BUSINESS ANALYSIS AND VALUATION

(Introduction)
• Business Analysis involves making a
comprehensive analysis of business activities
with a view of formulating business strategies
to achieve organizational goals and objectives
• Firm’s business activities are influenced by the
economic environment and the firms own
strategy
 Cont’d
• The economic environment under which the
firm operates include; the firm’s industry,
inputs, outputs, markets, regulations, etc.
• Firm’s business strategy determines how it
positions itself in its environment to achieve a
competitive advantage.
• The scope of business analysis include;
 Cont’d
• Financial Analysis
• Business strategy analysis
• Accounting analysis
• Prospective analysis
A. FINANCIAL ANALYSIS.
• The goal of this analysis is to use financial data
to evaluate the current and past performance of
a firm and to assess its sustainability.
 Cont’d
• The analysis should be systematic and efficient
and should also allow the analyst to use
financial data to explore business issues
• Cash flow analysis and ratio analysis are the
two most commonly used financial tools in
financial analysis.
• Ratio analysis focuses on evaluating product
market performance and financial policies
while cash flow analysis focuses on firm’s
liquidity and financial flexibility.
 Cont’d
B. Business strategy analysis
• The purpose of this analysis is to identify key profit
drivers and business risks and to assess the
company’s potential of generating profits at a
qualitative level.
• It involves analysing the firm’s industry and its
strategy to create a sustainable competitive
advantage.
• Assessment of s firm’s competitive strategy facilitates
evaluating whether the current profitability is
sustainable.
 Introdn cont’d
C. Accounting analysis
• The purpose of this is to evaluate the degree to
which the firm’s accounting method/ approach/
policies, capture the underlying business reality.
• The analysis helps to identify areas where there is
accounting flexibility, and evaluating the
appropriateness of the company’s accounting
policies and estimates. This further helps the analysts
to assess the degree of distortion in firm’s accounting
numbers.
 Introdn cont’d
D. Prospective analysis
• Focuses on forecasting a firm’s future
• There are two commonly used techniques in
prospective analysis i.e. Financial statements
forecasting and valuation.
• Both techniques allow the synthesis of the
insights from business analysis, accounting
analysis and financial analysis in order to make
predictions about a firm’s future.
 FINANCIAL ANALYSIS
• This analysis is carried out using mainly ratio
analysis and cash flow analysis.
USING RATIO ANALYSIS.
• In financial analysis, ratios are used to evaluate the
financial position and performance of a firm. This is
because the absolute accounting figures reported in
the financial statements do not provide a meaningful
understanding of the performance and financial
position of a firm
 Ratio Analysis Cont’d
• To determine the financial condition and
performance of a firm, the ratios are compared with
average ratios of the whole industry
TYPES OF RATIOS
• Liquidity ratios: They measure the firm’s ability to
meet current obligations.
• Leverage ratios: They show the proportion of debt
and equity in financing the firm’s assets.
• Activity/efficiency ratios: They reflect the firm’s
efficiency in utilizing its assets.
 Ratio Analysis Cont’d
• Profitability ratios: Measure the overall performance
and effectiveness of the firm in using its resources to
generate profits.
• Shareholders investment ratios .Used to assess the
value and quality of investing in ordinary shares of a
company.
1. LIQUIDITY RATIOS
• Current ratio. Evaluates the relationship between
current assets & current liabilities (ratio of 2:1)
• Quick ratio. Evaluates the relationship between
quick/liquid assets & current liabilities (ratio of 1:1)
 Ratio Analysis Cont’d
2. LEVERAGE/GEARING RATIOS
• They are used to judge the long term financial
position of the firm. The ratios include;
• Debt to equity The ratio used to indicate a mix of
debt and owners equity in financing the firms’ assets.
• Debt to total assets. Measures the extent to which
assets are covered by borrowed funds
• Interest cover. Indicates the numbers of times,
earnings can cover interest charges. More times, the
better.
 Ratio Analysis Cont’d
3. ACTIVITY/ EFFICIENCY RATIOS.
• Measures how efficient a firm is in utilising its
resources/assets in day to day operations. The ratios
used here include;
• Rate of inventory turnover (times). Maximize
number of times
• Inventory turn over period (days). Minimize number
of days
• Debtors turn over (times). Maximize number of
times
• Debtors turnover/collection period (days). Minimize
number of days.
 Ratio Analysis Cont’d
• Creditors turn over (times ).Minimize number
of times.
• Creditors turn over/payment period (days).
Maximize number of days.
• Asset turnover. Sales/net assets. Shows the
utilization of assets capacity to generate
revenue. Low ratios indicate excess capacity
not utilized.
 Ratio Analysis Cont’d
4. PROFITABILITY RATIOS
Ratios considered here include;
• Return on equity (ROE). EAT/Equity
• ROCE. PBIT/Capital employed
• Net profit margin. EAT/sales
• Gross profit margin. Gross profits/sales.

Examples ………………..

SHAREHOLDERS INVESTMENT RATIOS.

 SHAREHOLDERS INVESTMENT RATIOS.
• These are ratios used by equity shareholders
and other investors to assess the value and
quality of an investment in the ordinary shares
of a company. The value of an investment in
ordinary shares in a listed company is the
market value.
• Therefore investment ratios must have regard
to not only information in the company’s
published accounts but also to the earnings
per share. EPS is a valuable indicator of an
ordinary share’s performance.
 Investment ratios cont’d
• The ratios include;
Dividends per share = Total Dividends of the year
Number of shares
• Dividends cover = Earnings per share (EPS)
Dividends per share
• It is also given by;
Profit after tax and pref. dividends
Dividends on ordinary shares
 Investment ratios cont’d
• This shows how safe dividends are or the
extent of profit retention. Variations may be
due to maintaining dividends when profits
are declining.
• It shows the proportion of profit for the year
that is available for distribution to
shareholders that has been paid (or proposed)
and the proportion that will be retained in the
business to finance future growth.
 Investment ratios cont’d

• Note; For instance, a dividend cover of 2

times would indicate that a company has paid
50% of its distributable profits as dividends
and retained 50% in the business to finance
future operations.
• iii) Dividend yield
• It is the return (dividends) a shareholder is
currently expecting on shares of a company
 Investment ratios cont’d

Dividends yield is given by:

dividend per share x 100%
Market price of a share (ex div)
• Note: The dividend per share is taken as the dividend
of the previous year and Ex-div means that the share
price does not include the right to the most recent
dividend.
•
 Investment ratios cont’d
Example:
• In the year to 30th September, 2010, an advertising
agency declared an interim ordinary dividend of
$0.074 per share and a final dividend of $0.086 per
share. Assuming an ex-div share price of $3.15, what
is the dividend yield?
Solution
• Total dividend per share = (0.074 + .086) = $0.16
• Dividend yield = 0.16 x 100% = 5.1%
3.15
 Investment ratios cont’d
• Low yield indicates that the company retains a large
proportion of profits for re-investment and therefore
the dividend per share is low compared to the
current market value of a share

iv) Earnings per share:

• It is the amount of net profits for the period that is
attributable to each ordinary share which is
outstanding during all or part of the period
• EPS = Earnings after tax
• No of outstanding shares.
 Investment ratios cont’d
v).Price earnings ratio
It is the ratio of a company’s current share price to
earnings per share.
• (P/E Ratio) is given by Market price of a share
Earnings per share
• The higher the ratio, the better. It reflects the
confidence the market has in the company and its
future e.g in profit growth. The P/E ratio of one
company can be compared with the P/E ratios
of;
 Investment ratios cont’d
• Other companies in the same business sector
• Other companies generally
• It is often used in stock exchange reporting
where prices are readily available.
v) Earnings yield Earnings per share
Market price of a share
• It shows the dividends yield if there is no
retention of profits.
 Debt holders ratio
i) Interest cover
Interest cover is a measure of the adequacy of a
company’s profits relative to its interest
payments on debt. It is given by:
Operating profits before interest & tax
Debt interest
• The lower the interest cover, the greater the
risk that profits (before interest & tax) will
become insufficient to cover interest
payments.
 Debt holders ratio
• In general, a high level of interest cover is
good but may also be interpreted as a
company failing to exploit gearing
opportunities to fund projects at a lower cost
than from equity finance.
• Note: An interest cover ratio of 2 times or less
would be low and should really exceed 3 times
before the company’s interest costs are to be
considered within acceptable limits.
 Debt holders ratio
• Other ratios that are of interest to debt
holders include;

• ii) Debt ratio

• iii) Gearing/ leverage

Example