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Industry Identication through Ratio Analysis*

MERRIDEE BUJAKI, University of Ottawa


SYLVAIN DUROCHER, University of Ottawa
ABSTRACT
This case
1
is designed to help students see through the numbers. Written initially
for MBA students and senior analysts attending executive education sessions, it
provides participants with (1) a common-size balance sheet and selected nancial
ratios for ten anonymous Canadian public companies, and (2) a list of ten diverse
industry sectors. Participants are invited to reect on the meanings of the dierent
ratios provided in order to match the anonymous companies with their correspond-
ing industry sector. Seeing through the numbers fosters the development of partici-
pants analytical skills, and group discussions contribute to the sharing of
participants knowledge about the various industry segments involved.
Keywords Executive education; Industry classication; MBA; Ratio analysis
DTERMINATION DU SECTEUR GRCE LANALYSE INDICIAIRE
RSUM
Le cas propose a pour but daider les e tudiants a` percer le sens des chires . Re dige
au de part pour les e tudiants de programmes MBA et les analystes principaux assistant
a` des se ances de formation des cadres, il fournit aux participants 1) un bilan en chires
relatifs et certains ratios nanciers se lectionne s pour dix socie te s canadiennes anony-
mes faisant appel public a` le pargne et 2) une liste de dix die rents secteurs dactivite .
Les participants sont invite s a` re e chir au sens des die rents ratios qui leur sont pre -
sente s an dassocier les socie te s anonymes au secteur dactivite correspondant. Percer
le sens des chires favorise le de veloppement des compe tences analytiques des
participants, et les discussions de groupe contribuent au partage des connaissances
que posse` dent les participants au sujet des divers secteurs dactivite en cause.
Mots cls : analyse indiciaire, classication sectorielle, formation des cadres, MBA
The common-size balance sheets and a selection of nancial ratios for ten anony-
mous Canadian public companies pertaining to their 2009 scal years are provided in
Exhibit 1. These companies are listed as A to J. The nancial information was
* The authors would like to thank Industry Canada and the Centre for Executive Leadership of the Tel-
fer School of Management of the University of Ottawa for the multiple opportunities oered for class-
room testing of this case. They would also like to thank two anonymous reviewers and the editor for
their helpful comments.
1. The format of this case is based on Drivers of Industry Financial Structure by Dwight B. Crane and
Indra A. Reinbergs, published by Harvard Business School Publishing (HBS 9-201-039). Unlike the
HBS case that used U.S. company data, this one is based on Canadian companies, uses more recent
data and dierent industry segments, and provides a discussion of learning objectives, implementation
guidance, and the results of classroom testing.
AP Vol. 11 No. 4 PC vol. 11, n
o
4 (2012) pages 315322 CAAA/ACPC
doi:10.1111/1911-3838.12003
computed from the nancial statements published on their respective websites or
from the SEDAR database. Because ratio denitions can vary from one textbook to
another or from one database to another, Exhibit 2 presents the precise denitions
used in the present case.
The companies for which nancial information is provided in Exhibit 1 were
selected from ten dierent industries. They pertain to the following industry classi-
cations:
1. Airline
2. Bank
3. Developer and manager of commercial property
4. Electricity utility
5. Gold producer
6. Large retailer
7. Manufacturer of communications hardware
8. Oil producer
9. Professional services
10. Software developer
Required
Use the nancial information provided for each company in Exhibit 1 and your
personal knowledge of the industries listed above to match each company with its
respective industry segment. Provide a brief rationale for your classications. If
needed, refer to the ratio denitions provided in Exhibit 2.
CASE LEARNING OBJECTIVES AND IMPLEMENTATION GUIDANCE
The traditional way to teach nancial statement analysis to nonaccountants is to
discuss the nature and meaning of each nancial statement and its components, to
present the relevance of horizontal (trend) analysis and vertical (common size)
analysis, and to see how dierent categories of ratios reect an enterprises prot-
ability, operating activities, solvency, and leverage. Ratio analysis is also used to
infer management strategies, for instance through the use of the du Pont model.
The traditional teaching approach usually requires students to perform ratio analy-
sis for a specic company, and to perform comparisons of dierent companies
within the same industry and/or across industry sectors. The conventional
316 ACCOUNTING PERSPECTIVES / PERSPECTIVES COMPTABLES
AP Vol. 11 No. 4 PC vol. 11, n
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4 (2012)
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INDUSTRY IDENTIFICATION THROUGH RATIO ANALYSIS 317
AP Vol. 11 No. 4 PC vol. 11, n
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4 (2012)
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318 ACCOUNTING PERSPECTIVES / PERSPECTIVES COMPTABLES
AP Vol. 11 No. 4 PC vol. 11, n
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approach thus involves a single company population
2
oriented teaching strat-
egy.
Thinking the other way around involves a reection on how dierent industry
sectors, given their respective characteristics, would retrospectively aect nancial
statement gures and nancial ratios. This involves a population single com-
pany oriented teaching strategy. This approach involves a higher degree of
EXHIBIT 2
Ratio denitions
a
Ratio Calculation Interpretation
Gross
margin
(Sales cost of
goods sold)/sales
A measure of the amount of each sales dollar that
is available to cover operating expenses and
generate prot.
R&D/sales R&D/sales Level of investment in research and development relative
to sales.
Prot
margin
Net income/sales Net income resulting from each dollar of sales; an
indicator of protability.
Days of
receivables
Accounts receivable/
average days sales
Average age of the accounts receivable; an indicator of
the eciency of the rms collection policies relative
to its credit terms.
Inventory
turnover
Cost of goods sold/
inventories
Number of times per year that the value of inventory is
replaced; an indicator of the eciency of the rms
inventory management practices.
Fixed asset
turnover
Sales/plant &
equipment
The eciency with which xed assets are used to
generate sales.
Total asset
turnover
Sales/total assets The eciency with which assets are used to generate sales.
Return on
assets
Net income/assets How much prot is generated for each dollar invested
in assets; an indicator of success in generating prot
for each dollar of assets.
Return on
equity
Net income/total
owners equity
Rate of return on that portion of the assets
provided by the owners.
Debt/
equity
Total liabilities/
total owners equity
Proportion of debt in capital structure; reects the risk
caused by the interest and principal requirements of debt.
Notes:
a
The denitions provided in this table are classical ones used in nancial analysis textbooks (see, e.
g., Marshall, McManus, and Viele, 2011). Some ratios may be computed slightly dierently for
rms in specic industry segments. The balance sheet numbers considered in the ratio
computations in this table are those as at 2009 year-end.
2. The term population is used to represent the large number of companies that compose an
industry segment. However, the authors recognize that it may be dicult to make inferences
and draw conclusions on populations.
INDUSTRY IDENTIFICATION THROUGH RATIO ANALYSIS 319
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abstraction for students, essentially seeing through the numbers. It also involves
the use of adapted teaching material, which is an objective of the present case.
The choice of industry sectors included in the case was driven by two selection
criteria. First, a sucient number of Canadian companies had to exist in the sec-
tor. Second, the sectors activities had to be not so specialized that we could not
expect our class participants to be able to infer them.
Case Learning Objectives
The general objective of this case is to enhance participants analytical skills, in
particular their nancial analysis skills. The case requires a higher level of abstrac-
tion than the usual single company population approach. Indeed, it requires
students to imagine the activities involved in specic industry segments and their
respective unique characteristics and gure out how these activities and characteris-
tics would be reected in a companys nancial statements and nancial ratios,
given the period under study (i.e., 2009). Additional specic objectives include
enhancing participants knowledge of the content of nancial statements and the
computation of nancial ratios, increasing their ability to compare industry seg-
ments, and stimulating the sharing of knowledge, learning from peers and group
discussion.
Implementation Guidance
This case is targeted at senior undergraduate students, graduate students, or execu-
tives who possess a basic knowledge of nancial statements and ratio analysis. For
example, it is well-suited for MBA or executive MBA accounting courses or execu-
tive education. The case is designed to be discussed in small groups of four to six
members with diverse industry backgrounds. The professor or facilitator circulates
from one group to another to stimulate discussion, provide insights to deepen the
analysis and answer specic questions in relation to prerequisite knowledge. The
group discussion of about 30 to 40 minutes is then followed by a plenary class dis-
cussion of another 20 to 30 minutes to compare the classications adopted by each
group, discuss the rationales supporting these classications, provide the partici-
pants with the names of the ten companies involved (and thus the appropriate clas-
sication), and nally obtain feedback from participants about the merits of the
activity.
CLASSROOM TESTING
This case was used ten times by the authors in 2010 and 2011. It was developed
for the specic needs of an executive MBA accounting course oered in a Cana-
dian university and for the specic requirements of executive training sessions
mainly involving Industry Canada senior analysts. More recently, the case was
used in several MBA classes as well. Each time, the use followed the implementa-
320 ACCOUNTING PERSPECTIVES / PERSPECTIVES COMPTABLES
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tion guidance stated above. The average time required to complete the activity was
60 minutes. The verbal feedback obtained from participants revealed that they
found the case to be of appropriate level of diculty (i.e., not too complex and
not too easy). About 90 percent of the groups involved were able to perform an
appropriate matching. The plenary discussions about the matches were fruitful for
identifying the dierent rationales supporting the classication of a company under
a specic industry segment. All groups did not necessarily invoke exactly the same
reasons for their classication. Also of particular relevance were the discussions
about the mismatches, in the sense that the groups had to explain why the nan-
cial statement and ratio gures led them to think that the mismatched enterprise
belonged to a specic industry segment. The other groups were then able to pro-
vide their own rationales. Ideas could then be debated, which contributed to a dee-
per understanding of the meanings of key ratios and nancial information, and of
the similarities and dierences across industry segments.
As group members held dierent backgrounds, the group discussions were
fruitful in sharing knowledge about the diverse industries involved, in confronting
interpretations of nancial ratios, and in imagining the types of accounts likely to
be included in nancial statement information. Participants considered having
groups made up of individuals with a variety of backgrounds to be an important
aspect of the case. It is also worth noting that while circulating among groups,
professors were frequently asked to explain the meaning of asset retirement obliga-
tions, minority interests, and unearned revenues appearing on the common-size
balance sheets.
One instance of the use of this case highlighted the importance of participants
having sucient basic knowledge of nancial statements and nancial ratios. Dur-
ing one particular executive training session, some participants who were not su-
ciently familiar with these concepts were quite lost in their respective group
deliberations, and found the case to be beyond their capabilities.
In evaluating the case, many individuals commented on how much they enjoyed
the challenge of the exercise, which some described as an intellectual puzzle. Other
individuals commented on how the exercise gave them condence that through their
previous life experiences they had acquired considerable background information
relevant to understanding nancial statements and nancial statement analysis.
TEACHING NOTES
Teaching notes for instructional cases are not published in the journal but are
made available to full CAAA member subscribers in a password-protected area of
the CAAA website.
If you are a full member of the CAAA with a subscription to Accounting
Perspectives and wish to obtain a copy of the Teaching Notes, please go to http://
www.caaa.ca/AccountingPerspectivesAP/JournalIssues/CasesTNSM to log in and
access the notes.
INDUSTRY IDENTIFICATION THROUGH RATIO ANALYSIS 321
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REFERENCES
Crane, D. B., and I. A. Reinbergs. 2000. Drivers of industry nancial structure. Boston:
Harvard Business School Publishing.
Marshall, D. H., W. W. McManus, and D. F. Viele. 2011. Accounting: What the numbers
mean. New York: McGraw-Hill/Irwin.
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