Financial Statements and Firm Value 113Chapter 5
Financial Statements and Firm Value
OBJECTIVES
Calculate all the significant financial ratios for firms and interpret them.
Perform DuPont Analysis.
Draw up funds flow and cash flow statements.
Use financial information to predict financial distress.
Prepare financial and cash flow forecasts.
Understand the role of financial statement information in asset pricing.Financial statements are reports of business performance of the company during the year, and are used by
different groups of people for different purposes. Lenders are interested in financial statements, to assess the
creditworthiness of the company; investors are interested in assessing the profit potential, bankers in fixing
the working capital limit, academic researchers in the quality of disclosure, etc. Nobody would be as much
interested as the managers of the company simply because their personal fortune and jobs are tied to the
performance of the company. They would be interested, for example, in assessing the indebtedness of the
company and when they come due in relation to cash flow available or the impact of extending credit to
customers on the financial condition of the company. The set of analytical tools available is the same regardless
of who you are; only the emphasis changes.
A company’s management is responsible for anticipating future imbalances in the company’s financial
system before its severity is reflected in the company’s financial statements. The starting point for a financial
forecast is the formulation of management goals and product market strategy, which in turn determines the
outlook for sales. The firm’s strategy and sales growth will determine the investment in fixed assets and
working capital to support these strategies. The effectiveness of these strategies coupled with competitive
reaction will influence the company’s financial performance and future need for finance. Needless to say
future profitability is necessary for access to capital markets.
This chapter introduces introductory techniques like ratio analysis, funds flow and cash flow analysis and
financial forecasting commonly used by managers and analysts to assess a firm’s financial health.
HLL was formed in 1956 by the merger of Hindustan Vanaspati Manufacturing Company Ltd, Lever
Brothers India, and United Traders.^1 The company offered 10 percent shares to the public in 1956. In the
1970s, Unilever diluted its stake to 51 percent to comply with FERA and other regulations.
(^1) This section is drawn from CMIE’s Prowess database.