This assignment will address the necessary steps involved with evaluating the use of financial accounting information in making informed and ethical business decisions using comparative analysis and financial ratios.
Managerial Analysis – Assignment 2
In order for any entity (the company, its managers, investors, debt holders, etc.) to understand the valuation of a company, one must look at not only the company itself, but the company in the context of the overall economy (or stock market) as well as how that company performs within its industry sector. Comparative analysis is one way of determining valuation gaps among a company within its peer groups. Other valuation techniques could include discounted cash flow analysis and analysis of transactions that have recently occurred (ie: merger activity, and the relevant multiples of revenue/EBITDA upon deal closure.). Comparative analysis is easiest when the companies being evaluated are public, as information is publicly available, as is the software, to examine and analyze a company against a peer group and, say, the S&P 500. But it can be done for private companies as well, if the data can be uncovered. If we take global public companies, we see comparative analysis occurring everywhere.
We see it in the media, from research analysts’ reports, internal financial modeling, and institutional investor research. The one problem we all must recognize is that we do not live in a vacuum, where information is always sound (honest), perfect, and instantly available to everyone except insiders. This is where there is any potential for corporate fraud, as is suggested in one of this week’s readings. The ratios used in a comparative analysis also depend on the industry the company and peer group that are being analyzed. Many times a “sub-market” index will be used to represent the entire sector as “the market. It is this author’s opinion that while comparative analysis is a terrific tool, the key are the inputs into the financial accounting which ultimately calculates these ratios. Proper financial controls, compliance, and oversight are extremely important, along with a Board of Directors (in order to maintain checks and balances), in order to achieve ethical accounting standards within an organization. As a final thought, please see below an example of a comparative analysis of British Petroleum from a recent Reuter’s research report dated June 17, 2010:
British Petroleum Peer Comparison: