A REVIEW OF BASIC FINANCIAL ANALYSIS

Alix Mandron - Financial analysis 53-251-02

Overview
1. A very quick review of classical financial

analysis 2. The Fletcher Leisure Group: case discussion 3. The Cash Flow Statement (CFS), a review
structure meaning
Alix Mandron - Financial analysis 53-251-02 2

1. Classical ratios
You can invent as many ratios as you like, provided they make sense to you No ratio, or system of ratios, is perfect; some classical ratios are of doubtful interest (more on
this in later sessions);

therefore, you do not have to compute an ocean of ratios; a selected few will do

Be fastidious regarding definitions: the same name often covers different computations
(e.g.: debt ratio, profitability margin, etc.)
Alix Mandron - Financial analysis 53-251-02

Be extra-careful when comparing with benchmarks

Check the definitions and use the same Make sure you compare comparables
companies in the same industry may not be comparable they may not have the same FY = a problem in seasonal industries Etc

Never forget that the others do not own the truth nor that average is often synonymous with mediocre.
Alix Mandron - Financial analysis 53-251-02 4

A review of the DuPont system (see the summary included in the CP and/or any textbook) I prefer to modify it slightly:
operations include accounts receivable, inventory and accounts payable management (these are in no way investments) operations do not include interest payments, which belong to financing

Alix Mandron - Financial analysis 53-251-02

2. The Fletcher Leisure Group

Assume that you are at the end of 1990. On the basis of traditional ratios and common sense only, answer these questions: Is Fletcher a profitable company? I expect a straight answer: yes or no. Position Fletcher on the classification grid Would you recommend it as an investment? What advice, if any, would you give its managers? Justify.
Alix Mandron - Financial analysis 53-251-02 6

3. The Cash Flow Statement

Its objective Three sections covering the three areas of business management: operations, investments, financing. The last section (change in cash) is only there to make sure that nothing was forgotten. Increasing cash reserves is not a valid objective in and of itself.
Alix Mandron - Financial analysis 53-251-02 7

Cash flows from operations - Two alternative methods of presentation: direct, indirect
The direct method of presentation (follows the
computation method, i.e. from the electronic cash ledgers)

The indirect method of presentation (it is only a

presentation method; it does not follow the actual computation method: accounting software still uses the electronic cash ledgers)

A look at Fletcher The indirect method

undoes non-cash entries gets rid of pollutants (items unrelated to operations) adds forgotten cash transactions
Alix Mandron - Financial analysis 53-251-02 8

In the indirect approach to CFFOs, individual items are not sources of $; they are mere corrections to a wrong figure, namely Net Income
Net income is an accounting construct, not a measurement of cash earned N.I. is wrong when what matters is spendable money, i.e. when the focus is on treasury/cash management Never tell me that Net income or Depreciation etc. are sources of cash; it does not make sense.
Alix Mandron - Financial analysis 53-251-02 9

Beware: whatever its presentation, the CFS is always built from the cash transactions. It is NOT computed from 2 adjacent Balance Sheets, even though, in simple cases, you can reconstruct it in this way
it works for Fletcher in 1990, for example (try it) but, in more complex cases, in particular if several currencies are involved and if there were acquisitions, the difference approach will not work
Alix Mandron - Financial analysis 53-251-02 10

Try to reconstruct Fletchers change in non-cash operational working cap. for 1989 using the 1989 and 1988 BSs. Does it work?

Alix Mandron - Financial analysis 53-251-02

11