Project Forecast Paper

Analysis of Financial Statements

Finance 540

July 30, 2007

Financial Measures

Panorama Inc. chose the Wagner suite of ratios to conduct an analysis of five key financial measures to use in making a decision on the company with which it would enter into an alliance. These five financial measures consisted of sales growth, profitability, turnover, liquidity and capital structure. Sales growth Ð'- as the term indicates Ð'- pertains to year-over-year Earnings Before Interest and Taxes (EBIT) sales figures as compared to industry averages. Profitability ratios depict a company's return on its investments. Turnover in Wagner's suite of ratios is based on inventory and receivables. For liquidity evaluations the Wagner suite focuses on the current ratio. As for capital structure analysis, Wagner reviews the debt-equity ratio to determine the amount of debt that companies carry. As Panorama would be entering into a joint venture to manufacture and sell a new product, the most important ratios to serve as indicators of future success would be those closely related to sales and return on investment (ROI). Therefore, for this objective, sales growth and profitability ratios would distinguish those candidates with a solid track record with which a possible partnership with Panorama would prove less risky. If Panorama's objective had been a possible merger, then capital structure and the liquidity would have been more detrimental than other factors. However, other factors not necessarily tangible and measurable also carry a certain degree of importance for Panorama. Such factors include the level of innovation, employee satisfaction, corporate culture and employee turnover. These contribute towards construing an overall image of a company which could position the given company favorably or unfavorably, and could provide the overriding criteria towards a future collaboration.

Weighing Financial Ratios

Financial ratios are a way to summarize large quantities of financial data and are used to compare firms' performance (Brealey, 2006). Most ratios must be compared to historical values of the same firm, the firm's forecasts, or ratios of similar firms. The company would need to disclose if they used year-end values or average values. Year-end values may not be representative because certain account balances that are used to calculate ratios may increase or decrease at the end of the accounting period due to seasonal factors. These changes may distort the value of the ratio. The company should also be asked what type of accounting method they use because different accounting choices may result in significantly different ratio values. The Current ratio is one of the best known measures of financial strength.

Learning Objectives

In the Analysis of Financial Statements simulation there are four cycles and each cycle focuses on a specific analysis of a company's performance. The four major learning objectives are financial ratios, notes to the financial statements, non-financial measures, and a final analysis applying all measurements.

The financial learning objective focuses on comparing financial ratios to the industry average to determine the two company's strengths and weaknesses in leverage (debt-equity ratio), liquidity (cash), efficiency (turnover or productivity measure), and profitability (return on investment). These ratios are obtained from information provided on the company's balance sheet, income statement and owner's equity statement. By determining where the two companies, Lambda TV and Coral, stand in correlation to the industry, Panorama Inc.'s officers can determine which company is in better financial shape.

Although the financial picture may look clear through the ratios, the second learning objective of the simulation teaches the analysis to look at the picture more closely through the "notes to the financial statements". The notes allow the analysis to determine which alternative accounting methods are used, describe details of the financial statements, and disclose any information needed for the reader to have a full understanding of the financial statements. Often-times the notes assist the analyst in determining if any differences need to be noted in the comparisons that would skew the financial ratios.

In addition to the financial ratios and the notes, the non-financial indices of the company should be considered. For example, employee morale, corporate community involvement, and customer spread all contribute to these indices as well as others. "In the non-financial measures, Lambda TV has a better customer spread, higher proportion of income from new products, and a lower employee turnover when compared to Coral" (Analysis of Financial Statements, 2003). Although the analyst cannot quantify these indices, they still must be considered in any company's overall performance.

The final purpose of the simulation was the consideration of each objective to be used to make a comprehensive decision. By only using one objective, an analyst for Panorama Inc. might have chosen Coral as the joint venture company. For example, if sales growth alone had been used to make the decision, then Coral's would have been the logical growth as its sales growth was well above the industry average in 2002, contrary to Lambda TV's; however, with all things taken into consideration, Lambda's profitability, operational efficiency, capital structure, and non-financial measures collectively made for a better choice as a joint venture for Panorama Inc. To summarize, each method of analyzing a company is important to paint a clear picture.

Evaluation of Suites

After evaluating each suite it was determined that the Wagner suite was the better choice for Panorama Inc. The Wagner suite evaluates companies based upon the following five financial