Summary class preparation questions lecture 5&6

Lecture 5&6
1. What is the objective of ratio analysis? Why is cash flow analysis
useful?
Financial analysis = assess the performance of a firm in context of its stated goals and strategy 
important for the valuation of a company

 Ratio analysis= how various line items in a firm’s financial statements relate to one another
o Foundation for making forecasts of future performance
o Evaluate effectiveness of a firms’ policies in each of their areas
 Cash flow analysis= examine firm’s liquidity and how the firm is managing its operating,
investment and financing CF

Value of a firm=
Growth + profitability

Return on equity (ROE)=
profit ∨loss after tax
ROE=
shareholder s' equity
ROE  indicator of profitability company

2. Why is it useful to decompose the return on equity (ROE), i.e. the
measure of the
overall profitability of the firm?
ROE=ROA X equity multiplier
ROE=net profit margin ( ROR ) X asset turnover X equity multiplier
profit ∨loss
ROA=
total assets
TA
Equity multiplier=
equity
profit∨loss
ROR=
revenue
Revenue
Asset turnover=
total assets
ROE affected by 2 factors

 ROA: how profitable does a company uses its assets to generate profits
 Equity multiplier: to what extend are your assets financed with equity and debt

ROE is determined by how the company is financed ( equity or debt), but if you want to assess the
performance of the company and value the company  ROA Is a better measure

You can boost your ROE by having another the finance strategy (higher debt  higher ROE, but a lot
more risk)