Month: June 2017




Financial Ratio Analysis

 

There are essentially two basic techniques that are used in Corporate Finance. One is the ratio analysis of financial statements and the other is calculating the present value of future cash flows. Bankers, investors, financiers, CFOs and entrepreneurs use these tools and techniques to value assets and make decisions.

 

 

Lets look at using financial ratios as a capital budgeting tool. There are lots of different accounting ratios that get used inside of a firm. In fact, a lot of times the same accounting ratio gets called different things at different firms.

 

 

By ratio analysis I mean taking two numbers from financial statements and dividing one by the other. What we are doing is taking two pieces of accounting data, put one over the other, and this forms a ratio. We are taking two pieces of data and forming a performance metric. Ratios are usually presented as a percentage or a number depending on whether the usual case is bigger or less than one.

 




 

Besides being a capital budgeting tool, ratios allow us to compare different companies or a company over time. Ratios are great tools to do this comparison because they allow us to “normalize” the numbers. A ratio eliminates any size differences and allows for pure comparison so you can compare apples to apples.

 

 

Financial ratios are derived from accounting information and rely on an understanding of financial statements. If you need a primer on the subject download a FREE copy of MBA ASAP 10 Minutes to Understanding Financial Statements. It will get you up to speed on this critical business skill quickly. The NACVA uses this book as a preliminary text in their training.

 


 

Get Your FREE copy of MBA ASAP 10 Minutes to Understanding Financial Statements

 


 

A particularly common valuation of companies done by ratio analysis is based on multiples of Earnings. The Price/Earnings ratio, or P/E for short, is a way companies are compared based on their stock price relative to their earnings. The earnings number is the bottom line of the Income Statement. Earnings are also referred to as Net Income or Profit.

This ratio works well for comparing public companies that report these numbers. This technique can also be used to value a private company by comparing its earnings and valuation range to an average of public reporting companies in similar industry sectors and markets.

 


Related:  The Big Picture of Financial Statements: Interconnection and Flow


 

Other common ratios based on the Balance Sheet are Return on Equity (ROE) and Return on Assets (ROA). A company can basically be thought of as a bunch of income producing assets. Theses assets are bought using two types of funds, Equity, which is money investors put in, and Debt, which is borrowed from a bank or other lender.

We can use ROE and ROA to analyze the performance of the Assets of a company. Here we take the money generated by the income producing assets and divide it by Equity for ROE or total assets for ROA.

Ratio analysis is a powerful tool for investing in the stock market. If you like the idea of being a player in stock market and making good investments, check out The Intelligent Investor by Benjamin Graham. It is the bible of value investing and it’s the way Warren Buffett and other successful investors do it.


The above blog post is excerpted from our eBook MBA ASAP 10 Minutes to Understanding Corporate Finance.

 

 

 

 


MBA ASAP is dedicated to helping you learn skillsets that will make you more valuable at your job, help you start something on the side, or let you quit your job and start your own business.

We focus on helping overcome the fear and intimidation of diving into subject matter that is embedded with arcane buzzwords and sophisticated concepts. By applying concepts of accelerated learning we break down business subjects and disciplines and give you the core 20% knowledge that gets you 80% of the practical skills and knowledge ASAP.

Whether its corporate finance, entrepreneurship and startups, accounting, understanding financial statements, becoming a better negotiator, management and leadership, digital marketing and growth hacking, or how to draft and file a patent; we give you what you need to get to work.

The Approachable MBA

 

Develop you MBA-style business knowledge ASAP. There are tons of resources available to increase your business knowledge. There are powerful books to help you continually expand your horizons. Here is a blog post on how books are helpful experience accelerants.

Business and management, like science, guilds and trades, has its own language and vocabulary. Strategy, Corporate Finance, Entrepreneurship and other disciplines are littered with buzzwords and theory. As in other professions, its partly shortcuts in discussing concepts and partly obscurantism. It can seem intimidating at first. Don’t be intimidated. Relate it to what you already know.

 

You already run a complex enterprise

 

It’s called your life, and it’s about getting, spending and saving; in business it’s called Revenues, Expenses and Retained Earnings. You have a job where you make your money, it gets deposited in your checking account, and you use it to pay your bills, buy groceries and clothes, go out to eat or a movie; and hopefully there is some left over at the end of the month that you can put aside for a rainy day. You manage bank accounts, checkbooks, debit and credit cards, electronic transfer, PayPal, a mortgage or rent, car payments, insurance, healthcare, utilities… It’s complicated! Sometimes (most of the time) you must make hard decisions about what you can and can’t purchase or afford to do. You have plenty of hard-won experience running an enterprise and have earned your Domestic MBA.


You also have your work experience to draw on to form opinions about how best to operate a business. In any job, we are thrown together with a bunch of people for a large part of each day and we have to figure out their personalities and how to navigate working with them. There are bosses, colleagues, clients and customers you like, and ones you don’t like (not all of them have heard of the No Asshole Rule). There are stupid processes that don’t make sense and annoy you with their inefficiency. But there are also things that make you feel good about the work you do and give you a sense of accomplishment and self worth. And then there are the things that make you feel less than good.
These experiences and knowledge, from both your personal and working life, form the basis and context for what you already know about business and management. This knowledge base should form the touchstone against which you can test anything you read or study about business and management to see if it rings true to your experience.
Integrate your learning into what you already have experienced. At the end of the day, it’s all elaborations and nuance of common sense.
The core concepts of business are basic common sense:
• Create something of Value
• Make People Aware of it
• Sell it for more than it costs you to make
• Duh

 

Don’t be intimidated by arcane language and theories. Test them against your experience and add the ones that resonate and discard the ones that don’t. The ones that don’t resonate are also very helpful in that they force you to articulate and acknowledge what you don’t like.
This is an extract from my book Managing and Leading People and Organizations available from Amazon in Kindle and Paperback.

 

 

 

 

Becoming an autodidact, a self-directed learner, is the most efficient way to accumulate the knowledge that seems most important to you and where you want to go. Here are some curated suggestions of the top books on Startups and Entrepreneurship, Technology and the Future, Business Biographies (check out this post on why biographies are important), and top business books written by women.

Reading books about business management isn’t going to make you a great manager all by itself but it can get you thinking about the most important concepts and give you ideas to test and incorporate into your personal style. They will certainly make you better.

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The National Association of Certified Valuators and Analysts are using MBA ASAP 10 minutes to Understanding Financial Statements as a pre-read to their Business Valuation Certification Program. Get you free copy here and level up your financial literacy!