unit
• Theft, change in productivity, inventory write offs
• Manipulation: closing inventory, sales.
Gross Margin and Net Margin
• Variation in Net Margin
• Ability to control costs
• Exceptional costs
• Gross profit issue

• Analysis should include a review of all cost items to

isolate reason for variation
We will apply this knowledge – next
class!!
• Look at C&C Group plc 2021 Annual Report (On Moodle page –
notice it is loss making!)

• Also look back to two consecutive years when C&C Group made a
profit (should find this on their website)!

• We will analyse the companies profitability

• You will find the figures we need in Income Statement and Balance
Sheet
Next class
• We will apply the Profitability ratios to C&C plc.
• We will comment on the results
• Look at the limitations
• Move on to Efficiency Ratios!