Financial Analysis and Reporting

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Accounting, Law, Finance & Economics Department

Intervenant/Lecturer: Amandine GERARD


Financial Analysis & Reporting Part II : Ratio analysis and valuation methods following


Course Outline

1. 2.

Ratios analysis
Profitability analysis Risk analysis

1. 2.

Peers Valuation Method
Firm value multiples Equity multiples

1. 2.

Value creation method
Value based management Measuring value creation : EVA, MVA, CFROI, TSR


Ratios analysis Profitability : ROA & ROE


Profitability analysis
This lesson will deal with some of the most widely used analytical tools for analyzing the financial performance of a company. These tools are essentially used for assessing profitability and risk. •

Profitability analysis deals with the relative performance of profits to some other measure. Investors are not only interested in aggregate profits but are also interested in profitability measures. They need to use these measures to evaluate the performance of the companies in which they may have a stake. This is more relevant in the case of institutional investors such as mutual funds, banks, etc. From the point of view of institutional investors, two of the most important tools are Return on Assets and Return on Common Equity. These ratios are essentially two variants of the most popular category of ratios, called the Return on Investment or ROI. These ratios help the analyst to evaluate the performance of the individual company on a comparable basis. The institutional investor is interested in getting the optimum returns on his investment. He is not concerned about the size, product line, etc. of companies, but uses them as indicators towards return and risk. Thus, these ratios have their own utility.


Profitability analysis : ROA (Return on assets)
The return on assets (ROA), or return of investment (ROI), which is obtained by comparing the value of the assets with the profit that can be used to remunerate the debts and the equity as well as to pay the income tax: ROA = EBIT / Assets

– – EBIT earnings before interest expenses and income tax Assets total assets

The ROA is independent of the level of debt and is an indication of the ability of the company to generate profit, exclusively from an industrial and/or commercial point of view. In that sense, ROA plays a central role in financial analyis. • In order to provide a better analysis of the return of assets and why it can vary widely over period of time, we can decompose the ROA as follows : ROA = (EBIT / Sales) * (Sales/Assets) Where we have: – – Economic profit margin (EBIT / Sales) expressed in percentage, which tell us how many cents are earned on a unit sold Assets turnover ratio (Sales/Assets), which indicates the degree of use of the assets


Profitability analysis : ROE (Return on equity)
• The return on equity (ROE), can be calculated before or after tax by directly using the straightforward relationship between the profit and equity, or by using the financial leverage formula: ROEbt = EBIT / Equity = ROA + (ROA – i) * (Debt/Equity)

– i Average interest rate on total debts = Interest expenses / Total debts

The ROEbt is the sum of the ROA plus the leverage before tax. The analysis of the variations of the ROEbt contains the analysis of the ROA, with the return on operating assets and the return on non-operating assets that give the return on total assets. Secondly, it concentrates on the variations of the other components of the leverage effect, i.e. i and the debt/equity ratio. For a given ROA and leverage ratio, it may be useful to consider various levels of average interest rates to better understand the impact of the average interest rate on the return on equity. A company with a higher level of debt will have a ROEbT more sensitive to a change in the average interest rate....
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