Analysis of the capacity to pay, Financial Management

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In addition to management quality, an assessment of the financial capacity of a company should also include an evaluation of trends, regulatory environment, basic operating and competitive positions, financial position etc.

Businesses can have a bad year without resulting in financial difficulty. Evaluating trends over a three to five year period will give a clear picture of the direction a firm is heading to. Profitability over time is an excellent indicator of management's efficiency. Raising revenue will not help if the firm cannot control costs. A reduction in expenses may have a minimal impact if revenues do not increase. A host of questions can be answered with a thorough analysis of a company's financial capacity. Ratio results should always be compared to a peer group for an industry comparison to answer questions like: Is the firm collecting faster or slower than the rest of the industry? Is this company more profitable than other companies or just like them?

  1. Industry Analysis: Analyzing industry trends provides important indications of future profitability, asset values, upcoming financing needs, and potential liabilities. For companies that operate in several industries, it is critical that each major business segment is analyzed separately, looking at each Industry from a global perspective. In considering industry trends, analysts look at the vulnerability of the company to economic cycle, globalized commodity pricing, domestic and global competition, barrier to entry, cost factor and the vulnerability to technical changes.

  2. Traditional Ratios: Traditional ratios evaluate the ability of an issuer to meet its obligations and include:

  • Profitability ratios

  • Debt and coverage ratios.


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