Financial Statement Analysis

L E C T U R E 2 - I N T R O D U C T I O N T O B U S I N E S S A N A LY S I S A N D VA LU AT I O N U S I N G
F I N A N C I A L S TAT E M E N T S
How Financial Statements
can be used by stakeholders
Financial Statements can be used in various ways for each stakeholder group.
Business Strategy Analysis
Definition:

 Qualitative analysis of the economic and financial context an organization operates in.

 Identification of an organization’s profit drivers.

 Evaluation of an organization’s key risks.

Objectives:

 Set the business context upon which the Accounting and Financial analysis will be based on.

 Assess the sustainability of an organization’s current financial performance.

 Make realistic future performance forecasts.

How to determine the firm’s
value
“A firm’s value is determined by its ability to earn a return on its capital in excess of the cost of
capital.”
Cost of capital:
◦ Represents the return which needs to be achieved to cover for the cost of capital of a new project.
◦ Capital can be in the form of equity and debt - then the Weighted Average Cost of Capital (WACC) is
computed.
◦ Determined by the capital markets.

Profit potential is influenced by:

1 – Industry choice
2 – Competitive strategy
3 – Corporate strategy
Business strategy analysis
involves…

2 – Competitive 3 – Corporate
1 – Industry
strategy strategy
analysis
analysis analysis
1- Industry analysis
1. Profitability varies between different industries.
2. Profitability metrics:
◦ Gross Profit Margin: (Gross Profit / Revenue) x 100
Measures the efficiency of production.

◦ Operating Profit Margin: (Operating Income / Revenue) x 100

Measures the operational efficiency and profitability.

◦ Net Profit Margin: (Net Income / Revenue) x 100

Percentage of revenue that translates into net profit after accounting for all expenses and
taxes.

◦ Return on Assets: (Net Income / Total Assets) x 100

Measures the company's ability to generate earnings from its asset base.
Porter’s 5 forces
- Drivers of industry
profitability
Explaining the 5 competitive
forces (1/2)
1. Rivalry among existing firm
◦ Industry growth rate
◦ Competitors
◦ Switching costs
◦ Economies of scale and Fixed to Variable costs
2. Threat of new entrants & Barriers to entry:
◦ Scale
◦ First mover advantage
◦ Access to channels of distributions and Relationships
◦ Legal barriers
Explaining the 5 competitive
forces (2/2)
3. Threat of substitute products
◦ Relative price and performance of substitute products
◦ Customer willingness to substitute

4. Bargaining power of buyers

◦ Price sensitivity
◦ Relative bargaining power

5. Bargaining power of suppliers

◦ Critical nature of the suppliers’ product
 2 - Competitive strategy
analysis - types
A. Cost leadership: B. Differentiation:
“Supplying the same product as the “Providing a product or service that is
competition at lower cost.” unique and distinct in the way perceived
◦ Economics of scale and valued by the consumers.”
◦ Efficient production ◦ Supplier product quality
◦ Simpler product designs ◦ Superior product variety
◦ Lower input costs ◦ Superior customer service
◦ More flexible delivery
◦ Low-cost distributions
◦ Investment in brand image
◦ Little Research & Development
◦ Tight cost control system
Competitive strategy analysis
– how to achieve and sustain
1. Unique core competencies – can not be easily acquired by the
competitors

2. System of activities – that can not be easily imitated

3. Positioning – carving out a profitable subsegment of the

organisation
3 - Corporate strategy analysis
(1/2)
I. Some companies manage different businesses under one umbrella

II. Corporate strategy analysis evaluates whether a company can

create value in a multi-business model

III. Cost synergies and increased revenues through cross-selling

Corporate strategy analysis
(2/2)
Multi-business model:
PROS (+): Less costly than market transactions due to:
Information sharing
Enforcement
Asset sharing
CONS (-): Hard in practice due to:
Failing to create value through acquisitions
Incentives misalignment
Corporate strategy
analysis
1. Some companies manage different businesses
under one umbrella
2. Corporate strategy analysis evaluates whether
a company can create value in a multi-business
model
3. Cost synergies and increased revenues through
cross-selling
Limitations and Evaluation
1. Industry analysis:
◦ Industries do not have clear boundaries
◦ Inappropriate industry definition may result to incomplete analysis and inaccurate forecasts

2. Competitive strategy analysis:

◦ Similar as Industry analysis, it focuses on the individual business level

3. Corporate strategy analysis:

◦ Always be skeptical when conducting such analysis in order to evaluate the benefits and limitations of
each corporate strategy
CASE STUDY 1 – Pharmaceutical
industry
1. Rivalry among existing firm

2. Threat of new entrants & Barriers to entry

3. Threat of substitute products

4. Bargaining power of buyers

5. Bargaining power of suppliers

Introduction to the Pharmaceutical Industry

11️⃣ Overview of the Industry

The pharmaceutical industry develops, produces, and markets drugs for medical use.
It plays a critical role in global healthcare by improving quality of life and increasing life expectancy.
Companies operate in prescription drugs, generics, over-the-counter (OTC) medicines, and biotechnology.

2️⃣ Key Industry Characteristics

Highly regulated (FDA, EMA, WHO set drug approval and safety standards).
R&D Intensive 🧪 (Takes 10-15 years and billions of dollars to develop a single drug).
Strong patent protection 🔏 (Exclusive rights to sell new drugs for 20 years before generics enter).
Global impact 🌍 (Pharma companies operate worldwide, with major hubs in the U.S., Europe, China, and India).

3️⃣ Major Players in the Industry

Pfizer 💊 (Vaccines, cardiovascular, oncology).
Johnson & Johnson 🏥 (Pharmaceuticals, medical devices, consumer health).
Novartis 🔬 (Oncology, generics, gene therapy).
Roche 🧫 (Biotechnology leader, cancer drugs).
Merck & Co. 💉 (Infectious diseases, immunology).

4️⃣ Industry Trends & Challenges

Biotech & Personalized Medicine 🧬 (Tailored treatments based on genetics).
Drug Pricing & Affordability 💰 (High costs vs. government pressure to lower prices).
Generic Competition ⚖️(Big pharma vs. generic manufacturers).
Digital Health & AI 🤖 (Using AI for drug discovery and virtual clinical trials).
CASE STUDY 2 – Electric Vehicle
(EV) industry
1. What type of competitive strategy is being followed by each of the two
companies?

2. How do both companies achieve their competitive strategy?

- How does each company gain a competitive advantage?

- What challenges does each strategy face?
- Can Tesla or BYD adopt elements of the other’s strategy? How?
- If you were starting an EV company, which strategy would you choose?
Why?
Tesla: Competing Through Innovation & Branding

🚀 Key Features of Tesla’s Strategy:

Premium branding & strong customer loyalty.
Industry-leading battery range & self-driving AI.
Exclusive Supercharger Network for fast charging.
Direct-to-consumer sales model (no dealerships).
Higher price point with high-end design & technology.

📌 Main Competitive Advantage: Innovation & exclusivity attract high-paying customers.

BYD: The Low-Cost EV Leader

⚡ Key Features of BYD’s Strategy:

Focus on affordable, mass-market EVs.
Owns battery production, reducing costs significantly.
Government support & economies of scale in China.
Competes aggressively on price, making EVs more accessible.
Targets middle-class consumers rather than premium buyers.

📌 Main Competitive Advantage: Cost efficiency allows BYD to sell EVs at a lower price than competitors.
Feature Tesla (Differentiation) BYD (Cost Leadership)

Target Market Premium, high-end Mass-market, affordable

customers buyers

Technology Focus AI, self-driving, high- Cost-efficient production &

performance batteries battery manufacturing

Brand Positioning Luxury, high-tech Affordable, practical EVs

innovation

Competitive Edge Brand loyalty, exclusive Low-cost production, mass

tech availability