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Review questions

It means that the book keeping is performed properly, so that the income statement, balance sheet and cash flow statement relate in a certain way.

By ensuring that the internal coherence of the income statement, balance sheet, statement of changes in owners’ equity and cash flow statement is intact. For example, equity at year end, calculated as total assets less total liabilities, must equal equity at the beginning of the year plus net earnings less dividends.

Revenue growth, EBITDA-margin, depreciation and amortisation as a percentage of intangible and tangible assets, tax rate, net borrowing rate, intangible and tangible assets as a percentage of revenue, net working capital as a percentage of revenue and net interest bearing liabilities as a percentage of invested capital.

Revenue growth: Demand, product development, pricing policy, etc.

EBITDA-margin: Cost efficiency, (in/out)sourcing, raw materials, etc.

Depreciation: Depreciation policy, assets mix, quality of assets, etc.

Tax rate: Tax system, country of income generation, etc.

Net borrowing rate: Type of loan, variable versus fixed interest rates, maturity, currency, etc.

Intangible and tangible assets: Investment plans, growth, (in/out) sourcing, etc.

Net working capital: Growth, efficiency, etc.

Net interest bearing liabilities: Target capital structure, investment plans, access to capital etc.

Following a top-down approach the following main themes should be included:

  • Macro-analysis such as the PESTLE analysis
  • Industry-analysis such as Porter’s Five-Forces
  • Firm-specific analysis such as a value chain analysis and an assessment of internal resources
  • SWOT-analysis – summarising the results of the strategic analysis

Since the objective is a time series analysis, the analyst needs to address the following issues before calculating and interpreting financial value drivers for a specific firm.

  • Are accounting policies the same across time?
  • Are reported earnings affected by non-recurring items?
  • Has the firm introduced new products or entered new market(s) with a different risk profile?
  • Has the firm acquired or divested businesses, which have changed the levels and trends in key financial value drivers?

The purpose of a time series analysis is to identify and analyse the levels and trends in the underlying performance of a firm. Thus, the historical value drivers are calculated with the purpose of assessing levels and trends in these drivers.

The design of the value drivers and thereby the level of aggregation is influenced by a number of factors that need to be taken into account. For example, if detailed information is available such as internal information it seems useful to apply a more refined value driver approach. If the purpose of the analysis is short term forecasting such as predicting next year’s earnings, a more refined value driver approach also seems useful as more information tend to be available. However, if the purpose of the analysis is long term forecasting, it is likely that a more aggregated value driver set up is more appropriate. This is mainly due to the fact that information tends to become cruder and less accurate the further ahead in time forecasts are made. In these cases analysts tend to focus on the long term behaviour of key financial value drivers such as growth and EBITDA-margins.

An evaluation of the estimates supporting the pro forma statements includes:

  • A quantitative assessment of historical and future ROIC (and potentially other financial ratios such as revenue growth rate)
  • A qualitative assessment of the analysis performed and evidence/data being used.