Analyzing Financials - A Lost Art?

[mac_bolan00]

i've worked in real estate, banks, the stock market. in those fields, even the so-called technical guys often fail to come up with a correct analysis of a business' financial condition and its probable future condition.

to all analysts and accountants: share your thoughts!

[KuyaDanny]

I agree with you. Several factors contribute to this decline in the quality of financial analysis:

1) Tendency to regard financial analysis as a specialty - maybe it is a result of our training, or the increasing trend toward specialization in the job markets, but I think there is a tendency to believe that financial analysis is a specialty for accountants and financial people. No. Financial analysis is, in my mind, a basic business skill, useful for anyone in IT, marketing, human resources, and certainly anybody aspiring to be a CEO or entrepreneur. On the list of "must have" skills, financial analysis ranks up there with word processing, spreadsheet construction, oral and written communication, and basic arithmetic.

2) Tendency to rely on machines to crunch the numbers - there seems to be a feeling that after the computers have done the grunt work, we don't need to think anymore. Analysis therefore suffers.

3) Lack of industry experience/exposure - someone who has been exposed to many different types of business enterprises in various industries will appreciate that every business has different "financial" characteristics. The more homogenous our exposure is, the less imaginative our analytical minds will be when we look at businesses.

[zimdude]

OK, I'm in IT, Internet engineering. How do I get started in learning the Finance I need to know?

[mac_bolan00]

zimdude,

financial analysis is a tool and each business requires custom tools. if you are an IT engineer, you are most likely involved in product/systems design, development, production and marketing. end result: profits. expenses come right at the start. what is good financial analysis and management? knowing the profit (or the lack of it) before you even start.

[zimdude]

Well yes that is a given. I do crunch numbers that contribute to the bottom line. But what is it that our company's CEO, CFO, and financial analysts that I don't know and should learn?

[mac_bolan00]

zimdude,

financial analysis is often interwoven into financial management. gets? analysis is too often a managerial function. also, as stated by kuya danny, it cannot be taken singly but should coordinate closely with marketing and operations.

let's see, how will FA help someone who's there in the "trenches"? it makes your objectives clearer. it empowers you to decide (or at the least recommend) a project or a change in operations. so how does an operations guy like you become self-sufficient wrt financial analysis and management?

1. know your company's business plan. FA is useless if you don't know the business' overall plan.

2. you have to know the rudiments of financial acounting. a three-day course for non-accountants or a few hours each night going though a good accounting book will take care of that.

3. learn to distinguish between mere book-keeping and real financial analysis.

4. there are two aspects of FA as taught in school: short-term FA which aims to maximize profits and liquidity within a year and long-term FA which aims to maximize shareholder value. remember: maximize profits and liquidity in the short-term, and maximize shareholder value in the long-term.

i could e-mail you a manual on short-term FA which i made for our company clients. just give me your e-mail address.

[zimdude]

Thanks, you can send it to me at map@internet.org.ph and I think it would be good to post it somewhere (the PEx vault?) for others to appreciate if you would let them take a peek. As for...

(1) I am involved in the planning.

(2) What Accounting book can you recommend for beginners? I doubt if I could take time out for a course.

(3) I have an idea. I crunch Internet engineering numbers using Perl scripts. Our analysts crunch 'em with Excel. What-if scenarios in both cases.

(4) I hope I'm in this for the long term.

I'm looking forward to studying this, previously I thought Finance was a boring subject (like I have posted in the past), but now there is a ray of promise.

[manabs]

Send one also at manabs@hotmail.com. I'm a practicing analyst so I feel I might be able to pick up something useful there. :)

[mac_bolan00]

zimdude and manabs,

i e-mailed your requests. for zimdude, most acctg studes still prefer the meigs & meigs book. after that, you could move on to a real financial management textbook. madami sila.

[mac_bolan00]

here's a one-item quiz for financial analysts:

True or false: a high current ratio is actually bad for a company's cash postion. Please qualify your answer by stating all your premises and assumptions.

[mac_bolan00]

Hey come on, guys! Give it one stab. You are analysts, aren't you?

One-item quiz # 2:

True or false: assuming constant turnover rate, rising sales by a business is usually bad for that business' cash position.

[this topic is of strategic importance for most businesses]

[zimdude]

Thank you mac_bolan00, the documents are a good intro to the subject. I can post them on a website if you wish.

I'll take some time out to learn this stuff, it will be a help with my Engineering work.

Sorry I can't answer your quiz questions, just yet.

[lupuS]

First Question

Answer: TRUE

A high current ratio can be bad for a company's cash position when it is used to judge the health of a company's liquidity without regard for the limitations of the measure. When the current ratio is high, and management uses this indicator, and nothing else, to make its cash forecasting decisions, it may be lulled into a false sense of security.

How? Well, examine the formula: Current ratio = Current Assets / Current Liabilities. What are current assets? Typically, cash (in various forms), accounts receivable, and inventory. The formula implies that these assets are more or less the same kind.

But are they really? Imagine a slowing economy, such as what we have today. Consider the components:

1) Inventory - valued at cost. What items are these? Are you holding a warehouse full of 386 PC systems which you bought eight years ago for P15,000 each? Or maybe the warehouse is full of last year's fashion items which are now no longer the rage. Are they really worth the value you have assigned to them in your books? To convert them to cash, you'll likely need to sell them at a discount. 386 systems are about P1,500 each in the gray market, and as for fashion items, well...I'll get back to you on that after I check out the tiangge this weekend. ;)

2) A/R - valued at face (sales invoice equivalent). How old are these receivables? Have some been hanging around your books for a year or two? Are you sure the customer who owes you is still around? He may have taken off on a plane to Nauru.

The case with Accounts Receivable is even more complicated when considered in the context of today's service businesses. Law firms, accounting firms, consulting, and IT are examples of these. Usually, these businesses charge for services, which charges have little direct relation to the cost of these services. When the customer is in a bind, and needs to restructure his obligations, what is one of the first tactics he employs? Tatawad sa supplier. Therefore the A/R figures on your books get shaved.

3) Placements and Marketable Securities - What are these? Placements at Urban Bank? Hahaha!!! Can you even go INSIDE your Urban Bank branch? When will you be able to get your cash? Or maybe you decided to buy PLDT one year ago at 1100, or BW Resources at...never mind. You get the idea.

The point I am driving at is that the value of these assets must be adjusted to make the realistic. Good managements do that - to a point. Too much downward adjusting nowadays hits your P&L and makes management look bad (hence the temptation to leave things as they are).

Once these adjustments are accounted for, you may be left with the realization that the cash you have on hand, and have provided for, is not enough to pay for your liabilities, and your cash position is effectively impaired.

Current ratios are convenient to use, because they can be crunched by the computers right after your financial statements are generated. But no amount of computer power can evaluate the quality of the current assets from which the current ratio is derived. Going back to KuyaDanny's point, if we have the tendency to let the computer do the work, we stop thinking. That's not good for anyone.

[mac_bolan00]

Very good, Lupus. Actually, the time frame for making the pronouncement is important. You have a high CR now, it means your cash is tied up at the moment. Having too many current assets other than cash and marketable securities is never a good thing (although still arguable).

Therefore, why is a high current ratio considered good for a company????

answer: Simply because it means the company has enough assets it can liquidate within the year (kuno), in time to pay off liabilities that become current. This means the CR indicator assesses the company's liquidity one year hence. The books are very clear on this.

OK, on to question # 2 (rising sales)!!!!

[zimdude]

... to learn something. Borrowed a copy of Managerial Accounting, Ninth Edition by Garrison and Noreen...

[stat]

Originally posted by mac_bolan00
zimdude,

financial analysis is often interwoven into financial management. gets? analysis is too often a managerial function. also, as stated by kuya danny, it cannot be taken singly but should coordinate closely with marketing and operations.

let's see, how will FA help someone who's there in the "trenches"? it makes your objectives clearer. it empowers you to decide (or at the least recommend) a project or a change in operations. so how does an operations guy like you become self-sufficient wrt financial analysis and management?

1. know your company's business plan. FA is useless if you don't know the business' overall plan.

2. you have to know the rudiments of financial acounting. a three-day course for non-accountants or a few hours each night going though a good accounting book will take care of that.

3. learn to distinguish between mere book-keeping and real financial analysis.

4. there are two aspects of FA as taught in school: short-term FA which aims to maximize profits and liquidity within a year and long-term FA which aims to maximize shareholder value. remember: maximize profits and liquidity in the short-term, and maximize shareholder value in the long-term.

i could e-mail you a manual on short-term FA which i made for our company clients. just give me your e-mail address.

can i also have a copy of this manual? am sure it will help me a lot. thanks.

[mac_bolan00]

zimdude,

Nyek!!!! Managerial accounting is already slightly removed from the usual financial acounting course. MA requires a rudimentary knowledge of financial accounting. However, oks lang if you wish to read on MA. Actually, it's a good course for non-accountants.

Matalino ka naman ata, eh. Kung ganun, I would advise you to do a syntopical reading on the three subjects:

1. financial accounting

2. managerial accounting and control

3. financial management

Happy studying!

[zimdude]

... that is the book that our Finance folks had at hand! so I took it home for the weekend.

[lechon 2000]

Originally posted by mac_bolan00
True or false: assuming constant turnover rate, rising sales by a business is usually bad for that business' cash position.



I'm not an analyst. I'm a roasted pig. ;) But I'll attempt an answer.

Answer: TRUE

If sales are rising, and turnover is kept constant, then the business must invest more cash in receivables and inventory to maintain the turnover rate and support the higher level of sales.

In a service business (such as IT or consulting), the biggest cost item typically is payroll. If revenues are increasing, it usually means that more people are needed to do the job, or that people work longer to cover the increased business. Either way, payroll costs increase, which require more cash to pay off.

[mac_bolan00]

dear lechon,

seeing how comfortable you are with the term "turnover", i know you've had training in finance. good answer, bro.

question # 3!

How is a high exit barrier manifested within an industry with regard to:

1. capacity utilization

2. days inventory

3. trade discounts

[S I N G L E]

Originally posted by mac_bolan00
zimdude,

financial analysis is often interwoven into financial management. gets? analysis is too often a managerial function. also, as stated by kuya danny, it cannot be taken singly but should coordinate closely with marketing and operations.

i could e-mail you a manual on short-term FA which i made for our company clients. just give me your e-mail address.

Hello mac... could you send me a manual also... i think i will find it resourceful.. thanks.

single@impactnet.com

[DAILO]

Hello MAC_BOLAN00... Interesting thread you have here... At last some one to discuss financials with.. I thought i was the only one before with my GREED IS GOOD!!! i'll post here later.. i have alot to catch up on.

GREED IS GOOD!!! :D :D :D

[payaSo]

Originally posted by mac_bolan00
question # 3!

How is a high exit barrier manifested within an industry with regard to:

1. capacity utilization
2. days inventory
3. trade discounts

Hi, mac_bolan00. I'd like to take a stab at this question, but I'm a little confused and would like a clue. Are you asking, for example, how (a high or low) capacity utilization constitutes a high exit barrier?

[KuyaDanny]

Hey, mac_bolan00, I hope you have not forgotten this thread. It is quite informative.

[mac_bolan00]

KD, i was kinda remiss on this thread of mine. thanks for the bump. few mods grant this favor. :)

to payaso,

bro, you may no longer be around to read this but i'll answer your last question just the same:

barriers to exit refer to the ease/difficulty in liquidating one's position in a given business. a decision to exit a type of business may be influenced by numerous factors, not just unprofitable operations.

businesses that are hard to skip are usually those manufacturing concerns that utilize SPECIALIZED MACHINERY. as you can imagine, specialized machinery are rather hard to dispose of (unless you're willing to sell them for scrap :lol: ) operations that use all-purpose machines are more easily liquidated.

a manufacturing sector shows signs of high exit barriers when available capacity is way beyond current output. this is with the understanding that managers will always try to avoid overcapacity either through increased output or downsizing.

another sign of a high exit barrier is the build-up of salable units or inventories beyond a demand forecast of, say, 3 years. no industry displays this phenomenon better than the real estate industry.

lastly, sellers might be resorting to selling terms that seem attractive to buyers but are grossly disadvantageous to themselves.

[tr|n|ty]

wow, a thread that i can actually relate with in terms of work :lol:

Analyzing Financials is not a lost art..well, it's my freakin' profession. I'm a freshman analyst for a top financial services firm and i have done different industries since i started. Accordingly, ratios and numbers are not the same for all industries. we all know that there are benchmarks for each of them.

Reading this thread, honestly, i learned a lot :) keep it up, guys!