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FINANCE 300 RATIO ANALYSIS EXTENSIONS SPRING 2010 Limitations of Ratio Analysis -Many large firms operate many divisions in different industries. It is thus difficult to determine which industry to compare them to. -Most firms want to be better than average. Compare to the best in the industry or the average of the beat. Benchmarking is valuable in this regard. -Inflation may distort balance sheets (assets book value, depreciation, inventory costs, profits). -Seasonal factors can distort ratio analysis. -Firms can employ window dressing. -Different GAAP -Hard to tell if a ratio is good or bad. -Sometimes a firm has some ratios that look good and some bad. What is the net effect? LOOKING BEYOND THE NUMBERS Sound financial analysis should be more than just calculating and comparing numbers. When evaluating a company certain qualitative
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Unformatted text preview: factors must be considered.-Are the firm’s revenues tied to one (or a few) key customer(s)?-To what extent are the firm’s revenues tied to one (or a few) key product(s)?- To what extent does the firm rely on a single supplier?-How much of the firm’s business is generated overseas and where?-How much competition is there and what are the competitors doing?-What are the firm’s future prospects and how successful is their R&D?-What is the legal environment? Are there many law suits or there expected changes in the law that will impact the firm?-What is the regulatory environment? Are there expected changes that will impact the firm? ROA and ROE are two very useful ratios to evaluate management’s performance. ROE and shareholders’ wealth are highly correlated....
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This note was uploaded on 05/19/2010 for the course FNAN 300 taught by Professor Boudreaux during the Spring '10 term at University of Louisiana at Lafayette.

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