How to Analyze a Company’s Financial Position.
To understand and appreciate a company, investors must look at their financial position. Fortunately, this is not as difficult as it sounds.
If you borrow money from a bank, you must list all the values of your important assets. Of course all your important obligations. Your bank uses this information to assess the strength of your financial position. The total value of all assets minus the total value of all obligations giving net value, or your equity.
Evaluating the financial position of listed companies is quite similar. Unless investors need to take other steps and consider financial positions with respect to market value. Let’s see.
Start with a Balance Sheet
The financial position of a company also includes shareholder equity.
Suppose that we are examining the financial statements of a fictitious retail retailer, The Outlet, to evaluate its financial position. To do this, we examine the company’s annual report, which can often be downloaded from the company’s website. The standard format for balance sheets is assets, followed by liabilities, then shareholder equity.
Current Assets and Liabilities
Like most other retailers, Outlet supplies represent a large portion of their current assets, and therefore must be examined carefully. Because inventory requires a very valuable capital investment. So the company will try to minimize inventory value for a certain level of sales. Or maximize sales levels for certain inventory levels. So, if The Outlet sees a 20% decrease in inventory value along with a 23% increase in sales from the previous year. So this is a sign that they manage their inventory quite well. This reduction contributes positively to the company’s operating cash flow.
Current liabilities are obligations that must be paid by the company in the coming year. And includes obligations (or accrued) that exist to suppliers, employees, tax offices and short-term financial providers. The company tries to manage cash flows to ensure that funds are available to meet these short-term obligations at maturity.
Current ratio where total current assets are divided by total current liabilities. Usually used by analysts to assess a company’s ability to fulfill its short-term obligations. The acceptable current ratio varies across industries. However, it should not be too low, indicating bankruptcy that will occur. Or so high that it indicates an increase in money, accounts receivable and unnecessary inventory. Like ratio analysis, evaluation of company ratios must now be made in relation to the past.
Non-Current Assets and Liabilities
Non-current assets or liabilities are assets that are expected to continue beyond next year. For companies such as The Outlet, the largest non-current asset is likely to be a fixed asset that the company needs to run its business.
Long-term liabilities may be related to liabilities under lease contracts, factory equipment, and other loans.
Financial Position: Book Value
If we reduce total liabilities from assets, we are left with shareholder equity. In essence, this is the book value, or accounting value, of shareholders in the company. This mainly consists of capital contributed by shareholders from time to time.
Some Markets to Books
By comparing the market value of a company with its book value, investors can determine whether the stock is below or above the price. Some markets to books, despite their shortcomings, remain a key tool for value investors. Extensive academic evidence shows that companies with low market-to-book shares perform better. The performance is better than those with high multiples. This makes sense because many small market-to-books indicate that the company has a strong financial position related to its price label.
To find out whether some of the books to the Outlet market are high or low. Then you need to compare it with multiples of other retailers listed on the exchange.
The company’s financial position tells investors about general welfare. A study of it (and footnotes in the annual report) is very important. Of course for serious investors who want to understand and respect the company properly.