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Financial Statements Analysis
Week 3: Industry Analysis, Business Strategy Analysis, and Economic Analysis Lecturer: Khoa Duong, Master of Finance & Banking, Monash University, Australia Lecture notes available at: http://sdrv.ms/T5Ucm3 Khoa Duong, Master of Banking & Finance 1

Steps in the Valuation Process
We will consider the first stage of business valuation: 1. Strategy analysis 2. Corporate governance analysis 3. Accounting analysis 4. Financial analysis 5. Prospective analysis 2

Strategy Analysis

A firm’s profit potential is determined by:

◦ (1) Strategic choices of management:
 Industry choice  Competitive positioning/strategy  Corporate strategy

◦ (2) Economic environment firm operates within



Strategy Analysis

Strategy analysis comprises:

◦ Industry analysis
 Porter’s ‘five forces’ framework

◦ Business strategy analysis
 Competitive strategy  Corporate strategy

◦ Economic analysis
 Influence of economic climate on the above

Strategy Analysis


Industry Analysis: Its Importance

A firm’s profit potential is heavily influenced by the industry in which it competes: ◦ Half-year profit announcements in materials industry (BHP; Boral) vs. retail industry (NoniB; Reject Shop) Understanding the environment and competitive forces within an industry helps evaluate the quality of management’s strategic choices Porter’s ‘5 forces’ framework evaluates the competitive forces within an industry 6



Porter’s Five Force Framework

Industry Analysis: Porter’s 5 Forces
Degree of Actual and Potential Competition 1.Rivalry among existing firms 2.Threat of new entrants 3.Threat of substitute products/services Bargaining Power in Input and Output Markets 4. Bargaining power of buyers 5. Bargaining power of suppliers


Industry Structure and Profitability




Competitive Force 1: Rivalry Among Existing Firms
Varying degrees of competition among firms: Aggressive Competition on Price ◦ Push prices towards (or below) the marginal cost of production  Airline and hotel industries ◦ Co-ordinated pricing  Retail industry (petrol stations) ◦ Non-price dimensions of products/services important  Innovation/brand name 10

Non-aggressive Competition on Price

Competitive Force 1: Rivalry Among Existing Firms

Determinants of the intensity of competition among existing firms: ◦ Industry growth rate ◦ Concentration and balance of competitors ◦ Degree of differentiation in products/services and switching costs ◦ Scale/learning economies and ratio of fixed to variable costs ◦ Excess capacity and exit barriers 11

Competitive Force 2: Threat of New Entrants
The ease with which a new firm can enter an industry will affect the profitability of other firms within the industry  Factors affecting the barriers to entry are: ◦ Economies of scale  Extent of investment required by new entrants (e.g. ‘private’ university) ◦ First mover advantage  Exclusive arrangements/switching costs (e.g. Microsoft) ◦ Access to distribution channels  Strength of existing relationship (e.g., shelf-space for ‘new’ soft drink) ◦ Legal or political barriers  Patents/copyrights;  Licensing regulations (e.g. taxi services; television/radio) 




Competitive Force 3: Threat of Substitute Products

Substitutes are those of the same function (not form) ◦ Public transport vs. taxis to travel over short distances The threat of substitutes depends on customers’ willingness to accept substitutes: ◦ the relative price and performance of competing products/services; ◦ technology (e.g., Article: “Book chains’ collapse brings retail nightmare closer”) ◦ community awareness (e.g. public transport vs. taxis to travel over short distances

• The threat of substitutes affects the industry’s bargaining power with suppliers and customers, and ultimately profitability 13...
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