Corporations can be privately owned (and do not report earnings to the general public, only shareholders) or publicly owned (equity shares trade on a regulated
exchange and the company is required to report earnings on a quarterly basis).
Assets
Current Assets
Cash in banks (should be free and not earmarked for an acquisition or near-term project, nor locked up in a country
where the ability to repatriate cash is limited). Negative cash should be treated as an over draft / current liability.
Cash Equivalents: short-term, highly liquid securities. These instruments include short-term certificates of
deposit, money-market funds which offer a floating interest rate and unlimited access to funds; and Treasury bills,
which are sold by the U.S. Government.
Marketable securities: easily (liquid) tradeable debt and equity instruments; securities of affiliated
companies should be discounted.
Accounts Receivable: to be collected by the end of the financial period; a/r with trade customers should be
examined for quality. Check the accounts receivable in days ratio to determine whether the collection period is
lengthening/shortening to determine quality; a/r from affiliated companies should be discounted. Is the amount also being
shown net of reserve for bad debts? (more conservative).
Notes Receivable: may also be short-term trade receivables.
Notes Receivable (Contra / Discounted): a note receivable sold at a discount which represents an asset and liability at the same time. This is usually shown off-balance sheet as a contingent liability or as a reduction to notesreceivable.
Inventory: raw materials, work in progress, finished goods and inventory in transit; finished goods have greater value in liquidation, raw materials are merely comodities. Supplies used in operations should not be included in inventory.
Refundable or recoverable income taxes: are considered collectible in the current year.
Long-term Assets
Notes Receivable: it is hard to determine why a company would hold a long-term note as it is in the business of
selling items and receiving cash. This could be a mortgage the company took back on the sale of fixed assets or an agreed
to long-term financing arrangement.
Net fixed assets: buildings, furniture, fixtures, and equipment net of depreciation. Leasehold improvements
are to property not owned by the subject thus there is uncertainty of their liquidation value and they should really
be shown as intangibles.
Capitalized leases: represents property leased rather than purchased; if the asset will be leased for most of
its expected life or has a purchase option at the end of its lease, then it may be capitalized and depreciated similar
as to a purchased asset.
Other assets: if "other" is substantial in relation to the balance sheet, then it should be questioned.
Deferred taxes: are sometimes related to pension items. This represents taxes paid to the IRS but have not
yet been recognized as an expense.
Loans to/due from officers: usually have an unspecified amortization.
Pre-paid taxes: have no definite recovery or liquidation value.
Goodwill (intangible asset of the value of the asset over it actual cash price. Some UK corps. tend to write
off good will directly against reserves at the outset of the acquisition, whereas companies in other parts of the
world tend to amortize goodwill over time against earnings).
Book Value The depreciated value of a company's assets (original cost less accumulated depreciation) less the
outstanding liabilities.
Capital Asset All property used in conducting a business other than assets held primarily for sale in the ordinary course of business or
depreciable, and real property used in conducting a business.
Liabilities
Current Liabilities
Bank overdrafts: due within the current period.
Notes payable - bank: borrowings utilized for working capital purposes.
Notes payable
Current Portion of Long-term debt
Long-term Liabilities
Notes Payable to banks
Long-term bond payable(s)
What is the schedule of repayment of the long-term debt? What is coming due within the next 6 months and 12 months?
Subordinated Debt
Stockholder's Equity/Share Capital
Common shares
Preferred shares
Reserves: restricted for any reason?
Subordinated debt
Retained earnings
Treasury: shares purchased in either the open market or under agreement, "buy back," and held by the coprporation.
Surplus/Additional Paid-in-capital: shares issued at a later date in excess of par.
Interest income: net? From the investment of excess funds or an additional operation conducted by the corporation?
As part of project financing?
Commission and Trading Income: One time gain or loss or a definite trend/operation?
Related party transactions: should be subtracted from sales figures.
Total Income / Net Sales
Cost of Goods Sold
Direct charge(s) against the primary manufacturing/sales process
Gross Profit: Total Income / Net sales minus the Cost of Goods Sold
Operating Expenses
Personnel Compensation
Senior Management
Expenses necessary to run the company
Cash Flow
Sometimes also referred to as EBIT - A company's Earnings Before Interest and Taxes. Typically is used in presentations by companies to demonstrate
cash flow available to fund operations (considered a non-GAAP financial measure under the
SEC’s rules).
Cash Flow Value - The value of a firm based on the cash flow available for distributing to any of the providers
of long-term capital to the firm. The free cash flows equal operating cash flow less any incremental investments made to
support a firm's future growth.
Depreciation Expense
If a company does not accurately depreciate an asset, either knowingly or unknowingly, then the net income
result is higher or lower than it should be. If the company knowingly takes less depreciation then it is pumping up the
earnings of the company. If the company applys too much depreciation then it is decreasing earnings. The analyst needs to look at what the
historical depreciation has been and whether there heve been any recent capital expenditures (increases depreciation) or
asset sales (decreases depreciation). If the company knowingly applys too much depreciation then it may be looking to
push up earnings in a later period by applying the accurate (and lesser) amount of depreciation during that period. The amount
of depreciation charged against earnings each accounting period is the based on the assumption of management. In addition,
companies in a growth phase will have higher capital expenditures (acutal cash spent, which reduces earnings) than
depreciation (non-cash item, which does not affect actual cash flow).
Interest Expense
If you are increasing facilities or the company is increasing borrowings to fund an acquisition or expansion of
operations then this figure will be increasing.
Deferred Income: Money received from customers in advance of performance of revenue activities. This amount will
be spent on goods or services, or will be repaid to the customer.
Taxation
Is the rate consistent with the past several years?
Net Income
What is the trend compared to the previous year(s)?
How much is committed to dividends? Is the payout consistent with previous years?
Cash Flow Analysis:
The statement of cash flows indicates a company's major sources of cash receipts and major uses of cash payments for
a given period.
Operating activities entered into for the purpose of earning net income.
Financing activities include obtaining resources from owners and creditors and providing them with a return, or
return on, such a interest, dividends and payment of principal; proceeds from issuance of equity securities (preferred
and common), bonds and other short-term and long-term borrowing. Payments of cash dividends, acquisition of treasury
stock and repayments of amounts borrowed.
Investing activities include acquiring and selling or otherwise disposing of securities which are not cash equivalents,
and productive assets that are expected to generate revenues over the long term.
Free cash flow, which is someties defined as net cash provided by operating activities of continuing operations in the
period minus payments for property and equipment made in the period, is considered a non-GAAP financial measure under the
SEC’s rules but is still an important financial measure for use in evaluating a company’s ability to generate additional
cash from business operations.
Profitability
Under GAAP guidelines, a company's income statment includes non-cash items. The amount of the these items is derived
by management's estimate, and what ever the company's auditors will agree to.
How do companies smooth or manage their earnings:
Plan ahead: time store openings or asset sales to show earnings rising.
Aggressively book sales and/or revenue recognition at the end of a weak quarter, or hold off if the quarter's goal
has already been met.
Capitalize expenses (amortization or lengthening a depreciation schedule) as oppose to expensing it.
Writ-off a restructuring in order to lower one quarter to make it easier to meet future earnings quarters.
Utilize reserves to reduce income by building them up for allowances or potential insurance losses, and then draw
them down to bolster earnings.
(Gross Profit) Net Sales minus Cost of Goods Sold (profit remaining after the cost of goods sold has been deducted
from sales).
Gross Profit Margin equals Net Sales minus Cost of Goods Sold, divided by Net Sales
(Profit Margin) Net Income divided by Net Sales
(Operating Profit Margin) equals Operating Profit divided by Net Sales. This is the core cash flow source that is
expected to grow year to year as the business grows, and it excludes interest expense, taxes, and extraordinary items such
as asset sales. Higher profitability from one year to the next is generally considered a good sign for the company.
Structural costs are expenses that company has little or no control over such as income tax, employee benefits
(particularly health care costs) and compliance.
Key Ratios for Examining Profitability
Sales in Period 2 - Sales in Period 1 / Sales in Period 1
Gross Profit (Sales minus Cost of Goods Sold) / Sales
A ratio that is high indicates that the company is either not overpaying for materials and/or has a product or service
that is in high demand, or highly regarded, but the customer base.
Net Profits / Net Sales
Measures the profit after taxes on present year sales. The higher the ratio, the better prepared the business is to
handle downward trends.
Net operating income (annualized) after taxes (including realized gain or loss on investment securities) / Total Average Assets (assets at the previous fiscal year plus assets
at this current fiscal year divided by 2) for a given fiscal year
Is the key indicator of a company's profitability. It matches net profits after taxes with the assets used to earn
such profits. A high percentage rate will tell you the company is well managed and has a healthy return on assets.
If the company is a Subchapter S Corp. then the coporation is treated as a pass-through entity and is not subject to
Federal income taxes at the corporate level.
Net operating income after taxes (including realized gain or loss on investment securities) / Total (average) equity
(common stock) for a given fiscal year
Measures the ability of a company's management to realize an adequate return on the capital invested by the owners in
a company.
This ratio is affected by the level of capitalization of the company.
Measures the ability to augment capital internally (increase net worth) and pay a dividend.
Measures the return on the stockholder's investment (not considered an effective measure of earnings performance from the company's standpoint).
In the long run, a return of around 15% to 17% is
regarded as necessary to provide a proper dividend to shareholders and maintain necessary capital strength in the event
of an earning decline.
Liquidity/Working Capital
Liquidity refers to a company's ability to convert an asset into cash. The faster the conversion the more liquid
the asset. Illiquidity is a risk in that a company might not be able to convert the asset to cash when most needed.
Moreover, having to wait for the sale of an asset can pose an additional risk if the price of the asset decreases while
waiting to liquidate.
Is a measure of how much cash does a company have on hand for immediate use.
A company will have both on balance sheet liquidity and off-balance sheet sources of liquidity. On balance sheet
will be actual issued debt, commercial paper. Off-balance sheet will consist of committed, unused bank credit facilities
to support commercial paper.
What is the mix of debt according to maturity, rate structure (mixed versus floating rate), and currency?
Key Ratios for Examining Liquidity
Current Assets - Current Liabilities
Current Assets / Current Liabilities
Measures how well current assets could cover current liabilities if
for some reason they all became payable simultaneously and how much is available for short-term operations over and above
current liabilities. A minimum of 1:1 is required, the industry standard is approximately 1.2:1, however as a rule of
thumb, at least 2:1 is considered a sign of sound financial strength.
Cash + Cash Equavilents+ Receivable / Current Liabilities measures .
Measures the extent to which a business can cover its current liabilities with those current assets readily
converted to cash (the ability to cover short-term
liabilities without the need to convert inventory into cash). Only cash and accounts receivable would be included, as inventory and other current assets would
require time and effort to convert into cash. A minimum ratio of 1:1 is desirable.
Cash + High Quality Marketable Securities / Current Liabilities
Net Credit Sales / Average Accounts Receivable (Accounts receivable at the beginning of the period + accounts receivable
at the end of the period / 2)
A receivable is essentially an interest-free loan by the company to the customer. Thus, it is an asset that is not earning
a return (in addition, the company already had to pay for the materials, sub-assembly or services in order to produce the product or service).
Thus, the faster the the receivable is turned over, the faster the company has received the cash plus profit back to cover
the cost of producing the product or service.
Please note: the numerator must be Credit Sales or Net Credit Sales (usually net of returns). If the company sells a
product or service for cash then no receivable was created. Thus, the numerator cannot be Gross Sales, Net Sales or Sales.
It is only when a company extends credit for 30, 60 or 90 days that a receivable is created.
Income Before Taxes + Interest / Interest Expense
Computes the number of times ordinary income before interest and taxes covers interest payments.
Capitalization & Leverage
The company's equity base is considered of high quality if it consists primarily of common equity, with
small/moderate goodwill, and small/moderate preferred equity with high percentage/dividend rates, and low subordinated debt. Capital
formation can be strong if the company has a high return on equity and modest dividend payout to shareholders resulting
retained earnings growth.
Reliance on debt financing and the nature of the assets being financed; and the relation of debt to equity
capital (the company's use of borrowed funds in relation to the amount of funds provided shareholders).
Borrowed money carries interest costs and the company must generate sufficient cash flow to cover interest and
principal payments, thus low to moderate leverage is viewed as more favorable.
Croporate debt is no longer just secured and unsecured creditors. There are now several levels of debt holders,
each earning a specific interest rate to match the level of risk in lending to the company and being in a subordinated
position:
senior creditors (first lien), second lien, mezzanine, senior subordinated, subordinated. Shareholders (equity) are last
in the hierarchy of claims against the assets of a company.
Loan covenants usually specify that financial ratios (for instance, interest coverage or the ratio of a company's
earnings to its interest payments) must be adhered to or the company will be in breach of the loan agreement.
Gearing, which is the term used in the United Kingdom, for the ratio of total debt to equity in the balance sheet
of a company (net debt as a percentage of shareholder's funds). A highly geared balance sheet
is one where the level of debt is high in relation to the equity base of the company.
Key Ratios for Examining Leverage
Earnings before interest, taxes, depreciation and amortization (EBITDA; or some other cash flow measure) /
Debt Service Costs
Measures annual cash requirements to meet interest and repayment obligations on debt and provides an indication
of the company's ability to pay.
Total Liabilities / Total Equity
Total Debt / Total Equity
Includes all short-term and long-term interest bearing debt, including commercial paper, bonds and bank borrowings to Equity.
Total Long-Term Debt (Total Debt less Short-Term Debt) / Total Equity
Total Debt / Tangible Equity (Stockholder's Equity minus Intangibles)
Total Liabilities / Total Liabilities + Stockholder's Equity>,/p>
Indicates how much of capital is borrowed funds.
Efficiency / Turnover
Focus on the operating cycle of the company by examining the cash flow. These ratios give an indication of the
amount of time it takes for cash to move through accounts receivable, inventory account and accounts payable.
How long does it take for a company to purchase inventory, pay for it, sell it, and collect the cash for the
sales. A company can get squeezed if it has to pay for supplies but not collect for 30 to 90 days.
(Collection Period Ratio) equals Average Accounts Receivable divided by Net Sales, multiplied by 365 (days) (Accounts
Receivable x 365 days ÷ Sales) and indicates how quickly a company collects cash from customers that owe. The
sooner it is collected, the sooner the company can put it to work to purchase more inventory or paying for current
orders. It is helpful in analyzing the collectibility of accounts receivable, or how fast a business can increase its
cash supply. Although businesses establish credit terms, customers do not always adhere to them. In analyzing a business,
you must know the credit terms it offers before determining the quality of receivables. While each industry has its own
average collection period (number of days it takes to collect payments from customers), there are observers who feel
that more than 10 to 15 days over stated terms should be of concern.
(Days to Sell Inventory Ratio) equals Average Inventory divided by Cost of Goods Sold, multiplied by 365 (days), and
indicates how efficiently a company is in matching its purchases to its sales. Low inventory days indicate accurate
forecasting of demand for the product, which means that inventory is not accumulating on the shelves and incurring
storage costs.
(Days Purchases in Accounts Receivable) equals Average Accounts Payable divided by Cost of Goods Sold plus Change in
Inventory, multiplied by 365 (days), and indicates how quickly a company pays its suppliers for inventory purchased.
If a company is paying promptly it may be receiving price discounts.
(Inventory Turnover) equals annual sales divided by inventory. Low turnover is a sign of excess stocks and/or poor
sales.
(Total Asset Turnover) equals Net Sales divided by Average total assets
Sales in Days: Should ideally be a determination of "credit sales" however, sales figures do not normally break-down
what was sold for cash and what was sold on credit. First compute average receivables: opening receivables + closing
receivables divided by 2; Determine "fiscal" year which is normally a 360 day year.
Receivable Turnover:
The higher the turnover of receivable, the shorter the time it takes to convert sales into cash. This ratio can
be divided into 365 days to demonstrate the amount of time it takes to convert $1 of sales into $1 of cash.
Cost of Sales ÷ Average Receivables
Payables Turnover:
Dividing this number into 365 days gives you the average number of days it will take to pay for material(s). In
effect, it is the number of days you are financing your sales with your creditor's money. This should be used in
conjunction with the inventory and accounts receivable ratios to arrive at a more accurate assessment of your
cash management policies. For example, if your payable days figure is considerably less than receivables days, you
are probably wasting a valuable asset - your vendor's permission to use his money. On the other hand, an extended
payback period should be a warning that there is a danger of vendors assessing finance charges, refusing credit, or
refusing to deal with you altogether.
Cost of Sales ÷ Average Trade Payables
Sales to Inventory:
When this ratio is high, it may indicate a situation where sales are being lost because a concern is understocked
or customers are buying elsewhere. If the ratio is too low, it might indicate that inventories are obsolete or stagnant.
Annual Net Sales ÷ Inventory
Assets to Sales:
Measures the percentage of investment in assets required to generate the current annual sales level. If the
percentage is abnormally high, it indicates that a business is not being aggressive enough in its sales efforts, or
that its assets are not being fully utilized. A low ratio may indicate a business is selling more than can be safely
covered by assets.
Total Assets ÷ Net Sales
Sales to Net Working Capital:
Measures the number of times working capital turns over annually in relation to net sales. A high turnover rate can
indicate over-trading (excessive sales volume in relation to the investment in the business). A high turnover rate may
indicate that the business relies extensively upon credit granted by suppliers or the bank as a substitute for an
adequate margin of operating funds.
Sales ÷ Net Working Capital
Accounts Payable to Sales:
Measures how the company pays its suppliers in relation to the sales volume being transacted. A low percentage would
indicate a healthy ratio.
Accounts Payable ÷ Sales
External forces that may affect the Corporation:
Corporations incur foreign exchange exposure as a result of:
Export sales invoiced in foreign currencies.
Imported raw material or intermediate comoponents invoiced in foreign currencies.
External debt denominated in foreign currencies.
External investment (direct/portfolio) generating foreign currency interest and dividends.
Licensing agreements, etc., denominated in foreign currencies.
Competitive Position
What is the level of market share and the ability to protect it? (long-term sales contracts, new
product development, confirmed order backlog, and comprehensive sistribution network)
Operating efficiency (through a period of economic stress).
Where does the subject fit within its peer group and how does it form in comparison to them?
What is the strength of the local currency in relation to trade partners?
Industry Risk
What are the prospects for growth, stability and decline?
What are the patterns of business cycles and what phase of the cycle is it in now?
Vulnerability to technological change, labor unrest, or regulatory interference?
Levels of fixed or working capital intensity?
Ongoing needs for spending on capital equipment or research and development?
What is the nature and intensity of the competitive environment (domestic and international)?
What are the domestic and world-wide demand factors?
Country Risk
What is the real GDP growth, CPI change, size and composition of savings and investment, public sector
financial balances, public debt and interest requirements, rates of money and credit growth, exchange rate policy and
performance, and central bank objectives and authority? Companies tend to postpone their investment decisions in an
uncertain environment.
What is the situation of the internal labor market?
Political: form of government, degree of popular participation, orderliness of leadership succession, economic
policy consensus and objective, internal strife, civilian control of the military.
Integration in the global trade and financial system.
Cultural, social, religious and demographic trends
Hostilities with neighbors.
Reliance on commodity economy or diversification?
Sovereign Ceiling suggests that the debt rating of a corporation can not exceed that of the nation of domicile
although the company's own position and ability, or parent support, or external guarantees may suggest otherwise.
Through some intervention by the government, or simply by how it manages economic conditions, the corporate entity will
have no recourse other than to mirror the country's actions.
Market Measures for Corporations:
Book Value: The value of something on the books. Typically refers to stockholders' equity or plant and equipment net
of depreciation.
(Price-earnings Ratio) Market Price per share/Earnings per share. U.S. corporations normally sell on a multiple of
12x to 14x.
Dividend Payout Ratio: Common stock dividend divided by net income. It is a measure of the percentage of income
paid out as dividends.
EVA: Economic Value Added equals a company's after tax operating profit, subtract the cost of capital used to make
the profit. Indicates how efficient management is at turning investor capital into profits.
Market/Book Ratio: Equal to the return on equity multiplied by the price/earnings ratio. It is the relationship
between the value the stock market has placed on the company relative to the money invested by stockholders
(stockholders' equity).
MVA: Market Value Added equals the total current market value of the company (both stocks and bonds), minus all
the money that has ever been invested in it (including debt and equity offerings, bank loans, and retained earnings).
SVA: Shareholder Value Added equals operating earnings minus preferred dividends and an explicit charge for capital
Statement of Cash Flows: sources of cash from net income, new capital and loan proceeds and the expenditure of this
cash.
