Accounting and Financial

Management

Master in Services Engineering and Management

Financial Analysis
Course Program (II)
Part II – Financial Statement Analysis

1. Overview of corporate financial management

2. Purpose and steps
3. Common-size analysis
4. Indicators and ratios
5. Cost-volume-profit analysis
6. Some rearrangements to the financial statements and ROIC
Before taking decisions you must assess the
current economic and financial condition of a
firm…
“Financial Statements are like fine perfume; to be
sniffed but not swallowed”
ABRAHAM BRILLOFF
Accounting and Financial Analysis (Higgins 2007)

Accounting is the scorecard of business. It translates a company’s

diverse activities into a set of objective numbers that provide
information about the firm’s performance, problems, and
prospects.

Financial analysis involves the interpretation of these accounting

numbers for assessing performance and planning future actions.
Quick Recap – Balance sheet
Balance Sheet: accounting document that expresses the financial position of a company at a given
date. Is an equality between two components referred to a certain date and concerning a given
company. It represents the company’s property both in composition and in value.
The components of the Balance Sheet must be written according to the following order :
• The Assets values must be presented from top to bottom , in order of increasing liquidity, and
the components that are intended to stay in business for several years must therefore be
represented in the first place.
• The values ​of Equity and Liabilities are grouped from top to bottom in descending order of
deadlines for claiming, and therefore shareholders’ equity must therefore be represented in
the first place.
Quick Recap – Income statement
Income Statement : a document that shows the results (profits or losses) in a
certain financial period ( between two balance sheets).
• assesses the economic performance in the period.
• identifies the income and expenses incurred during a given period.

Financial period
Balance sheet n-1 Balance sheet n

Income statement by nature

Financial Analysis
Financial analysis is the selection, evaluation and
interpretation of financial data (and all other relevant available
information) to assist the financing and investment decision
making.
Financial Analysis Steps
• Step 1: Set the purpose of the analysis

• Step 2: Collect relevant data

• Step 3: Process Data

• 3.1: Understand the macro and industry context

• 3.2: Analysis of the structure and evolution of the financial

statements (common-size analysis)

• 3.3. Financial Ratios

• Step 4 : Analysis and Recommendation

Financial Analysis: Step 1
Purpose of the analysis:
- Inside the company: to evaluate its performance, implement
compensation systems, support investment decisions and
financing.
- Outside the company: assess the credibility of a supplier or
customer, evaluate and compare with the performance of a
competitor, evaluate financing and investment opportunities
(banks/markets)
Financial Analysis: Step 2
Relevant data for financial analysis:
• Company Financial Statements
• Company website and press releases
• Economic data, industry information, market information
• Information about comparable peer companies
• Other financial websites, industrial associations websites, central
bank information
• Discussion with management, suppliers and customers.
Step 3.1 – Understand the macro
and industry context
• Macro environment: Trends that can influence company’s performance
• GDP growth rate
• Employment rate;
• inflation;
• Consumption rate;
• Policy;
• Other International trends.

• The industry environment: company’s position and evolution:

• Industry evolution
• Company’s position in the industry
• Comparison with competitors/benchmark
Step 3.2 – Analysis of the structure and evolution of
financial statements (common-size analysis)
• Common-size analysis
expresses financial
statement data relative to
some benchmark item –
usually total assets for the
balance sheet and sales
for the income statement.

• Facilitates the comparison

of revenues and cost
structure with the
industry.
Step 3.2 – Analysis of the structure and evolution of
financial statements (common-size analysis)

2017 2017 2016 2016 2015 2015

% of % of % of
Assets Assets Assets
Assets
Cash and marketable securities $ 288.5 15.3 $ 16.6 1.1 $ 8.2 0.6
Accounts receivable 306.2 16.2 268.8 18.0 271.5 19.4
Inventories 423.8 22.4 372.7 24.9 400.0 28.6
Other current assets 21.3 1.1 29.9 2.0 24.8 1.8
Total current assets $1,039.8 55.0 $ 688.0 46.1 $ 704.5 50.4
Plant and equipment (net) 399.4 21.1 394.2 26.4 419.6 30.0
Goodwill and other assets 450.0 23.8 411.6 27.6 273.9 19.6
Total assets $1,889.2 100.0 $1,493.8 100.0 $1,398.0 100.0
Step 3.2 – Analysis of the structure and evolution of
financial statements (common-size analysis)

Liabilities and Stockholders’

Equity:
Accounts payable and accruals $ 349.3 18.5 $ 325.0 21.8 $ 395.0 28.3
Notes payable 10.5 0.6 4.2 0.3 14.5 1.0
Accrued income taxes 18.0 1.0 16.8 1.1 12.4 0.9
Total current liabilities $ 377.8 20.0 $ 346.0 23.2 $ 421.9 30.2
Long-term debt 574.0 30.4 305.6 20.5 295.6 21.1
Total liabilities $ 951.8 50.4 $ 651.6 43.6 $ 717.5 51.3
Common stock (54,566,054 shares) 0.5 0.0 0.5 0.0 0.5 0.0
Additional paid-in capital 892.4 47.2 892.4 59.7 892.4 63.8
Retained earnings 67.8 3.6 (50.7) (3.4) (155.8) (11.1)
Less: Treasury stock (23.3) (1.2) – – (56.6) (4.0)
Total stockholders’ equity $ 937.4 49.6 $ 842.2 56.4 $ 680.5 48.7
Total liabilities and equity $1,889.2 100.0 $1,493.8 100.0 $1,398.0 100.0
The Managerial Balance Sheet
Accounting Balance Sheet Managerial Balance Sheet
Assets Equity + Liab. Applications of Capital Sources of Capital

Net fixed Long-term

Non-Current Equity financing
assets
Assets Equity + Long.term debt

Operating
Non-Current Working Capital Liabilities
Liabilities Operating assets Accts Payable + Accrued
Expenses
Current
Assets Current Short-Term
Liabilities Cash Debt
The Managerial Balance Sheet
Managerial Balance Sheet
Applications of Capital Sources of Capital

Net fixed Long-term

Investment financing Capital
assets Equity + Long.term debt

Operating
Working Capital Liabilities Operations
Operations Operating assets Accts Payable + Accrued
Expenses

Short-Term Treasury
Treasury Cash Debt
Step 3.3 – Financial Ratios
• Financial ratios establish a common reference point across firms, even though
the numerical value of the reference point will differ from industry to industry.
o Ratios make it easier to compare the performance of large firms to that of
small firms.
o Ratios make it easier to compare the current and historical performance of a
single firm as the firm changes over time (trend analysis).
• Types of ratios:
• Liquidity
• Efficiency
• Leverage and coverage
• Profitability
• Growth
• Market Value
Step 3.3 – Liquidity Ratios
• Liquidity ratios: Liquidity ratios indicate a firm’s ability to pay short-term obligations with short-
term assets without endangering the firm. In general, higher ratios are a favorable indicator.
• To what extent is the company able to respond to its short-term liabilities?

Current Assets
Current Ratio =
Current Liabilities
Current Assets − Inventory
Quick Ratio =
Current Liabilities

𝐶𝑎𝑠ℎ
𝐶𝑎𝑠ℎ 𝑅𝑎𝑡𝑖𝑜 =
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
 Efficiency Ratios
• Efficiency ratios: Efficiency ratios indicate a firm’s ability to use assets to generate income. These
are also called activity or turnover ratios. In general, higher turnover numbers are a favorable
indicator. For average inventory period, however, a lower number is favorable.
• To what extent is the company managing its resources in an efficient way?

𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠
𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝐴𝑠𝑠𝑒𝑡 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟 =
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝑃𝑒𝑟𝑖𝑜𝑑 = × 365 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠
𝐶𝑜𝑠𝑡 𝑜𝑓 𝐺𝑜𝑜𝑑𝑠 𝑆𝑜𝑙𝑑
𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠
𝐸𝑞𝑢𝑖𝑡𝑦 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟 =
𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒 𝑇𝑜𝑡𝑎𝑙 𝐸𝑞𝑢𝑖𝑡𝑦
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐶𝑜𝑙𝑙𝑒𝑐𝑡𝑖𝑜𝑛 𝑃𝑒𝑟𝑖𝑜𝑑 = × 365
𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠 Cost of Goods Sold
Inventory Turnover =
𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑃𝑎𝑦𝑎𝑏𝑙𝑒 Inventory
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑃𝑎𝑦𝑚𝑒𝑛𝑡 𝑃𝑒𝑟𝑖𝑜𝑑 = × 365
𝑃𝑢𝑟𝑐ℎ𝑎𝑠𝑒𝑠 Net Sales
Accounts R e ceivable Turnover =
Accounts R e ceivable
Leverage and Coverage
• Leverage and coverage: Leverage ratios indicate whether a firm is using the appropriate amount of
debt financing. In general, higher ratios indicate greater potential return and greater bankruptcy
risk. For the coverage ratios, a higher number generally indicates less bankruptcy risk and (possibly)
lower potential return.
• To what extent is the company able to respond to its long-term liabilities?
Total Debt
Total Debt Ratio = should be ≤ 2Τ3 𝐸𝐵𝐼𝑇 𝑜𝑟 𝐸𝐵𝐼𝑇𝐷𝐴
Total Assets 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝐶𝑜𝑣𝑒𝑟𝑎𝑔𝑒 =
𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡
Total Debt
Debt to Equity = should be ≤ 2
Total Equity Total Assets
Equity Multiplier =
Total Equity
𝐸𝑞𝑢𝑖𝑡𝑦
𝐹𝑖𝑛𝑎𝑛𝑐𝑖𝑎𝑙 𝐴𝑢𝑡𝑜𝑛𝑜𝑚𝑦 = should be ≥ 1Τ3
𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠

𝐸𝑞𝑢𝑖𝑡𝑦
𝑆𝑜𝑙𝑣𝑒𝑛𝑐𝑦 = should be ≥ 1Τ2
𝑇𝑜𝑡𝑎𝑙 𝐷𝑒𝑏𝑡
Profitability Analysis and Ratios
• Profitability determines the long-term financial survival of the company and the attraction of new
capital.
• Profitability ratios: Profitability ratios indicate whether a firm is generating adequate profit from its
assets. In general, higher ratios indicate better performance.
• To what extent are the company’s activity, assets profitable? To what extent is the
shareholders’ equity profitable?

• Key Performance Indicators:

• EBITDA = Earning before taxes depreciation and amortization
• EBIT = Earning before interest and taxes
• Net Income
Jerónimo Martins Income Statement
Key Performance Indicators
• EBITDA = Earning before taxes depreciation and amortization
• Minimum requirement of economic viability of a company
• Indicates profitability before replacing equipment and without taking into
account the type of financing
• Useful in comparisons between companies (preferable to EBIT which
encompasses amortization and depreciation policies)

• Net Income
• Absolute indicator of overall profitability
• Is the basis for remunerating equity (Earnings per share) or to increase the
financial autonomy of the company
Profitability Ratios - Margins
• Margins (can be directly taken from the common size income statement): allows us
to see the ability of the company to produce/sell their products at cheap cost
and/or to sell it at a high price.
• Margins are highly dependent on the industry (luxury vs commodities).

𝐺𝑟𝑜𝑠𝑠 𝑃𝑟𝑜𝑓𝑖𝑡
𝐺𝑟𝑜𝑠𝑠 𝑃𝑟𝑜𝑓𝑖𝑡 𝑀𝑎𝑟𝑔𝑖𝑛 =
𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠

𝐸𝐵𝐼𝑇
𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑀𝑎𝑟𝑔𝑖𝑛 =
𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠

Net Income
Net Profit Margin =
Net Sales
Profitability Ratios - Return
To what extent are the company’s activity, assets profitable? To what extent is the
shareholders’ equity profitable?

Net Income
Return on Assets =
Total Assets
Economic Profitability (point of view of the company)

𝐸𝐵𝐼𝑇
𝑅𝑒𝑡𝑢𝑟𝑛 𝑜𝑛 𝐼𝑛𝑣𝑒𝑠𝑡𝑒𝑑 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 =
𝐷𝑒𝑏𝑡 + 𝐸𝑞𝑢𝑖𝑡𝑦

Net Income Financial Profitability (point of view of the owners)

Return on Equity = ROE =
Total Equity
Economic Profitability - ROA

𝑅𝑒𝑡𝑢𝑟𝑛 𝑜𝑛 𝐴𝑠𝑠𝑒𝑡𝑠 =

𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒
= =
𝐴𝑠𝑠𝑒𝑡𝑠
𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒 𝑆𝑎𝑙𝑒𝑠
= 𝑆𝑎𝑙𝑒𝑠 𝑥
𝐴𝑠𝑠𝑒𝑡𝑠
Net Profit Margin Assets Turnover
(Profitability) (Efficiency)
Two Strategies to achieve a higher ROA

To maximize a firm’s ROA, management can focus more on achieving high profit
margins or on achieving high asset turnover. High-end retailers like Tiff any & Co.
and Burberry Group plc focus more on achieving high profit margins. In contrast,
grocery and discount stores like Whole Foods Market and Wal-Mart tend to
focus more on achieving high asset turnover because competition limits their
ability to achieve very high profit margins.

Company Asset Turnover × Profit Margin (%) = ROA (%)

High Profit Margin:
Tiffany & Co. 0.80 11.30 9.04
Burberry Group plc 1.09 12.33 13.44
High Turnover:
Whole Foods Market 2.48 3.22 7.99
Wal-Mart Stores 2.42 3.05 7.38
Financial Profitability

Net Income
Return on Equity = ROE =
Total Equity

• Widely used ratio by analysts, shareholders and managers.

• Reflects the efficiency in which the company/the managers use the owner´s money.
Financial Profitability
𝑅𝑒𝑡𝑢𝑟𝑛 𝑜𝑛 𝐸𝑞𝑢𝑖𝑡𝑦 =

𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒
= =
𝐸𝑞𝑢𝑖𝑡𝑦

𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒 𝑆𝑎𝑙𝑒𝑠

= 𝑆𝑎𝑙𝑒𝑠 𝑥
𝐸𝑞𝑢𝑖𝑡𝑦
=
Net Profit Margin Equity Turnover
(Profitability) (Efficiency)

𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒 𝑆𝑎𝑙𝑒𝑠 𝐴𝑠𝑠𝑒𝑡𝑠

= 𝑥 𝑥
𝑆𝑎𝑙𝑒𝑠 𝐴𝑠𝑠𝑒𝑡𝑠 𝐸𝑞𝑢𝑖𝑡𝑦
Net Profit Margin Assets Turnover Equity Multiplier
(Profitability) (Efficiency) (Leeverage)
Financial Profitability
𝑅𝑒𝑡𝑢𝑟𝑛 𝑜𝑛 𝐸𝑞𝑢𝑖𝑡𝑦 =

𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒
= =
𝐸𝑞𝑢𝑖𝑡𝑦

𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒 𝑆𝑎𝑙𝑒𝑠

= 𝑆𝑎𝑙𝑒𝑠 𝑥
𝐸𝑞𝑢𝑖𝑡𝑦
=
Net Profit Margin Equity Turnover
(Profitability) (Efficiency)

𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒 𝑆𝑎𝑙𝑒𝑠 𝐴𝑠𝑠𝑒𝑡𝑠 Lower financial autonomy leads

= 𝑥 𝑥 to greater returns?
𝑆𝑎𝑙𝑒𝑠 𝐴𝑠𝑠𝑒𝑡𝑠 𝐸𝑞𝑢𝑖𝑡𝑦
Net Profit Margin Assets Turnover Equity Multiplier
(Profitability) (Efficiency) (Leverage)
Financial Profitability
𝑅𝑒𝑡𝑢𝑟𝑛 𝑜𝑛 𝐸𝑞𝑢𝑖𝑡𝑦 =

𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒
= =
𝐸𝑞𝑢𝑖𝑡𝑦

𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒 𝑆𝑎𝑙𝑒𝑠

= 𝑆𝑎𝑙𝑒𝑠 𝑥
𝐸𝑞𝑢𝑖𝑡𝑦
=
Net Profit Margin Equity Turnover
(Profitability) (Efficiency)

𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒 𝑆𝑎𝑙𝑒𝑠 𝐴𝑠𝑠𝑒𝑡𝑠 Lower financial autonomy leads

= 𝑥 𝑥 to greater returns?
𝑆𝑎𝑙𝑒𝑠 𝐴𝑠𝑠𝑒𝑡𝑠 𝐸𝑞𝑢𝑖𝑡𝑦
Net Profit Margin Assets Turnover Equity Multiplier • Leverage is beneficial when
(Profitability) (Efficiency) (Leverage) business runs well but is bad if
things go bad.
The Du Pont System
The Du Pont System
• Diagnostic tool for evaluating a firm’s financial health
• Uses related ratios that link the balance sheet and
income statement
• Used by management and shareholders to understand
factors that drive ROE
• Based on two equations that connect a firm’s ROA and
ROE
𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒 𝑆𝑎𝑙𝑒𝑠
𝑅𝑒𝑡𝑢𝑟𝑛 𝑜𝑛 𝐴𝑠𝑠𝑒𝑡𝑠 = 𝑥
𝑆𝑎𝑙𝑒𝑠 𝐴𝑠𝑠𝑒𝑡𝑠
𝐴𝑠𝑠𝑒𝑡𝑠
𝑅𝑒𝑡𝑢𝑟𝑛 𝑜𝑛 𝐸𝑞𝑢𝑖𝑡𝑦 = 𝑅𝑂𝐴 𝑥
𝐸𝑞𝑢𝑖𝑡𝑦
ROE Limitations
• Backward-looking based on historical data, doesn’t take into account
market or strategical shifts.
• Book value: ROE is based on the book value of shareholders’ equity, not
is market value. These figures can be substantially different.
• The market value of equity is more significant to shareholders
because it measures the current, realizable worth of the shares,
while book value is only history.
• However, stock price is often influenced by a wide array of factors
outside a company’s control.
Market Value Ratios
• Market Value ratios: Market value ratios indicate how the market is valuing the
firm’s equity. Higher ratios indicate greater shareholder wealth.

• Indicators:
• Price: Price per share
• (quotation)
• Market Capitalization: price x nr. of shares
• Market Value Added (value added by shareholders): Market capitalization –
book value
• Enterprise Value (EV): Market Capitalization + Market Value of Debt – Cash
 Market Value Ratios

Net Income 𝐸𝑎𝑟𝑛𝑖𝑛𝑔 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒

Earnings Per Share = 𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑌𝑖𝑒𝑙𝑑 =
Shares Outstanding 𝑃𝑟𝑖𝑐𝑒

Price Per Share 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒

Price to Earnings Ratio = Divident 𝑌𝑖𝑒𝑙𝑑 =
Earnings Per Share 𝑃𝑟𝑖𝑐𝑒

Market Value of Equity Per Share 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑𝑠

Market to Book Ratio = 𝑃𝑎𝑦𝑜𝑢𝑡 =
Book Value of Equity Per Share 𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒
Selecting a Benchmark
• A ratio or ratio analysis is relevant only when compared to an
appropriate benchmark
o Trend Analysis – comparison to the firm’s historical
performance
o Industry Analysis – comparison to the aggregate of firms in the
same industry
• Standard Industrial Classification (S I C) System
• North American Industry Classification System (N A I C S)
o Peer Group Analysis – comparison to a select group of firms in
the same industry
Quick Recap – Cash Flow Statement
Cash flow statements: document which presents the detailed historical information
about what were the receipts and payments of a company during a specific period
of time. Shows:
• How much cash the firm has generated
• How that cash has been allocated

Cash receipts and payments are classified into three major activities :
• Operational activities;
• Investment activities;
• Financing activities.
Cash Flow Statement
Cash receipts and payments are classified into three major activities :
• Operational activities: indicates the extent to which the company’s
operational activities generate enough money to maintain current activities,
repay loans, pay dividends and make new investments without external
financing sources.

• Investment activities: indicates how the company applies (invests) the money
that came from its operating (generated by the company) or financing (from
outside the company) activities.

• Financing activities: indicates how the company is financed.

Grupo Vista
Alegre/
Atlantis

https://inve
stidores.vist
aalegre.co
m/assets/V
AA_SGPS_C
onsolidated
_Financial_
Statements
_2017.pdf
Cash Flow Ratios

𝑂𝐶𝐹 should be as high as possible, which indicates that an

𝐶𝑎𝑠ℎ 𝐶𝑜𝑣𝑒𝑟𝑎𝑔𝑒 = organization has sufficient cash flow to pay for scheduled
𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡𝑠
principal and interest payments on its debt.

𝑂𝐶𝐹 more reliable metric than net profit, since it gives a clear
𝐶𝑎𝑠ℎ 𝐹𝑙𝑜𝑤 𝑀𝑎𝑟𝑔𝑖𝑛 =
𝑆𝑎𝑙𝑒 picture of the amount of cash generated per dollar of
sales

𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑦 𝐶𝑜𝑣𝑒𝑟𝑎𝑔𝑒 If this ratio is less than 1:1, a business is not generating
𝑂𝐶𝐹 enough cash to pay for its immediate obligations, and so
=
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 may be at significant risk of bankruptcy
Cash Flow Ratios

𝐹𝐶𝐹 the higher the number, the more dependent the business
𝐸𝑥𝑡𝑒𝑟𝑛𝑎𝑙 𝐹𝑖𝑛𝑎𝑛𝑐𝑖𝑛𝑔 = is on external money
𝑂𝐶𝐹
Cash Flow Ratios

𝐹𝐶𝐹 the higher the number, the more dependent the business
𝐸𝑥𝑡𝑒𝑟𝑛𝑎𝑙 𝐹𝑖𝑛𝑎𝑛𝑐𝑖𝑛𝑔 = is on external money
𝑂𝐶𝐹
Benchmark Selection
• A ratio or ratio analysis is relevant only when compared to an
appropriate benchmark
o Trend Analysis – comparison to the firm’s historical
performance
o Industry Analysis – comparison to the aggregate of firms in the
same industry
• Standard Industrial Classification (S I C) System
• North American Industry Classification System (N A I C S)
o Peer Group Analysis – comparison to a select group of firms in
the same industry
Limitations of Financial Analysis

o Not an exact science

o Relies on accounting data and historical costs
o Few guidelines or principles for determining whether a
ratio is “high” or “low,” or is a reason for confidence or
for concern
Acknowledgements
The materials presented here were prepared by Professor Jorge Grenha Teixeira,
especially following the book “Fundamentals of Corporate Finance”, by Parrino,
R., Kidwell, D.S. and Bates, T. (2011), Prentice Hall, with contributions from
Maria Dulce Lopes, Lia Patrício, Sofia Cruz Gomes and myself

I am grateful to all involved and any error or omission is of my exclusive

responsibility