Financial Analysis and Business Valuation
Core Concepts
Financial analysis involves ratio analysis and valuation. Key areas:
- Profitability ratios: gross margin, net margin, ROA, ROE.
- Liquidity ratios: current ratio, quick ratio.
- Solvency ratios: debt-to-equity, interest coverage.
- Efficiency ratios: inventory turnover, receivables turnover, asset turnover.
- Valuation methods: discounted cash flow (DCF), market multiples (P/E, EV/EBITDA), asset-based valuation.
Common Traps
- ROE can be distorted by leverage; use DuPont analysis (ROE = net margin × asset turnover × equity multiplier).
- Quick ratio excludes inventory; it is a stricter test of liquidity.
- DCF is sensitive to terminal value assumptions.
- Market multiples require comparable companies; differences in accounting policies can distort.
- Book value may not reflect market value.
Worked Example
A company has net income BGN 50,000, sales BGN 500,000, total assets BGN 400,000, and equity BGN 200,000. ROE = 50,000 / 200,000 = 25%. Using DuPont: net margin = 50,000/500,000 = 10%; asset turnover = 500,000/400,000 = 1.25; equity multiplier = 400,000/200,000 = 2. ROE = 10% × 1.25 × 2 = 25%. Rule of thumb: Use DuPont to understand drivers of ROE.