This Week In Finance

"See Companies Naked!"

How does one motivate students to learn and remember the five categories of ratios - Liquidity, Long-Term Solvency, Asset Management, Profitability, and Market Value measures? Use the "firm dimensions" approach; i.e., describe the role of the analyst as one hired to "describe" the firm by enumerating its attributes (much as one would describe an object by its physical attributes - length, width, height, color, etc.).

Since a corporation exists only as a legal fiction, it is difficult to describe. Ask students to describe, say, the Anheuser-Busch corporation. When they inevitably mention Budweiser, Sea World, the St. Louis Cardinals (which were sold recently), point out that what they are describing is not the firm, but products and assets of the firm.

What is needed is a systematic approach with which to describe managerial actions and to enable us to evaluate their likely effects on firm value. The five "dimensions" listed above, and the financial ratios therein, constitute descriptors of managerial decisions and their effects on cash flows and, ultimately on firm value. Thus, financial statement analysis is just how one describes the firm (or put another way, how one "sees the firm naked").

I have found that, when framed this way, the topic of ratio analysis, and the discussion of the ratios themselves, tends to make a lot more sense to students, and helps to move them away from the relatively mindless "plug-and-chug" calculator drill that ratio analysis can become if we aren't careful. Good luck!