Financial Management and Analysis
Core concepts
Master ratio analysis across four families: liquidity (current, quick), solvency/leverage (debt-to-equity, times interest earned), efficiency (inventory turnover, receivables turnover, asset turnover), and profitability (gross margin, net margin, ROA, ROE). Know the DuPont decomposition: ROE = net margin × asset turnover × equity multiplier. Understand time value of money, NPV, IRR, payback, and the cost of capital (WACC). Working capital management, the cash conversion cycle, and capital budgeting decision rules round out the domain.
Traps in questions
- Averages vs. ending balances: turnover ratios typically use average balances; using ending balances changes the answer.
- NPV vs. IRR conflicts: when projects differ in scale or timing, NPV is preferred because it measures value added.
- WACC weights: use market values where available, and remember debt is after-tax (multiply by 1 − tax rate).
- Cash conversion cycle: days inventory + days receivables − days payable. A higher number means more cash tied up.
Worked example
Suppose a firm has net income of 60,000, sales of 600,000, total assets of 400,000, and equity of 250,000. Net margin = 10%, asset turnover = 1.5, equity multiplier = 400,000/250,000 = 1.6. ROE = 0.10 × 1.5 × 1.6 = 24%, which also equals 60,000/250,000. Use DuPont to diagnose why ROE changed - margin, efficiency, or leverage.
Rule of thumb
For capital budgeting, accept projects with positive NPV and IRR above the hurdle rate; when they conflict, trust NPV.