The Financial Detective, 2005
4 Pages Posted: 21 Oct 2008 Last revised: 10 Nov 2021
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The Financial Detective, 2005
The Financial Detective, 2005
Abstract
The case presents the student with financial ratios for eight pairs of unidentified companies and asks them to mate the description of the company with the financial profile derived from the ratios. The primary objective of this case is to introduce students to financial ratio analysis—in particular, the range of ratios and the insights each one affords. This case presumes that students have already been introduced to the definitions of various financial ratios through other readings or lectures. The structured exploration of pairs of companies within an industry affords a number of important insights into strategy and financial performance. First, the economics of individual industries account for significant variations in financial ratios because of differences in technologies, product characteristics, or competitive structures. Second, financial performance results from managerial choices: within industries, the wide variation in financial ratios is often a result of the differences in corporate strategy in marketing, operations, and finance. For those reasons, this case is a good springboard into subsequent classes, which deal with the interaction of strategy and financial performance.
Excerpt
UVA-F-1486
Rev. Apr. 26, 2018
The Financial Detective, 2005
Financial characteristics of companies vary for many reasons. The two most prominent drivers are industry economics and firm strategy.
Each industry has a financial norm around which companies within the industry tend to operate. An airline, for example, would naturally be expected to have a high proportion of fixed assets (airplanes), while a consulting firm would not. A steel manufacturer would be expected to have a lower gross margin than a pharmaceutical manufacturer because commodities such as steel are subject to strong price competition, while highly differentiated products like patented drugs enjoy much more pricing freedom. Because of unique economic features of each industry, average financial statements will vary from one industry to the next.
Similarly, companies within industries have different financial characteristics, in part because of the diverse strategies that can be employed. Executives choose strategies that will position their company favorably in the competitive jockeying within an industry. Strategies typically entail making important choices in how a product is made (e.g., capital intensive versus labor intensive), how it is marketed (e.g., direct sales versus the use of distributors), and how the company is financed (e.g., the use of debt or equity). Strategies among companies in the same industry can differ dramatically. Different strategies can produce striking differences in financial results for firms in the same industry.
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Keywords: financial ratios, strategy formulation
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