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)

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.

Income Statement

Income

Primary manufacturing, product, fabrication, extraction sales (turnover)

Services provided

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

                           

Free 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.

 

Free 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.

 

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.

Credit Analysis

Profitability

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.

Free cash flow is cash from operations less capital spending

Structural costs are expenses that company has little or no control over such as income tax, employee benefits (particularly health care costs) and compliance.

Liquidity/Working Capital

Key ratios for examining liquidity:

(Current Ratio) 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.

(Acid Test/Quick Ratio) Cash + Cash Equavilents+ Receivable/Current Liabilities measures the ability to cover short-term liabilities without the need to convert inventory into cash.

(Accounts receivable turnover) Credit Sales divided by Average accounts receivable

(Interest coverage) Income before taxes + interest expense divided by interest expense; computes the number of times ordinary income before interest and taxes covers interest payments.

Capitalization & Leverage

Gearing (U.K. term): The ratio of total debt to equity in the balance sheet of a company. 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:

Debt Service Coverage Ratio: Annual cash requirements to meet interest and repayment obligations on debt. Earnings before interest, taxes, depreciation and amortization (EBITDA) or some other cash flow measure as the numerator and debt service costs as the denominator are useful indicators of a debtor's ability to pay. Compare to Fixed Charges.

Debt to Equity Ratio: Long-term debt divided by equity capital

(Debt Ratio) Total Liabilities, divided by Total Liabilities plus Capital indicates how much of capital is borrowed funds.

(Debt Ratio) Total Liabilities divided by Total Assets

Debt/Tangible Net Worth

Net Assets/Tangible Net Worth

("Gearing" - UK accounting standards): net debt as a percentage of shareholder's 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.

Ratio Analysis

1. Quick Ratio:

Measures the extent to which a business can cover its current liabilities with those current assets readily converted to 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 + Accounts Rec. ÷ Current Liabilities

2. Current Ratio:

Expresses the working capital relationship of current assets to cover current liabilities. As a rule of thumb, at least 2:1 is considered a sign of sound financial strength.

Current Assets ÷ Current Liabilities

3. Current Liabilities to Net Worth:

Indicates the amount due to creditors within a year as a percent of the owner's investment. The smaller the net worth and the larger the liabilities, the less security for creditors. Normally, a business starts to have trouble when this relationship exceeds 80%.

Current Liabilities ÷ Net Worth

4. Current Liabilities to Inventory:

Identifies, as a percentage, the reliance on available inventory for payment of debt (how much a company relies on funds from disposal of unsold inventories to meet its current debt).

Current Liabilities ÷ Inventory

5. Total Liabilities to Net Worth

Shows how all of the company's debt relates to the equity of the owners and stockholders. The higher this ratio, the less protection there is for the creditors of the business.

Total Liabilities ÷ Net Worth

6. Fixed Assets to Net Worth:

Shows the percentage of assets centered in fixed assets compared to total equity. Generally, the greater this exceeds 75 percent, the more vulnerable a concern becomes to unexpected hazards and business climate changes. If capital is frozen, for example, in machinery, the margin for operating funds becomes too narrow for day-to-day operations.

Fixed Assets ÷ Net Worth

7. 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

8. 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

Efficiency Ratios

1. 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

2. 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

3. 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

4. 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

Profitability Ratios

1. Return on 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 Profits÷Net Sales

2. Return on Assets:

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.

Net Profits ÷ Net Assets

3. Return on Net Worth:

Measures the ability of a company's management to realize an adequate return on the capital invested by the owners in a company.

Net Profits After Tax÷Net Worth

Solvency

1. Inventory Turnover:

Analyzes a company's ability to cover current liabilities. Low inventory turnover can indicate possible overstocking, obsolescence, or poor production planning, while a very high turnover ratio can be a warning of the possibility of stock-outs and delayed shipments. One flaw in this formula is that it compares a whole year (or y-t-d) Cost of Sales with inventory at a specified time; it does not recognize seasonal fluctuations. The problem can be somewhat eliminated by using an average inventory value. If this ratio is divided by 365 days, the answer will tell you how long it will take to turn $1 of inventory into $1 of sales.

Cost of Sales ÷ Inventory

Market Capitalization

P/E Ratio (Price per share divided by the earnings per share) The price of a stock should express the present value of all future cash flows expected to accrue to the investor discounted at the investor's required rate of return. The P/E ratio states how much an investor must pay for one unit of expected earnings in a company. The P/E ratio can be compared with either its historical average, the P/E ratio of similar companies, an average of other selected stocks, a sector P/E or the market P/E.

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.

  Serving the Financial Industry