10 May Finance Case
The typical case report will be about 3 pages (single spaced) in length, not including spreadsheets and other calculations. You must show in the report or in the appendix, all formulas used and all calculations performed to support your analysis.
CASE 7: The Financial Detective, 2005
Synopsis and Objectives
The case presents you with financial ratios for eight pairs of unidentified companies and asks you to mate the description of the company with the financial profile derived from the ratios. The primary objective of this case is to introduce you to financial ratio analysis—in particular, the range of ratios and the insights each one affords. This case presumes that you have already been introduced to the definitions of various financial ratios through other readings or lectures, and prerequisite classes.
The structured exploration of pairs of companies within an industry affords a number of important insights into strategy and financial performance. First, the economics of individual industries account for significant variations in financial ratios because of differences in technologies, product characteristics, or competitive structures. Second, financial performance results from managerial choices: within industries, the wide variation in financial ratios is often a result of the differences in corporate strategy in marketing, operations, and finance. You should see the interaction of strategy and financial performance.
Comparisons among industries
This case is primarily about the effects of managerial strategy on financial ratios, but it also affords several insights about the effect of industry differences on financial ratios. For instance, differences in asset intensity can produce dramatically different asset structures (for example, compare the percentages of inventory and net property, plant, and equipment [PP&E] for paper products with computers). The rate of technological change can manifest itself in several ways including the reinvestment rate required to stay competitive (for example, compare dividend-payout ratios for newspapers, and books and music). Industry structure is believed to affect the profitability through the pricing power of the firm. The newspaper industry can be characterized as locally oligopolistic (in some areas, however, monopolistic); the discount retail industry is much more competitive in structure. The gross profit margins of the two industries differ substantially. The general insight is that, in conducting the financial analysis of a firm, one must understand the nature of the industry.
Some observations about the art of ratio analysis:
- Ratio analysis is only as good as the financial statements that underlie it. In particular, one needs to understand the accounting policies that generated the statements. The various treatments of goodwill, lease obligations, and equity interests in subsidiaries appear in the discussions. In addition, the absence of data can frustrate ratio analysis.
- Frameworks such as the DuPont system of ratios and categories of ratios (activity, profitability, liquidity, and leverage) are useful organizing schemes for an analysis.
- Naïve ratio analysis can absorb considerable time, as one seeks to find a pattern (any pattern) in the blizzard of numbers. Effort is economized by thinking first about the underlying business that generated the ratios.
In the Case Report, you must relate the description to the company (A,B,C,etc.) and list and discuss the ratios that justify your choice. You will need more than one ratio to support your choice. The chosen ratio must be relevant to the industry.
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