AEM 1200/2200: Introduction to Business Management: Section 2. Financial Analysis

   The financial analysis section contains the following:

1. A basic ratios analysis for the last 5 years;
2. Comparison of ratios with two relevant competitors for the last 5 years;
3. Comparison of ratios with the overall industry for the last 5 years.

The objective of the financial statement analysis is to examine the financial health of the business. While we ask that you use financial ratios, do not limit yourself to these tools. If you suspect some specific liquidity or profitability concerns, or if you feel that the organization is inefficient, or if you have a sense that upcoming events (maturing long-term debt, pending litigation, etc.) will significantly affect the financial health of the organization, state your case and base your analysis on it!  Be sure to explain what all of the ratios mean and what the calculated values indicate.  Do not simply perform the calculations.

   Where do I look?

The easiest source to use for this section is Capital IQ, but you must create an account.  To create a Capital IQ account, click on the Capital IQ link below. 

 Videos

Below are videos on how to calculate individual ratios for a company, it's top competitors, and it's industry, all for the last 5 years and all by using library resources.  

 Videos

in Capital IQ:

There is more than one way to calculate most ratios.  You do not have to use the formulas offered in these videos, however It is important that you remain consistant and calculate each ratio the same way for your company, the top competitors, and the industry.

As part of the 1 page memo in your assignment, you're expected to conduct a simple valuation of your company to determine if the trading price is fair.  You may choose how to conduct the valuation of your company.  A popular method is through relative valuation and the usual ratios for relative valuation are either the Price to Earnings Ratio or Enterprise Value/EBITDA.

The above video will give you a brief and basic understanding of the Price to Earnings Ratio.  It should be pointed out that the PE ratio does not mean much by itself.  It requires an understanding of the industry, a comparison to major competitors, an understanding of historical performance (and historical PE ratios) and projections of future performance. These factors should all be considered when making your final determination.

If you're looking for a more in-depth explanation of the PE ratio, have a look at Khan Academy's longer and more detailed videos on the PE ratio.

    How do I...

 ...find the information I need to calculate the ratios?
 

• The companies' 10-Ks and just about any company profile database (including sources like Yahoo! and Google Finance) will have the necessary financial information.  The major benefit to using the tools to the left (Capital IQ) is that it is much easier to pull all of the information into one or two spreadsheets, making the data retrieval portion of this section MUCH quicker and easier.  Remember, to calculate the ratio for the industry, you will need finances for many companies at one time!
   

...Where can I find the ratios?

• The standard ratios that you should be looking at are: 
  • Current Ratio
  • Quick Ratio
  • Debt to Equity
  • Inventory Turnover
  • Return on Equity
  • Return on Sales
  • Earnings per Share
     
• From time to time, a company will not list the required line items to calculate one of the above ratios.  When this happens, consider alternate ratios that get at the same thing.  For example, if you're trying to calculate Inventory Turnover, but your company does not have Inventory, consider another efficiency ratio such as Asset Turnover instead.  If you are uncertain about what ratios to use, (particularly as an alternate) ask your TA or professor.
   
• Beyond these ratios, we encourage you to examine the financial statements of your company to see if any other line items stand out.  We encourage you to explore additional ratios that highlight these line items.
   

...Calculate industry ratios?
 

• There are two critical components to calculating industry ratios.  First, determining the industry, and second pulling the appropriate data for each of the companies in the industry.  Capital IQ will all offer a list of competitors for any company you examine.  See if you agree with their list of competitors.  You can cross check with the other sources if you disagree with the companies on the list.  You can, and should, critically think about what companies should be on your competitor list to get the most accurate values possible.  You should also think critically about how many companies appear in your industry.  More companies will typically mean a more accurate number, but in some cases it may not make sense to include a large number of companies (for example, a very diverse company where relatively little of their activity is in your company's industry is one I would consider not adding).  In general I would try to have more than 10 companies in an industry and would consider 5 to be a mininum.
   
• If you'd like to create a custom industry in Capital IQ, that is built in to the Quick Comps features.  Click on the link labeled "Calculating ratios using Capital IQ" to see how to do this. 
  
  
• To pull the appropriate data, you can use any of a number of sources, but Capital IQ or Bloomberg will allow you to do so for each of the companies in your industry at one time.  Bloomberg is our most powerful Business resource, but you will need to visit Mann Library to use Bloomberg, and be prepared for a bit of a learning curve.  Capital IQ is much easier to access and use, and the videos to the left will show you how to calculate each of the ratios using CapitalIQ.
   
• These resources do provide some ready-to-use industry ratios. These can be used to check your work, but remember that you are required to calculate your own ratios.  First of all, this will illustrate your understanding of the ratio to your professor and TAs.  Second of all, different databases calculate ratios in different ways, and calculating ratios yourself is the best way to ensure consistency.  Finally, many of the databases will not tell you what the actual ratios are or how they are calculated, meaning you will not know how they obtained the numbers they have listed for ratios.

  Getting Help

1. First and foremost, please watch the videos available in this guide. They will show you how to use the resources, and therefore find the information you need.
2. If you need clarifications on the assignment, such as ratios or what each section means, please ask your TAs
3. For questions about resources and research, Please visit the NEED HELP? page on this guide.