Corporate Rating Methodology_FSA
-
Upload
arsalan-rafique -
Category
Documents
-
view
220 -
download
0
Transcript of Corporate Rating Methodology_FSA
-
8/2/2019 Corporate Rating Methodology_FSA
1/13
2/28/20
Understanding Industry Dynamicsand Financial Statements
1
Industry Classification
External Factors
Demand and Supply Analysis
Size and Growth trends
Profitability
1- Cost factors
2- Pricing
Competitive Strategies
-
8/2/2019 Corporate Rating Methodology_FSA
2/13
2/28/20
General classification by product or service type Segmentation by the Industrial Life Cycle:
Life Cycle Phase DescriptionPioneer Product is new, acceptance is
questionable, high riskGrowth Product acceptance is established,
accelerating growth in sales andearnings
Mature Growth in line with the economy,competition for market share
Decline Demand for product steadily decreasing
Classification by Business Cycle Reaction
Behaviour Pattern Description
Growth above-normal expansion in sales and profitsindependent of the business cycle
Defensive Stable performance during ups and downs
Cyclical Profitability tracks the business cycle, often inan exaggerated manner
-
8/2/2019 Corporate Rating Methodology_FSA
3/13
2/28/20
External factors
Technology survival with new products
Government and regulatory - policies can kill or servean industry
Demographics young or aging population affectdemand
Social Changes changes in Lifestyles
Foreign influences low cost production of textiles
overseas decimated the US textile industry
Demand and Supply Analysis
Demand
What derives an industrys revenue
Economic expansion or changing consumptionpatterns
Segmentation by users home, commercial, industrial
Segmentation by geographic region
Supply Existing suppliers and market shares
Attractiveness of industry to newcomers
Demand/Supply gap
-
8/2/2019 Corporate Rating Methodology_FSA
4/13
2/28/20
Industry Profitability
Cost structure and pricing f lexibility
Demand/supply balance as indicator of future profitability
Relationship between sales growth and profits
Product segmentation helps in pricing
High degree of concentration inhibits price movements
Local and international competition
High/low entry barriers affect pricing power in the long
run Ability to pass on increases in key raw material costs
Corporate Strategies
Cost leadership the firm sets out to become the low-cost producer in the industry
Differentiation unique positioning based onproduct, the delivery system or the marketing approach
Market share paradigm relative market share is anecessity because it drives relative cost
Rule of 3 and 4 a stable competitive market has nomore than 3 competitors and no more than 4 times theshare of the smallest player
-
8/2/2019 Corporate Rating Methodology_FSA
5/13
2/28/20
Five competitive forces that determine
industry profitability
Source: Competitive Advantage by Michael E. Porter(New York; The Free Press, 1085)
PotentialEntrants
IndustryCompetitors
Rivalry amongexisting firms
Suppliers Customers
Substitutes
Bargaining power of
suppliers
Bargaining power ofcustomers
Threat of substitute
products or services
Capital Adequacy
Size of Assets
Corporate Governance
Inefficient Processes
Technological
sophisticationCentral Bank
Regulations
Market Volatility
Legislation
Control
Yields Going Down
Narrowing Margins
Growing Risk
Competition
Banking
System
Management horizon:Problems and Challenges
Russian Banking
Sector Overview
Management
Concerns
Alfa Bank
Overview
Alfa BankBusiness Strategy
-
8/2/2019 Corporate Rating Methodology_FSA
6/13
2/28/20
Financial Statements- Income Statement, Balancesheet and Cash flow statement
Miscellaneous supporting calculations andadjustments
Ratios and trend analysis
Key value drivers
11
Financial Statement Analysis
Financial Statements comprise
12
Balance Sheet Provides a snapshoot of a firms financialposition
Income Statement Reports on the performance of the firm
5
Statement of CashFlows
Reports the cash receipts and cashoutflows classified according to operating,investing and financing activities
Statement ofStockholdersEquity
Reports the amounts and source ofchanges in equity from transactions withowners
Notes to FinancialStatements
Allow us to understand the amount,timing and uncertainty of the estimatesreported in the financial statements
-
8/2/2019 Corporate Rating Methodology_FSA
7/13
2/28/20
Financial Statements interactions
13
Balance Sheet
Assets
- Liabilities
Equity
Income Statement
Sales
- Expenses
Net Income
Cash Flow Statement
Inflows
- Outflows
Net Cash
Balance Sheet and its classification
Assets are the economic resources controlled by thefirm
Liabilities are the financial obligations that the firmmust fulfill in the future. Liabilities are often fulfilledby payment of cash. They represent source of financing provided to the firm by the creditors
Equity Ownership is the owners investment and theearnings retained from the commencement of thefirm. Equity represents source of financing provided tothe firm by the owners.
14
-
8/2/2019 Corporate Rating Methodology_FSA
8/13
2/28/20
Analysis and Adjustments to the Balance
Sheet
The balance sheet shows the recorded assets,liabilities and equity of the firm. The reportedbalance sheet usually suffer from two defects:
Some assets and liabilities are not recorded. These arecalled off-balance sheet items
The amounts at which assets and liabilities aremeasured may differ significantly from their economic
value
15
Income Statement and its significance
The income statement measures the success ofbusiness for a given period of time.
it recognizes a separation of operating transaction fromnon-operating transaction;
it matches costs and expenses with related revenues;and
it highlights certain intermediate components ofincome that are used for the computation of ratios usedto assess the performance of enterprises
16
-
8/2/2019 Corporate Rating Methodology_FSA
9/13
2/28/20
Quality of earnings
The quality of earnings refers to substance andsustainability of earnings. It refers to the use ofaccounting methods and assumptions that tendnot to overstate reported revenues and earnings.It may be affected by two factors:
The accounting methods and estimates chosen by thefirms management
The nature of non-operating items on the incomestatement
17
Adjustments to Reported Income
Reported net income should also be examined forpossible adjustments. There are two objectives:
Remove non-operating items from operating income toobtain a better measure of operating results for theperiod, and better inter-period comparisons
Obtain a measure of the earning power of the firm. Theconcept of earning power represent the (permanent)net income of the firm, ignoring temporary,
nonrecurring, or unusual factors.
18
-
8/2/2019 Corporate Rating Methodology_FSA
10/13
2/28/20
Normalized Net Income
Normalization is a process of estimating normaloperating earnings for each period by removingnonrecurring items from reported income. Suchitems may include:
Accounting changes
Realized capital gains and losses
Catastrophes such as natural disasters, accidents
Impairments or restructuring charges
Litigations or government actions
Discontinued operations
19
Statement of shareholders equity and itsadjustments
Original capital used to start the firm, plus proceedsfrom any additional shares issued, less the cost of shares repurchased
Retained earnings accumulated over the firms life
Accounting adjustments. Certain accounting standards
result in entries directly to equity, without flowingthrough the income statement. Examples includechanges in market value of long term marketablesecurities and foreign exchange effects
20
-
8/2/2019 Corporate Rating Methodology_FSA
11/13
2/28/20
Statement of cash flows and its significanceThe beginning and ending cash balances on thestatement of cash flows tie directly to the cash andcash equivalent accounts listed on the balance sheetsat the beginning and end of the period.
Cash receipts and payments during a period areclassified in the statement of cash flows in threedifferent activities:
Operating activities
Investing activities Financing activities
21
Analysis of Cash Flow Statement
Analysis of cash flow statement should lead toinsights into a firms financial position andperformance. Analysis should focus on both thelevel and trends in cash flow components. Ourprimary objective should be:
Determine the firms ability to generate cash flows tomeet operating needs
Evaluate the role of different sources of financing forcurrent operations and growth
Analyze to the extent to which cash flow classificationare affected by reporting choices
22
-
8/2/2019 Corporate Rating Methodology_FSA
12/13
2/28/20
23
Key ratios for a Corporate
Other important variables
Size of production lines and capacity utilization rate
Proximity to feedstock and consumption markets
Realization per ton, which, in turn, is a function of thefirst two variables
Cost of electricity
Closeness to ports and sea channels
Venturing into other areas such as blocks and ready-mix concrete manufacturing
Enterprise value (EV)* per ton
* EV = Market Cap + Debt-Cash & Equivalents
-
8/2/2019 Corporate Rating Methodology_FSA
13/13
2/28/20
25
Integrated Profitability Analysis:
Du Pont FrameworkROE = EBIT / Average Shareholder Equity
ROE=
EBITAve. Shareholder Equity
Profit Margin
=EBITSales
Asset/Equity Ratio=
Ave. Total AssetsAve. Shareholder Equity
Asset Turnover Ratio
=SalesAve. Total Assets
Profitability
of asset use
Profitability
of sales/Value
retention
Impact of
Debt in
Capital
Structure
Productivity/
Efficiency of
Asset Use
BUSINESS DRIVERS
X
=
What are some potential problems and
limitations of financial ratio analysis?
Comparison with industry averages is difficult if the firmoperates many different divisions.
Average performance not necessarily good.
Seasonal factors can distort ratios.
Window dressing techniques can make statements andratios look better.
Different operating and accounting practices distort
comparisons. Sometimes hard to tell if a ratio is good or bad.
Difficult to tell whether company is, on balance, in strongor weak position.
26