KCQ: strategy
The company’s strategy is the first emphasis of this section. The company’s strategy is the direction it intends to take and how it plans to achieve it. Simply put the company’s strategy is to achieve the goals and directions established for the purpose. For example, the hospital’s first strategy is to treat patients and save people, followed by income. 😀 The primary strategy of the school is to educate students, followed by achieving the world’s top rankings. The person who makes the strategy is the actual manager of the company. I know that Apple’s strategy was developed by Tim Cook, or perhaps another major shareholder, I don’t know. But he gave a speech at every press conference. In order to formulate a strategy that can achieve the goal, managers will consider the economics of the company’s business to begin the analysis of financial statements. We need to understand the company’s competitive environment including its industry and the overall economy and its position in that environment. I still use Apple as an example. The company has the world’s leading mobile phone technology, so every time a new model is released, other brands of mobile phones will always make their own brand phones similar to Apple phones. Apple phones are leading the way in the industry environment. I am a fully fans of Apple🍎. What are the main risks it faces, and which are the key economic factors driving its profitability? This is my first question. I think this part of knowledge can be combined with the fundamental analysis in chapter 1, because the factors for formulating strategies will not be found in the company’s financial statements. Similarly, fundamental analysis will not be reflected in financial statements. Therefore, from a series of details in the article, making a strategy requires premise of fundamental analysis.
As we all know, a good strategy can increase the value of the company, so that the company’s future benefits will exceed the cost of capital it uses. How do managers make a good strategy? I continued to study with this question.
Strategy is essentially our view of the company’s intentions. As I said before, strategy is something subjective. When the company succeeds, we can say that it is a strategic success, but when the company fails, we will say that it is also a strategic failure. I like Rumelt (1987) explains that “strategy is creating conditions for economic rents and finding ways to maintain rents”. This is closely related to the economic profit framework of financial statement analysis.
An example is given in the article about why Ryman Healthcare is building a retirement village. Because the population is aging and the proportion of the population over 75 years of age is increasing, the construction of retirement villages can give these elderlies a comfortable place to live, and on the other hand the village strategy can obtain a lot of economic benefits. This is an example of a good strategy. It equivalent to the medical insurance policy implemented by the Chinese government, because the population is aging, and the pension growth rate of a few elderly people is slower than the price of medical supplies. This has caused some poor elderly not have enough money to treat the disease. Therefore, the Chinese government has implemented a medical insurance strategy and basically achieved the status quo that all citizens can treat diseases. The article also quotes a point that I am very interested in. The French meaning of strategy is “un reve ou un bouquet de reves en quete de realitie”. From my perspective, strategy means dream. The enterprise achieved a good economic purpose because of a good strategy, and I realised my dream because of a good strategy.
KCQ: quantitative measures of value
The focus of financial statement analysis is to understand how to translate a company’s strategy into quantitative measures of value. In other words, it is how the company achieves its economic goals through the formulated strategy, that is, how the company makes money. There are many small examples of such success around me. For example, opening a small restaurant in the downtown area and using deliciousness as the main strategy of the restaurant. There should be a lot of customers who eat, and the restaurant definitely get a lot of income. But I have a problem, once the strategy formulated by the company has a problem, this leads to the company’s strategy has not been converted into a quantitative value, and even to this point, it has lost money. Whether this error is due to the manager’s wrong strategy formulation or to the fast-moving market.
KCQ: the cost of capital
The next key concept identified from the Study guide was cost of capital for a company.
The cost of capital is a lost return, which is the return of an alternative investment event that was abandoned for investing in the project. Wow, I used to think that the cost of capital was just a cost of investment. I didn’t expect its deep meaning to give up some investment opportunities. I understand that the most ideal use of the cost of capital is to invest limited funds into an unlimited market. However, this cannot be achieved. The author used the example of Sydney Fishing Port to make me understand this concept. From a fishing port perspective, the fish caught is just a commodity. After the commodity is sold, the fish have more uses and can be used for food, medicine or aquaculture. But these by-products have nothing to do with fishing ports, because it only chooses fishing fish resources as investment targets, and other investment directions have not been selected. This is my understanding of the status quo of the cost of capital of an enterprise: exchange finite for limited. I hope my example is correct. If there are errors, I hope Martin can contact me to correct them. 😜
KCQ: assessing strategy
The article mentioned the assessing strategy. In the analysis of financial statements, we need to adopt a strategic perspective. This means we need to think strategically about the company we are analysing. Just like the fish market mentioned in the article, according to the knowledge I have learned from the text, if I want to analyse this market, I will analyse the strategies related to the fish market, such as the price of fish at each stage, and the kind of fish, a variety of fundamental factors related to the fish market, such as species, national fishing policy, and so on. The fundamental purpose is to analyse how this goal adds value and hopefully adds value in the future. In financial statement analysis, we use sources of financial information to help us better understand the companies’ economic and business realities. However, before we start doing this, we had to identify that which financial information should be useful to us. We will consider whether important aspects of a company completely exclude its financial situation. I am not understanding the passage in this article, because one of the company’s financial statements changes, other factors will also change. I hope the teacher can answer this question for me.
KCQ: five ‘P’ strategy
The five ‘P’ strategy is a good way to analyse business strategy, just like PESTEL (Political, Economic, Social, Technical, Environmental, Legal) I used before. The five ‘P’ strategy is short for plan, ploy, pattern, position, perspective.
Plan refers to the strategy formulated by the enterprise for future development. Ploy refers to the strategy you want to achieve the desired goal. Pattern refers to the model of an enterprise, which is not formed in a short period of time, but a long-term operation of the enterprise. Position means the positioning of the company, what are the main products that the company deals with, which all belong to the category of positioning. Perspective is the perspective of managers, which is the decisive factor in the formation of corporate strategy. When I analyse the strategy of a company, the five ‘P’ strategy allows me to clearly see the composition of each part of the company.
KCQ: accounts leave out
The next focus is about accounts leave out. Because financial statements are an abstraction of reality and a simplification of all the complex and diverse things in an enterprise. This means that financial statements are missing a lot sometimes. Although the probability of making an error is very low, once an error is not detected, it will cause errors in each subsequent step, which is a chain reaction. Just like I wrote an assessment, if the middle paragraph does not match the theme, the whole article will have problems, which is why I will double check after I finish writing. Financial statements are mainly omitted in two aspects, first is its ability to generate positive net present value investments in the future; and another is the opportunity cost of its operating, or in other words the cost of capital. I understand that a positive net present value in the future refers to the difference between the present value of future capital income and the future value of future capital expenses. Because this money is positioned in the future, no one can predict what the future will look like, so this uncertain factor cannot be recorded in the financial statements.
KCQ: accrual accounting
Next, I saw a very familiar concept, accrual accounts. I know a language is about the biggest difference between an accrual account and a cash account is that the accrual account is recorded at the point in time when rights and obligations occur, while the cash account is recorded at the point in time when cash is specifically received. I don’t know if the concepts I remember are right, if not, I will review the knowledge I have learned more seriously. In the knowledge point of accrual accounting, there are also certain risks, because managers and accountants may want to manipulate outside perceptions of the company’s economic and business reality. They have considerable discretion in how to use financial statements to reflect these realities. This means that if the accountant wants to modify the amount or the manager wants to pay less taxes, it is entirely possible. Because accrual accounting is based on the recording of rights and obligations, the payee will not know what the specific amount is for the time being, which causes great inconvenience to the supervisor. The article said that regulations in many countries require listed companies to provide financial statements, and the regulations are enforced, which has greatly reduced the occurrence of this situation. According to the news I have seen, the amount of tax evasion due to accrual accounting is very large, which means that this method has a large loophole. So why is there no way to limit this disadvantage? Hope Martin can help me to add this knowledge. I have a question here, because only the supervision method is mentioned in the article, but the punishment measures are not mentioned, so I want to know the punishment measures for this situation in some countries.
Chapter 3
I like the description of the early analysis of financial statements in the article. This behavior originated in ancient Greece in the 19th century, but is not called analysing financial statements there, they are called focusing on financial statements. The ancient Greeks used the idea of ratios to focus on the communication between different businesses. Although use of ratios to analyse the communication between different projects in the financial statements originated early, there has been no clear reason to prove that this will help predict the future prospects of the company for a long time. This has stimulated my interest in learning. Until now, is there any way to accurately predict the future prospects of the company.
KCQ: comparables and P / E (price-to-earnings) multiples
The title of chapter 3 is about the method of assessing value. According to the knowledge learned from the previous two chapters, analysing the financial statements of companies is the most effective method of assessing value. But it’s unclear whether this data is useful for predicting the company’s future results. As the text says, we lack any convincing theory to support a method of analysing financial statements. But even so, people have summarised several methods in practice, such as comparables and especially the use of P / E (price-to-earnings) multiples. Does this mean that if you choose one of the companies in the same field and the same size and compare their financial statements, you can find out the advantages and disadvantages of each company? For example, KFC and McDonald’s? 🍟
But these methods also have limitations. They have no clear theoretical connection with the company’s current and future economic and business realities. They are usually based on speculation. What I understand is to say that these methods summarised by people have not been 100% verified. These methods are just some regular pattern, but these regular patterns will change at any time, because no one can be sure that it will happen in the future.
After a long period of practice, people have found that profitability and liquidity or solvency are useful aspects of checking the company’s financial statements. But this is one of them, not a consensus. I fully understand the meaning of this sentence, just like the example given in chapter 2, Ryman Healthcare made its own company’s financial statements excellent by constructing a retirement village. But I believe that the company’s internal view is not only about building a senior citizen’s village. Perhaps some managers think that introducing some medical devices is a better way. Until now, some ratios have proven useful, or the wrong ratios won’t last that long. These methods are not based on practical experience, but on methods that appear to work in practice. This passage in the text has shocked me. Since the emergence of the situation of analysing financial statements of enterprises, people have been analysing financial statements with no “most correct answer.” A hundred people have a hundred opinions. But what struck me the most was that many companies rely on this analysis method without the right answer to gradually expand their business scale. This status quo without the right answer does not satisfy the managers of the company. As stated in the article, they have been looking for reasons to believe that the company’s financial statements can assist us predict the future performance of the company; Many attempts have been made to determine which of the various ratios that can be calculated from the financial statements is the most useful. Seeing here I have a question, why some methods that are useful in analysing financial statements have not been promoted?
KCQ: business reality and economy
In the next paragraph, the author emphasised again that the key aspects of a company’s business reality and economy. It should be decided by the financial statement analysis. Although I said that analysing the financial statements of a corporate cannot include all the issues facing the corporate, the ratios and data appearing in the financial statements will definitely indicate the events it contains. Suppose a company is facing failure. It may not contain all the reasons for its failure, but the reasons contained in the file must have happened to the company. This is represented by the arrow:
financial statement business reality and economy
business reality and economy financial statement
I have a question, which of the company’s questions about the economy and the question of business reality is a key aspect? The text does not mention the answer to this question. Does this mean that what belongs to the key aspects need to be managed by manager their own judgment?
Concept: accounting and financial thinking
Financial statement analysis is where accounting and finance are combined. However, more importantly, this is where accounting and financial thinking can be realised. Financial statement analysis is the practical application or use of accounting and financial thinking. I know this very well. In the last term, the company I studied was Fleetwood, a construction company. In its financial statements in 2019, its expenditure was greater than its income, which means that it was losing money in 2019. My task is to study why it is a loss. I regard this stage as the application of my financial thinking. After analysing most of Fleetwood’s figures, I have concluded that the raw materials are too expensive, and the inventory backlog is too heavy. I call this process my accounting thinking. So, analysing financial statements is indeed where accounting and financial thinking can be realised. Of course, the article also mentions a commonly used technology widely used in practice, use of comparables. I understand that the comparable company analysis method can provide a market benchmark, so that investment bank analysts can analyse the value of listed companies at any time. In fact, the company to be analysed is compared with other benchmarks. But this method may not accurately represent the true value of the target company, because it does not consider every aspect of the company. So, if this method of comparison cannot be considered comprehensive, what method should we use to evaluate the company?
Immediately after that, several difficult formulas were pointed out in the article. This is also the focus of this article: ratios
Equity value = PV of expected future dividends
I don’t understand the formula, but I know asset-liability=equity. So, what different between equity and equity value. And then the article extends this formula.
“Equity value = DIV1÷ρE + DIV2÷ρE2 + DIV3÷ρE3 + … ” I’m sorry I’m confused, it’s hard for me to understand. “This is called the dividend discount (DD) model”. This is the theoretical basis for our evaluation of company equity. But this is the most ideal model for dividends, because the author assumes that dividends can always be received. This is unrealistic, because the company will have a life, so the company will terminate the dividend someday. If company managers use this method to evaluate company equity, financial statement analysis will focus on predicting the company’s future dividends. So according to my understanding, if the company’s managers want to evaluate the company’s dividend in a certain period in the future, they can use the dividend discount (DD) model.
Another formula is the relationship between cash flow and dividends, which is usually written as
“Dividends (d) = Operating cash flow (C) – Capital outlays (I) + Net cash flow from debt owners (F)“
The expected book value of the equity at the end of the period is equal to the opening book value of the equity plus the expected comprehensive income, minus the expected dividend on this basis. It can be expressed as:
“BV1 = BV0 + CI1 – DIV1“
I have listed a table summary and some basic formulas learned by this chapter. I understand them more difficult now, but after studying, I believe I will eventually master them.
| “Equity value = PV of expected future dividends” |
| “Equity value = DIV1÷ρE + DIV2÷ρE2 + DIV3÷ρE3 + …” |
| “Dividends (d) = Operating cash flow (C) – Capital outlays (I) + Net cash flow from debt owners (F)” |
| “BV1 = BV0 + CI1 – DIV1“ |
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