Infrastructure Finance: An Introduction
Traditional economists are of the opinion that infrastructure is the heart of the economy. Empirical data clearly shows that given a choice, investors prefer to invest their money in countries whose infrastructure is more developed. Hence, it can be said that rapid infrastructure development is one of the most basic ways in which a country […]
Fundamental Principles of Pension Fund Risk Management
Pension funds are amongst the most heavily supervised financial instruments in the world. This is because of the fact that these funds hold the retirement funds of a large number of people. This means that the risk management practices at a pension fund have to be top-notch. The inability to manage risks can cost the […]
Israel Economic Crisis: 1983
The Israeli bank crisis of 1983 rocked the Middle Eastern financial world. The Israeli economy was believed to be strong and has been able to navigate many wars since its inception in 1948 without breaking down. However, in 1983, the economy faced major shocks even in the absence of any major war or political upheaval. […]
A Primer on Bills of Exchange
What are Bills of Exchange? A bill of exchange is a promissory note that is usually issued by the buyer to the seller of goods in return for the goods. The seller would like to sell their goods for cash. However, in certain cases, the buyer may not have cash immediately at the moment. However, […]
The Socialization of Losses
Joseph Stiglitz is one of the most renowned economists of our time. He once criticized the current economic system after the great recession of 2008. He said that the current system is skewed in favor of the rich. This economic system is no longer capitalism. It is a strange combination of capitalism and socialism wherein […]
The ultimate aim of all business is to generate profit. That is what the investors invest for, management plans for and employees execute for.
Two companies may be generating the exact same amount of rupee profits, however that does not mean that they are equally profitable. This is because profit is an output measure. And jumping to a conclusion only by looking at the output and not the input that was used to generate the output would not be very prudent!
The profit numbers are therefore seen in relation to various measures of inputs like capital, equity, assets etc. Each of these measures tell a separate story about how the company is performing specific to the input. Analysts often use these numbers together, connect the dots and find out the true picture of the company’s profitability.
Shareholders want the business to generate as much profit as possible. Debt holders on the other hand are content with enough money to ensure that they get paid. Banks want to know whether the company has been making efficient use of fixed assets before granting a loan to buy another one. Thus different user groups have different needs. Hence there is a need for a wide variety of profitability ratios that serves them.
A careful analysis of the profitability ratios also unearths the drivers of profitability. Analysts can look at the financial ratios of an extended period of time and use correlation analysis to unearth the same. The ability to express the company’s business as an accurate input output model is vital for analysts. This is because they can then guess the input, obtain the output and value the firm based on this information.
Common drivers of profitability include economies of scale, economies of scope, mechanization, automation, investment in brand value etc.
Industries have their specific business cycles. These business cycles have similar duration and the highs and lows that the business will experience can also be gauged fairly accurately. Profitability ratios help in doing the same.
Analysts use ratios from past several years and then conduct a trend analysis to find out the patterns hidden in the data. This helps them find out how the sales are expected to move in the next quarter.
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