Page 24 - Study Guide 3

Study Guide – Chapter 3 – Introducing financial statements

Financial Statements where do they come in to the business situation? Without them I envisage a world in chaos money being used and no accountability.

Question 3-1

1. What is wrong with just doing what 'works' in relation to analysing financial statements?

By doing what ‘works’ in relation to analysing statements can in itself present many dangers. Yes I could agree with, if the system works don’t touch it keep working with it. However with the changing of time, systems are being constantly upgraded and unless we take steps to follow the procedures set in place, analysing of financial statements may become flawed. Errors may occur and systems fail.

I see financial statements as a story of what is happening within the organisation. Assets to liabilities, balance sheets to income statements have a role in the story. With an accountability of business features it would be useless to keep going.

There are plenty of experienced practitioners in our capital markets.Why do we not simply find out what most are doing and just do this ourselves? What do you think and why?

Each company has its own role within the world. You wouldn’t ask a butcher to bake a loaf of bread or nurse to be a bank clerk each role has its own purpose. So simply doing what most are doing is not the right solution. We must develop our own unique way of business.

Question 3-2

What is the benefit of having a structure, such as the du Pont Company’s framework, to help use ratios to analyse a firm's financial statements? Is it any better (or worse) than simply doing what experienced practitioners do? Why or why not?

To understand the du Pont Company Framework I felt I needed to find out the full definition of what it means.

Definition:

A method of performance measurement that was started by the DuPont Corporation in the 1920s. With this method, assets are measured at their gross book value rather than at net book value in order to produce a higher return on equity (ROE). It is also known as "DuPont identity".

DuPont analysis tells us that ROE is affected by three things:
- Operating efficiency, which is measured by profit margin
- Asset use efficiency, which is measured by total asset turnover
- Financial leverage, which is measured by the equity multiplier

ROE = Profit Margin (Profit/Sales) * Total Asset Turnover (Sales/Assets) * Equity Multiplier (Assets/Equity)

I would have to agree that we do not just rely on a firm’s financial statements. Looking beyond the financial statements and delving into the nuts and bolts of the business we will be able to determine how the company is performing. I would see it as a way of what would help me if I was the business organisation and how I could improve on the quality of business activities to ensure that my company was performing to the best of its current standings.