1.

Financial Analysis

What Does Financial Analysis Mean? The process of evaluating businesses, projects, budgets and other finance-related entities to determine their suitability for investment. Typically, financial analysis is used to analyze whether an entity is stable, solvent, liquid, or profitable enough to be invested in. When looking at a specific company, the financial analyst will often focus on the income statement, balance sheet, and cash flow statement. In addition, one key area of financial analysis involves extrapolating the company's past performance into an estimate of the company's future performance.

Investopedia explains Financial Analysis One of the most common ways of analyzing financial data is to calculate ratios from the data to compare against those of other companies or against the company's own historical performance. For example, return on assets is a common ratio used to determine how efficient a company is at using its assets and as a measure of profitability. This ratio could be calculated for several similar companies and compared as part of a larger analysis. What Does Balance Sheet Mean? A financial statement that summarizes a company's assets, liabilities and shareholders' equity at a specific point in time. These three balance sheet segments give investors an idea as to what the company owns and owes, as well as the amount invested by the shareholders. The balance sheet must follow the following formula: Assets = Liabilities + Shareholders' Equity It's called a balance sheet because the two sides balance out. This makes sense: a company has to pay for all the things it has (assets) by either borrowing money (liabilities) or getting it from shareholders (shareholders' equity). Each of the three segments of the balance sheet will have many accounts within it that document the value of each. Accounts such as cash, inventory and property are on the asset side of the balance sheet, while on the liability side there are accounts such as accounts payable or long-term debt. The exact accounts on a balance sheet will differ by company and by industry, as there is no one set template that accurately accommodates for the differences between different types of businesses. What Does Financial Statements Mean? Records that outline the financial activities of a business, an individual or any other entity. Financial statements are meant to present the financial information of the entity in question as clearly and concisely as possible for both the entity and for readers. Financial statements for businesses usually include: income statements, balance sheet, statements of retained earnings and cash flows, as well as other possible statements. It is a standard practice for businesses to present financial statements that adhere to generally accepted accounting principles (GAAP), to maintain continuity of information and presentation across international borders. As well, financial statements are often audited by government agencies, accountants, firms, etc. to ensure accuracy and for tax, financing or investing purposes. Financial statements are integral to ensuring accurate and honest accounting for businesses and individuals alike.

What Does Return On Assets - ROA Mean? An indicator of how profitable a company is relative to its total assets. ROA gives an idea as to how efficient management is at using its assets to generate earnings. Calculated by dividing a company's annual earnings by its total assets, ROA is displayed as a percentage. Sometimes this is referred to as "return on investment". The formula for return on assets is: ROA tells you what earnings were generated from invested capital (assets). ROA for public companies can vary substantially and will be highly dependent on the industry. This is why when using ROA as a comparative measure, it is best to compare it against a company's previous ROA numbers or the ROA of a similar company. The assets of the company are comprised of both debt and equity. Both of these types of financing are used to fund the operations of the company. The ROA figure gives investors an idea of how effectively the company is converting the money it has to invest into net income. The higher the ROA number, the better, because the company is earning more money on less investment. For example, if one company has a net income of $1 million and total assets of $5 million, its ROA is 20%; however, if another company earns the same amount but has total assets of $10 million, it has an ROA of 10%. Based on this example, the first company is better at converting its investment into profit. When you really think about it, management's most important job is to make wise choices in allocating its resources. Anybody can make a profit by throwing a ton of money at a problem, but very few managers excel at making large profits with little investment. What Does Income Statement Mean? A financial statement that measures a company's financial performance over a specific accounting period. Financial performance is assessed by giving a summary of how the business incurs its revenues and expenses through both operating and non-operating activities. It also shows the net profit or loss incurred over a specific accounting period, typically over a fiscal quarter or year. Also known as the "profit and loss statement" or "statement of revenue and expense" The income statement is the one of the three major financial statements. The other two are the balance sheet and the statement of cash flows. The income statement is divided into two parts: the operating and non-operating sections. The portion of the income statement that deals with operating items is interesting to investors and analysts alike because this section discloses information about revenues and expenses that are a direct result of the regular business operations. For example, if a business creates sports equipment, then the operating items section would talk about the revenues and expenses involved with the production of sports equipment. The non-operating items section discloses revenue and expense information about activities that are not tied directly to a company's regular operations. For example, if the sport equipment company sold a factory and some old plant equipment, then this information would be in the non-operating items section. What Does Cash Flow Statement Mean? One of the quarterly financial reports any publicly traded company is required to disclose to the SEC and the public. The document provides aggregate data regarding all cash inflows a company receives from both its ongoing operations and external investment sources, as well as all cash outflows that pay for business activities and investments during a given quarter.

Because public companies tend to use accrual accounting, the income statements they release each quarter may not necessarily reflect changes in their cash positions. For example, if a company lands a major contract, this contract would be recognized as revenue (and therefore income), but the company may not yet actually receive the cash from the contract until a later date. While the company may be earning a profit in the eyes of accountants (and paying income taxes on it), the company may, during the quarter, actually end up with less cash than when it started the quarter. Even profitable companies can fail to adequately manage their cash flow, which is why the cash flow statement is important: it helps investors see if a company is having trouble with cash.

2. Strategy: Porter's Five Forces Model: analysing industry structure

Porters Five Forces Context
Generally, strategic planning commences with an analysis phase, where you seek to refresh your understanding of your businesses 3 key strategic environments, these three strategic enviroments that you analyse during your strategic analysis are your
y y y

Macro Environment, Industry Environment, (or Porter's Five Forces), and Internal Environment

Porters five forces is a competitive analysis model, it helps you to understand at the nature of competition within your industry, hence it is used when completing your industry analysis.

Porters model provides a good, simple yet powerful, framework for developing an understanding of the competitive forces in your industry.

Defining an industry Five Forces Analysis helps the marketer to contrast a competitive environment. It has similarities with other tools for environmental audit, such as PEST analysis, but tends to focus on the single, stand alone, business or SBU (Strategic Business Unit) rather than a single product or range of products. For example, Dell would analyse the market for Business Computers i.e. one of its SBUs.The most influential analytical model for assessing the nature of competition in an industry is Michael Porter's Five Forces Model, which is described below:

The model of pure competition implies that risk-adjusted rates of return should be constant across firms and industries. However, numerous economic studies have affirmed that different industries can sustain different levels of profitability; part of this difference is explained by industry structure. Michael Porter provided a framework that models an industry as being influenced by five forces. The strategic business manager seeking to develop an edge over rival firms can use this model to better understand the industry context in which the firm operates. Porter explains that there are five forces that determine industry attractiveness and long-run industry profitability. These five "competitive forces" are - The threat of entry of new competitors (new entrants) - The threat of substitutes - The bargaining power of buyers - The bargaining power of suppliers - The degree of rivalry between existing competitors

Discovering the Five Forces

Michael Porter developed a framework, which identified 5 forces that act to either increase or reduce the competitive forces within an industry. These five forces are
y y y y y

The Bargaining Power of Your Customers The Threat of New Entrants into your Industry The Bargaining Power of Suppliers Threat of Substitute Products or Services Rivalry Amongst Existing Firms

In general terms, the greater the competitive forces in your industry the more pressure you are likely to find on your prices. Whereas, the weaker the competitive forces in your industry the less pressure you are likely to have on your prices.

Porters Five Forces will help you to analyze your industry and determine what your competitors might do next. What you do in response to your analysis is up to you and your organizations creativity.

Porters Five Forces Overview of Each Force

By completing a competitive analysis you are becomming informed on who has the bargaining power before you commence negotiations with your customers and suppliers. Being informed ensues that your negotiations are less influenced by the skill of the negotiator and more by your commercial reality. Now lets look at each of these five forces in more detail.

The Bargaining Power of Your Customers

When analyzing the power of your customers you are really determining who needs who the most. This is driven, in part, by the number of prospective customers compared to the number of suppliers (suppliers are your competitors). A strong or powerful customer can play you off against your competitors. Your strong customers may ask for higher quality or improved service at the same price or simply, for a lower price. Where a less strong customer may simply try to bluff you. In general
y y

The greater the number of customers to your inductry the less commercial power any one customer will have The greater the number of competitors you have the greater your customers negotiating power

However, other factors such as the significance of the customer to you or their ability to switch to your competitors also plays a part in determining who has the power.
To learn more about the bargaining power of your customers including the top 11 things to consider during your analysis, click here, you will also find out how to apply each of these 11 points of analysis to your industry and you will learn from the many examples provided. (When finished use your browser back button to return to this page)

The Threat of New Entrants to Your Industry

A new entrant to your industry is a brand new competitor or maybe a new brand from on old competitor. A new competitor to your industry may erode some of your customer base, your challenge is to determine if it is likely that a new competitor will come along and try to steal your customers away. New competitors are restricted by up front capital costs, access to technology or requirements to obtain licenses then your market position is likely to be protected. However, if there are no barriers to entry your position could be weakened. Tip: Sometimes a new competitor in your area is a good thing. For example if you own a craft shop and four more craft shops open near you, the collective scale of the five craft shops may attract significantly more people to the area resulting in growth of your business. You need to determine if a new entrant is a good or a bad thing for your business.

The Bargaining Power of Your Suppliers

The bargaining power of your suppliers is like the bargaining power of customers only in reverse, you are now the customer, where before you were the supplier. How dependant on your business is your supplier, or are you dependant on your supplier? How much power does your suppliers have? Can they raise prices or reduce service without the fear of losing your business? In general terms the fewer suppliers that you have to choose from the less power you have to negotiate. Other factors such as the cost to switch suppliers also plays a part in determine who has the power. You will find that a supplier with a unique product that contributes to the uniqueness of your product has a lot of negotiating power, unless they too are dependant on you. Note: The more powerful the suppliers to an industry, the less profitable the industry tends to be.

The Threat of Substitute Products or Services

A substitute product is a product that replaces the need for your product altogether. One example, Timber is the main component of house frames. However, more and more steel frames are being produced. From a timber mills perspective, steel is a substitute for timber in house frames. Are your customers likely to find an alternative product or service to use instead of your product or service? Will substitute products or services erode your profits?

Rivalry Amongst Existing Firms

In many industries most marketing is aimed at maintaining market share, especially when looking at fast moving consumer goods. The industry becomes stable and changes in market share tend to be slow. However, are any of your competitors thinking about growing their business? If so will you loose business? Will they steal your customers away? Some of the tactics that your competitors may use to compete for market position are
y y y y

Reduced prices or increased price competition Increased advertising Differentiating based on customer service or, many other techniques

3. How to use
The first three of the forces are external factors while the last two are internal factors that could affect you, your organization and /or project. For each factor you must look at exactly who, what, why and how these factors could potentially effect you, your organization and/or your project.

1. Competition

y y

Who is the current competition? What is the possibility of new competitors in your sector field?

y y y

What are the abilities that they posses? How could this affect you, your project and/or your organization? Are there any barriers that you and/or they must over come?

2. New entrants
y y y

Is their any potential threat of substitution? What are the factors that make them superior if any? Is there any fear of them replacing existing product(s) or service(s)?

3. End users/Buyers
y y

Determine who your organizations/ projects potential buyer could be. How many potential buyers could there be? Internally? Externally?

4. Suppliers
y y

Determine who your organizations/ projects potential suppliers could be. How many potential suppliers could there be? Internally? Externally?

5. Substitutes
y y y

Is there any rivalry internally or externally regarding your organization or project? How can you increase your strengths while diminishing theirs? Aim to minimize the relative competitive strength of rivals.

It is commonly used as a starting point or "checklist" that one can then develop into a strategic plan in conjunction with other analysis tools such as: The Sixth Force (from the Six Forces Model), SWOT, PEST, SLEPT, STEER.

Introduction to Industry Rivalry

The rivalry amongst existing firms analysis will help you to understand the risk that your competitors may compete for market position and if their competitive tactics are likely to be effective. You will find that your competitors may compete for market position using tactics such as;
y y y y

price competition, advertising, increased customer service, or through offering longer warrantee periods

Read on to discover how likely it is that your competitors will use these tactics and successfully lure your customers away.

4. Analyzing Industry Rivalry

To analyze industry rivalry in your industry, you will need to consider the following factors,
Analysis Criteria Description

Industry Growth Rate Refers to the overall growth rate of your industry When your industry is in a growth phase there will be room for all businesses in your industry to grow, as a result there will be a low risk of competitor rivalry. As your industry matures and demand flattens or even goes into decline, the only way for one business to grow is at the expense on another, (win / loose), this often results in a greater risk of industry rivalry. High Fixed Cost
Refers to the proportion of the total industry costs that are fixed verse variable cost

If the fixed cost is a high proportion of the total costs for the industry then each competitor will need to maintain volume, which can drive higher competitor rivalry. Alternatively, if fixed costs are only a small portion of total costs then the industry can reduce supply when demand drops, reducing the risk of competitive rivalry. Intermittent Over Capacity Refers products whose demand is less than supply for relatively short periods Intermittent over capacity exists in industries that have the same capacity all year and supply to a seasonal demand, or in industries where supply can only be increased in large lumps, such as adding an extra shift to a car manufacturing plant. During the periods of over capacity (too much supply) in the industry there is likely to be increased competitor rivalry. Product Differences
Refers to your ability to differentiate your product based on tangible product differences

If your customers perceive that your products or services are different to those of your competitors and your customer values that difference, then you have some protection from competitor rivalry. If your customer perceives that your products/services are essentially the same as others in your industry then competitor rivalry is more likely.

Brand Identity

Refers to the customers perception of the strength of the brands in your industry

The stronger the customers brand preference the lower the risk of competitive rivalry. Switching Costs
Refers to the cost incurred by customers of your industry to switch their source of supply

The lower the switching costs the easier it will be for customers to change suppliers and the higher the risk of competitor rivalry. Informational Complexity Refers to the how easy or hard it is to understanding your products. The easier it is to understand products in your industry the higher the risk of competitive rivalry. Concentration and balance Refers to the number of competitors in your industry and the degree to which they are satisfied with their market position If your industry has only a few competitors who are all happy with their market share then the risk of competitor rivalry is low. Alternatively, if there are a lot of competitors or any one competitor is not happy with their position in the market then the risk of competitor rivalry is higher. Industry Commitment Refers to the diversity or the competitors in your industry If your industry consists of businesses that only compete in your industry then they are likely to be more committed to your industry and will remain in the industry even if results are poor, increasing the risk of competitor rivalry. However, if your industry includes divisions of major global conglomerates then they maybe less willing to incur consecutive years of losses, which reduces the risk of competitor rivalry. Exit Barriers Refers to the ease with which your competitors can exit your industry. If there are high barriers preventing a firm from exiting an industry it is likely that they will be prepared to operate at a marginal profit or loss and your should expect high competitor rivalry. An example maybe a firm has a large investment in

capital say plant and equipment, unless there is a buyer for the plant and equipment they may need to remain in your industry even if it is not profitable.