Both companies enjoy economies of scale and are pro

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tly with Home Depot and Lowes. Both companies enjoy economies of scale and are pro- by barriers to entry including trained workforce, large capital start-up costs, prime loca- ,national brand recognition, and customer loyalty. However, threat of entry from online and ialty stores is medium to high. In sum, the industry in which a company operates dictates much of the company's potential bility and efficiency. Home Depot does business in a highly competitive market but enjoys supplier and buyer power. This indicates that, at least in the short run, the company should . profitable and the chance of default is relatively low. p 3: Perform financial analysis - - ancial analysis includes calculating ratios. But ratios are only as accurate as the numbers e numerator and denominator. Thus, it is crucial to begin with high-quality inputs. In later ules we explain adjusting the financial statements to ensure the quality of the numbers. We t the financial statement to exclude one-time events or transactions that will not persist and include all assets and liabilities at proper amounts; both for purposes of increasing the quality the ratio inputs. From the adjusted financials, we calculate ratios and then compare them to the " s of competitors as well as to broader industry averages. part from earnings per share (EPS), GAAP does not define ratios. Some ratios (such as nt ratio) are universally defined but many more ratios have no unique, commonly accepted - ition. For example, the debt to equity ratio is defined as either total liabilities to equity or total debt (interest bearing liabilities) to equity. Similarly, measures such as free cash flow or 3ITDA, which are inputs to ratio calculations, often have more than one definition. One ver- of free cash flow deducts capital expenditures from operating cash flow. Another version deducts dividends paid. It is not possible to specify the "correct" way to compute ratios. The advice is to know what is in the numerator and denominator of any particular ratio and then rpret the quotient accordingly. Just as no two analysts compute ratios the same, there is little agreement about the best set -ratios to assess credit risk. For example, this module's Appendix shows a list of ratios (along
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4-11 Module 4 I Credit Risk Analysis and Interpretation with their definitions) that S&P and Moody's use to prepare credit ratings. The ratios are widely divergent and similar ratios are defined differently by the rating agencies. For our purposes, we compute three classes of credit-risk ratios: profitability and coverage, liquidity, and solvency. Profitability and coverage ratios are called "flow" ratios because they include cash flow and income statement data. The liquidity and solvency ratios are called "stock" ratios because they use balance sheet numbers only. We use both flow and stock variables to assess credit risk.
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