There are a lot of reasons to do an MBA but one of my big drivers (and one I hear a lot from other people) is financial literacy. For those of us who come from a world outside of accounting and finance, our interactions have often been limited (maybe budgeting and cost tracking or maybe just small business BAS once a quarter) and self-taught through necessity.
MBS introduces accounting and finance from an external perspective, starting you off with balance sheets, cash flow and income statements and looking at the interactions between them. Internally, you’re unlikely to see these during day-to-day operations (unless you work in the accounting department) but these are also the basic tools that are used to assess a companies health and performance from the outside. When you are looking at investing in a stock this is a place that you can start. Using the Annual report of an organization, you can see the story told by the numbers. The other main component of a good annual report is the strategic plan or outline which tells you what the company plans to do to create value for shareholders. Investing is effectively betting whether or not the company can make good on the execution of this plan and the past performance and financial statements are their to help you decide whether their plan is credible or not.
There are bunch of tools that can be used for stock analysis but one that we’ve used consistently throughout the MBA is the 4 component Dupont model. This takes Return on Equity (which is a common metric for comparison of financial performance) and decomposes it to show you what the company does well and needs to improve
As you can see, the fact that all of these multiply across means that if a company has a really high value in one area (say leverage, because they’ve borrowed a lot of money) you can see how that’s skewing the ROE metric. Taking the leverage example, 4 companies in the same industry might have the same ROE but one has a much higher leverage value. As an investor you now want to ask a couple of questions: why are they underperforming on one of the other ratios (if ROE is the same for all 4 companies but leverage is high for one then that same company must have one, or several, low metrics to balance the equation) and more importantly, what are they doing with all that extra money that they borrowed (are they operating unsustainably or did they borrow to invest in a new facility that isn’t operational yet etc.)
Likewise it’s difficult to compare two companies from different industries. An industry like banking, where there are a lot of assets like branches and ATM’s and IT infrastructure is going to have a low asset turnover value as opposed to a consulting firm which needs office space & IT but not much else in terms of assets. This is why it’s important to compare banks with banks and even while you are doing that, be aware that different businesses may have different models. One bank might want to own all the branches it has where as another might only want to lease the real estate (or might operate predominantly online like ING direct here in Australia). Eitherway, drilling into this information will help you understand both performance and strategy.
That said, the Dupont model is not the most advanced tool for analyzing companies but it has been incredibly valuable to me because this was a big knowledge gap for me, pre-MBA. Although I’ll never work as a financial analyst, the point of the accounting and finance units at business school is to gain financial literacy so you can understand how companies generates revenue and how well they use what they have.
What Tim Learned at Business School 