Quantitative and Qualitative Analysis Notes

Chapter 12: Quantitative and Qualitative Analysis

12.1 Quantitative Analysis

• Prepare the quantitative analysis first, as it may reveal triggers for the qualitative analysis.

12.1.1 Step 1: Assess the Situation

• Three tasks:
  1. Determine the purpose of the analysis.
  2. Determine available information.
  3. Select the right tool for the job.

12.1.1.1 Determine the Purpose of Your Analysis

• Understand what you are trying to achieve with the quantitative analysis (quant).
• Clarify the question you are trying to answer.
• Example: Determining sales volume for a target profit vs. determining break-even sales volume.
• Hint: Start with a purpose statement to keep the quant focused.

12.1.1.2 Determine the Information You Have Available

• Organize data before preparing the analysis.
• Prepare an outline and note available facts and figures.
• Sources of information:
  • Dialogue between parties: Facts about growth, inflation, or estimates.
  • Financial statements and related notes: Extract revenues and costs for calculations like contribution margin analysis; build on results with assumptions.
  • Exhibits: Information on sales changes or inventory turnover.
• Remember: If financial statements are provided, they will likely be used.
• Hint: Consider the type of information needed to answer the question (e.g., fair value for asset-based valuation, normalization adjustments for projected cash flow).
• Flag potential biases in information based on who is providing the information.
• If management provides anticipated costs, caution that higher costs will require more sales to break even.
• Also, watch out for missing information.
• Be prepared to make assumptions, explain them, and move forward.
  • Example: Determine a discount rate based on the company’s borrowing rate.
• Hint: If given conflicting information or a range, pick the most realistic figure, document the assumption, and move forward.

12.1.1.3 Select the Right Tool for the Job

• Determine the correct quantitative tool after understanding the question and available information.

• Visualize how the quant will be laid out and use case facts to visualize the bottom line.

• Examples of types of analysis:

  • Capital budgeting: Discounted cash flow/net present value (NPV), internal rate of return (IRR), payback period.
  • Financing analysis: Undiscounted cash flow analysis.
  • Product analysis: Contribution margin analysis, constrained resource analysis.
  • Income tax calculations: Calculation of taxable income, taxes payable, capital cost allowance calculation.
  • CPA Canada Handbook – Accounting criteria
  • Analysis may require a discussion of financial reporting issues
  • Impairment — cash flow analysis
  • Capital lease analysis — NPV analysis
  • Deferred tax analysis

• Keep focused on the purpose when picking your quantitative tool.

• Emphasize generating positive undiscounted cash flows if viability is the primary concern.

• Consider a rate of return and discount cash flows if the client wants to know if something will meet a profitability threshold.

12.1.2 Step 2: Analyze Major Issue(s)

12.1.2.1 Preparing Your Calculation

• Quantitative analyses should be prepared in Excel.
• Analysis should be clear, concise, and easy to follow.
• Assume the marker cannot ask for clarification.
• A good quantitative analysis should:
  1. Begin with a purpose: State what you are trying to achieve.
     • Example: "Purpose: To calculate the IRR of expansion Option A" or "Purpose: To calculate taxable income for 20X7."
  2. Document all calculations and assumptions:
     • Use a referencing system or add explanations next to each number.
     • Do not assume familiarity with case facts; the analysis should stand on its own.
  3. End with a conclusion:
     • Answer the question posed in your purpose.
     • Example: "Conclusion: The IRR of Option A is 44%. Since the hurdle rate is 15%, this project returns more than the required return and should be accepted.”
• Hint: Include a conclusion directly on your quant that ties clearly to the purpose.
• In assignments and at work, use professional formatting:
  • Use bold font for column titles.
  • Use underlines to indicate subtotals and totals.
  • Format cells appropriately using commas, decimals, and percentages.
  • Show numbers being subtracted as negative numbers.
• Balance available time with formatting on an exam.
• Familiarize yourself with keyboard shortcuts.
• On an exam, formatting should make calculations clear and easy to follow.
• Note: Familiarize yourself with the exam writing software.
• Do not change font size, font color, or background color unless necessary due to vision problems.
• On an exam, clearly state the assumptions used for inputs into the calculations.
• On an exam, show your work and the inputs used for calculator calculations (including time value of money calculations).

12.1.2.2 Interpreting Your Calculation in Your Memo

• A quantitative analysis alone is insufficient; you must write a memo explaining the results.
• A good memo should include:
  1. Reference to the Excel spreadsheet for more detail.
  2. Interpretation of the results, including key information (e.g., assessment of viability and key points like negative cash flows).
  3. A summary of key assumptions that are not obvious from case facts, are subject to variability and, if changed or adjusted, would impact the calculation significantly — This should include identifying any missing information or limitations of the analysis.

12.2 Qualitative Analysis

12.2.1 Step 1: Assess the Situation

• Understand the objective of your analysis by focusing on who the users are, their objectives, and what decision(s) need to be made.

12.2.1.1 Users

• Understand who your analysis is going to, as different users require very different things.
• Pay attention to cues in the case, such as who the request is coming from as well as if there is evidence as to who the information will be presented to.
• If asked by an audit partner to prepare a memo, but the memo will be provided to management of a company. Your analysis should therefore be directed to management.
• Types of users:
  • existing shareholders
  • managers
  • potential new shareholders
  • bankers
  • angel investors
• Be aware of all users and their level of financial sophistication.

12.2.1.2 User Objectives

• User objectives are key; they are the reason for your analysis.
• Consider user objectives and reference them in your analysis.
• Watch out for conflicting objectives; address all objectives and identify conflicts.
• Example: Father nearing retirement (risk-averse) vs. son (higher risk tolerance).
• Users will likely have more than one objective.
• Example: Father/son scenario with succession planning:
  • maintaining or achieving steady cash flows to fund retirement
  • expanding the business
  • maintaining quality control
  • taking the business public
• User objectives are usually revealed in the case narrative; look for key success factors.

12.2.2 Step 2: Analyze Major Issue(s)

• A decision usually requires more than simply the numerical result; usually there are risks that cannot be quantified but that could impact the overall result.
• Discuss risks and rewards in your memo.
• Common risks:
  • lack of management time or expertise
  • cannibalization of sales from existing operations
  • production capacity constraints
  • uncertainties in demand or cost structure
  • unknowns in quality or impacts on existing customers
• Common rewards:
  • creation of synergies in the business
  • opening up a new market
  • potential for future growth
  • creating a competitive advantage
• Hint: Have a balanced discussion (risks and rewards).
• Fully explain the "so what?" question (why is the factor a risk or reward?).
• Discuss the "what" (case fact) and the "why" (explanation).
• Use headings and bullet points for the qualitative discussion (e.g., "Risks" and "Rewards").
• Hint: Qualitative analysis is often linked to a quantitative assessment; address both components together.

12.3 Integrating the Quantitative and Qualitative Analysis

12.3.1 Step 3: Conclude and Advise

• Give an integrated, comprehensive recommendation or conclusion.
• Tie in the results of any quantitative and qualitative analysis, and make a strong recommendation that connects back to the user objectives.
• Identify ways to mitigate risks.
• Hint: Conclusion should be logical, supported, and consistent.
• Always arrive at a conclusion for your client; provide advice.