corporate rating methodology_fsa

8/2/2019 Corporate Rating Methodology_FSA

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Understanding Industry Dynamicsand Financial Statements

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Industry Classification

External Factors

Demand and Supply Analysis

Size and Growth trends

Profitability

1- Cost factors

2- Pricing

Competitive Strategies


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General classification by product or service type Segmentation by the Industrial Life Cycle:

Life Cycle Phase DescriptionPioneer Product is new, acceptance is

questionable, high riskGrowth Product acceptance is established,

accelerating growth in sales andearnings

Mature Growth in line with the economy,competition for market share

Decline Demand for product steadily decreasing

Classification by Business Cycle Reaction

Behaviour Pattern Description

Growth above-normal expansion in sales and profitsindependent of the business cycle

Defensive Stable performance during ups and downs

Cyclical Profitability tracks the business cycle, often inan exaggerated manner


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External factors

Technology survival with new products

Government and regulatory - policies can kill or servean industry

Demographics young or aging population affectdemand

Social Changes changes in Lifestyles

Foreign influences low cost production of textiles

overseas decimated the US textile industry

Demand and Supply Analysis

Demand

What derives an industrys revenue

Economic expansion or changing consumptionpatterns

Segmentation by users home, commercial, industrial

Segmentation by geographic region

Supply Existing suppliers and market shares

Attractiveness of industry to newcomers

Demand/Supply gap


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Industry Profitability

Cost structure and pricing f lexibility

Demand/supply balance as indicator of future profitability

Relationship between sales growth and profits

Product segmentation helps in pricing

High degree of concentration inhibits price movements

Local and international competition

High/low entry barriers affect pricing power in the long

run Ability to pass on increases in key raw material costs

Corporate Strategies

Cost leadership the firm sets out to become the low-cost producer in the industry

Differentiation unique positioning based onproduct, the delivery system or the marketing approach

Market share paradigm relative market share is anecessity because it drives relative cost

Rule of 3 and 4 a stable competitive market has nomore than 3 competitors and no more than 4 times theshare of the smallest player


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Five competitive forces that determine

industry profitability

Source: Competitive Advantage by Michael E. Porter(New York; The Free Press, 1085)

PotentialEntrants

IndustryCompetitors

Rivalry amongexisting firms

Suppliers Customers

Substitutes

Bargaining power of

suppliers

Bargaining power ofcustomers

Threat of substitute

products or services

Capital Adequacy

Size of Assets

Corporate Governance

Inefficient Processes

Technological

sophisticationCentral Bank

Regulations

Market Volatility

Legislation

Control

Yields Going Down

Narrowing Margins

Growing Risk

Competition

Banking

System

Management horizon:Problems and Challenges

Russian Banking

Sector Overview

Management

Concerns

Alfa Bank

Overview

Alfa BankBusiness Strategy


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Financial Statements- Income Statement, Balancesheet and Cash flow statement

Miscellaneous supporting calculations andadjustments

Ratios and trend analysis

Key value drivers

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Financial Statement Analysis

Financial Statements comprise

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Balance Sheet Provides a snapshoot of a firms financialposition

Income Statement Reports on the performance of the firm

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Statement of CashFlows

Reports the cash receipts and cashoutflows classified according to operating,investing and financing activities

Statement ofStockholdersEquity

Reports the amounts and source ofchanges in equity from transactions withowners

Notes to FinancialStatements

Allow us to understand the amount,timing and uncertainty of the estimatesreported in the financial statements


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Financial Statements interactions

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Balance Sheet

Assets

- Liabilities

Equity

Income Statement

Sales

- Expenses

Net Income

Cash Flow Statement

Inflows

- Outflows

Net Cash

Balance Sheet and its classification

Assets are the economic resources controlled by thefirm

Liabilities are the financial obligations that the firmmust fulfill in the future. Liabilities are often fulfilledby payment of cash. They represent source of financing provided to the firm by the creditors

Equity Ownership is the owners investment and theearnings retained from the commencement of thefirm. Equity represents source of financing provided tothe firm by the owners.

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Analysis and Adjustments to the Balance

Sheet

The balance sheet shows the recorded assets,liabilities and equity of the firm. The reportedbalance sheet usually suffer from two defects:

Some assets and liabilities are not recorded. These arecalled off-balance sheet items

The amounts at which assets and liabilities aremeasured may differ significantly from their economic

value

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Income Statement and its significance

The income statement measures the success ofbusiness for a given period of time.

it recognizes a separation of operating transaction fromnon-operating transaction;

it matches costs and expenses with related revenues;and

it highlights certain intermediate components ofincome that are used for the computation of ratios usedto assess the performance of enterprises

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Quality of earnings

The quality of earnings refers to substance andsustainability of earnings. It refers to the use ofaccounting methods and assumptions that tendnot to overstate reported revenues and earnings.It may be affected by two factors:

The accounting methods and estimates chosen by thefirms management

The nature of non-operating items on the incomestatement

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Adjustments to Reported Income

Reported net income should also be examined forpossible adjustments. There are two objectives:

Remove non-operating items from operating income toobtain a better measure of operating results for theperiod, and better inter-period comparisons

Obtain a measure of the earning power of the firm. Theconcept of earning power represent the (permanent)net income of the firm, ignoring temporary,

nonrecurring, or unusual factors.

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Normalized Net Income

Normalization is a process of estimating normaloperating earnings for each period by removingnonrecurring items from reported income. Suchitems may include:

Accounting changes

Realized capital gains and losses

Catastrophes such as natural disasters, accidents

Impairments or restructuring charges

Litigations or government actions

Discontinued operations

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Statement of shareholders equity and itsadjustments

Original capital used to start the firm, plus proceedsfrom any additional shares issued, less the cost of shares repurchased

Retained earnings accumulated over the firms life

Accounting adjustments. Certain accounting standards

result in entries directly to equity, without flowingthrough the income statement. Examples includechanges in market value of long term marketablesecurities and foreign exchange effects

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Statement of cash flows and its significanceThe beginning and ending cash balances on thestatement of cash flows tie directly to the cash andcash equivalent accounts listed on the balance sheetsat the beginning and end of the period.

Cash receipts and payments during a period areclassified in the statement of cash flows in threedifferent activities:

Operating activities

Investing activities Financing activities

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Analysis of Cash Flow Statement

Analysis of cash flow statement should lead toinsights into a firms financial position andperformance. Analysis should focus on both thelevel and trends in cash flow components. Ourprimary objective should be:

Determine the firms ability to generate cash flows tomeet operating needs

Evaluate the role of different sources of financing forcurrent operations and growth

Analyze to the extent to which cash flow classificationare affected by reporting choices

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Key ratios for a Corporate

Other important variables

Size of production lines and capacity utilization rate

Proximity to feedstock and consumption markets

Realization per ton, which, in turn, is a function of thefirst two variables

Cost of electricity

Closeness to ports and sea channels

Venturing into other areas such as blocks and ready-mix concrete manufacturing

Enterprise value (EV)* per ton

* EV = Market Cap + Debt-Cash & Equivalents


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Integrated Profitability Analysis:

Du Pont FrameworkROE = EBIT / Average Shareholder Equity

ROE=

EBITAve. Shareholder Equity

Profit Margin

=EBITSales

Asset/Equity Ratio=

Ave. Total AssetsAve. Shareholder Equity

Asset Turnover Ratio

=SalesAve. Total Assets

Profitability

of asset use

Profitability

of sales/Value

retention

Impact of

Debt in

Capital

Structure

Productivity/

Efficiency of

Asset Use

BUSINESS DRIVERS

X

=

What are some potential problems and

limitations of financial ratio analysis?

Comparison with industry averages is difficult if the firmoperates many different divisions.

Average performance not necessarily good.

Seasonal factors can distort ratios.

Window dressing techniques can make statements andratios look better.

Different operating and accounting practices distort

comparisons. Sometimes hard to tell if a ratio is good or bad.

Difficult to tell whether company is, on balance, in strongor weak position.

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