Assess Future Profitability and Competitive Performance
Strong sustained profitability is an important determinant of (1) a firm’s access to debt and/or
equity finance on acceptable terms; (2) its ability to self-finance growth through the retention of
earnings; (3) its capacity to place major bets on risky new technologies, markets, and/or products;
and (4) the valuation of the company. A reasonable starting point for assessing firm’s future profitability is to analyze its past pattern of
profitability.
1. What has been the average level, trend, and volatility of profitability?
2. Is the level of profitability sustainable, given the outlook for the market and for competitive and regulatory pressures?
3. Is the current level of profitability at the expense of future growth and/or profitability?
4. Has management initiated major profit improvement programs? Are they unique to the firm or are they industrywide and may be reflected in lower prices rather than higher profitability?
5. Are there any “hidden” problems, such as suspiciously high levels or buildups of accounts receivable or inventory relative to sales, or a series of unusual transactions and/or accounting changes?
