Examples are brand name a superior management team

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most likely to confer a competitive advantage and create value. Examples are brand name, a superior management team, employee skills, and a reliable supply chain. 2. Non-capitalized costs. Related to the concept of measurability is the expensing of costs relating to "assets" that cannot be identified with enough precision to warrant capitaliza- tion. Examples are brand equity costs from advertising and other promotional activities, and research and development costs relating to future products. 3. Historical costs. Assets and liabilities are usually recorded at original acquisition or issuance costs. Subsequent increases in value are not recorded until realized, and declines in value are only recognized if deemed permanent. Thus, GAAP balance sheets omit important and valuable assets. Our analysis of ROE and our assessment of liquidity and solvency, must consider that assets can be underreported and that ratios can be distorted. We discuss many of these limitations in more detail in later modules. Company Changes Many companies regularly undertake mergers, acquire new companies and divest subsidiaries. Such major operational changes can impair the comparability of company ratios across time. Companies also change strategies, such as product pricing, R&D, and financ- ing. We must understand the effects of such changes on ratios and exercise caution when we compare ratios from one period to the next. Companies also behave differently at different points in their life cycles. For instance, growth companies possess a different profile than do mature companies. Seasonal effects also markedly impact analysis of financial statements at different times of the year. Thus, we must consider life cycle and seasonality when we compare ratios across companies and over time. Conglomerate Effects Few companies are pure-play; instead, most companies operate in several businesses or industries. Most publicly traded companies consist of a parent company and multiple subsidiaries, often pursuing different lines of business. Most heavy equipment manufacturers, for example, have finance subsidiaries (Ford Credit Corporation and Cat Financial are subsidiaries ofFord and Caterpillar respectively). Financial statements of such conglomerates are consolidated and include the financial statements of the parent and its subsidiaries. Consequently, such consoli-
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Module 3 I Profitability Analysis and Interpretation 3-20 ed statements are challenging to analyze. Typically, analysts break the financials apart into their ponent businesses and separately analyze each component. Fortunately, companies must report cial information (albeit limited) for major business segments in their l O-Ks. ~ View Ratios reduce, to a single number, the myriad complexities of a company's • rations. No scalar can accurately capture all qualitative aspects of a company. Ratios cannot . gfully convey a company's marketing and management philosophies, its human resource ivities, its financing activities, its strategic initiatives, and its product management. In our
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