Tag Archives | balance sheet

Financial Ratios

Monitoring a company’s performance using ratio analysis and comparing those measures to industry benchmarks often leads to improvements in company performance. Not to mention these ratios are often part of loan covenants. The following article provides an overview of the 5 categories of financial ratios and links to their description and calculation.

Use the following Financial Ratios to measure financial performance against standards. In addition, analysts compare these ratios to industry averages (benchmarking), industry standards or rules of thumbs and against internal trends (trends analysis). Furthermore, the most useful comparison when performing financial ratio analysis is trend analysis. They are derived from the three following financial statements:

5 Categories of Financial Ratios

The five (5) major categories in the financial ratios list include the following :

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5 Categories of Financial Ratios

5 Categories of Financial Ratios

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Warning Signs of a Company in Trouble

When considering an acquisition of, investment in, or employment with a company it is best for your peace of mind, as well as, financially to be aware of indications that the company’s true picture may not be what management would lead you to believe.

Warning Signs of a Company in Trouble

The surest sign that something is amiss is a frustrated stakeholder – be it the owner, investors, or lenders. What are their concerns? Have there been repetitive problems with the company? Does management not seem to have the right skill set to handle the most pressing issues? Does management spend too much time assessing blame and not a lot of time accurately identifying the company’s problems and devising solutions?

Where to Start

It is best to first take a look at the company’s financials. Start with the balance sheet. Are they building inventory and not able to sell it? Do they have a negative cash position? Have they maxed out their borrowing base? Also be sure that the balance sheet reflects the true state of affairs. For example, has the company written a check which it has yet to mail despite debiting its accounts payable account?

Take a look at the income statement, preferably one with monthly performance over the last 12 months. Group the items into three categories: sales, variable costs including direct sales costs, and fixed costs. What trends do you see in those categories? Perform a breakeven analysis. What is their contribution margin? Is it declining? What about EBIT? Is the company able to service its debt?

It can be helpful to simplify a company’s financial statements, combining similar items in order to move out of the detail and focus on the company’s overall performance and financial position.

The greatest mistake is not necessarily investing in a troubled company, but rather misdiagnosing the company’s problem(s).

Checklist

Here are some items to consider when performing diligence on a company:

Cash shortfall – does the company seem to be constantly in a cash crunch?

Physical deterioration of facilities – signs of inability to maintain facilities due to lack of proper planning and ability to re-invest.

Poor Accounting Systems – accounting records and reporting are delinquent. Often the company does not know if they are making money or losing money.

High concentration of leased assets – inability to secure traditional financing

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Warning Signs of a Company in Trouble
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Warning Signs of a Company in Trouble

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FASB Eases Mark-To-Market

Today the Financial Accounting Standards Board (FASB) changed FAS 157, providing companies more flexibility in determining the fair value of their investments held. In addition, the FASB also granted companies more flexibility in taking impairment charges on investment losses. The changes will take effect in Q2, though companies will be free to report Q1 under the new rules. Continue reading about how FASB eases mark-to-market.

FASB Eases Mark-To-Market

It will be interesting to follow the impact of these rule changes on those companies most affected by the “toxic assets” on their balance sheet. Will the change enable them to workout their problems or will it mask future poor decision making?

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FASB Eases Mark-To-Market

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FASB Change to FAS 157 at odds with Geithner’s Plan

This week the FASB is considering relaxing the mark-to-market accounting rule, which would seem to undercut the US Treasury Department’s plan to help banks fix their balance sheets by ridding themselves of the so-called “toxic assets.”

FASB Change to FAS 157

As a taxpayer, I’d have to say that I prefer the FASB’s approach to the Treasury’s. The Treasury plan counts on helping banks rid themselves of problem loans by selling those loans to private parties (presumably including those evil hedge funds), which would provide a limited amount of equity investment, along with Uncle Sam as a co-equity partner and also the provider of the debt financing. If the investment is good, the private partner gets a good chunk of the upside. If not, We The People eat it.

It makes good sense that at some point those who had a hand in making these now-problem loans find a way to get out of their mess. Changing the mark-to-market rule in this context is not a bad thing.

Geithner’s plan is less appealing, but may very well improve lending (albeit at a handsome price). Though it simply looks like another way for the taxpayer to subsidize those who got us into this predicament.

It will be interesting to see how this plays out. One thing does seem certain: the taxpayer will lose.

FASB Change to FAS 157

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Forecasting and Your Business

Do you manage your business looking backward or forward? Are you preoccupied with looking at how last month compared with the budget instead of where your business is headed? While examining actual performance against the budget can be a very useful approach to identifying areas of improvement in your organization, it can also take your focus away from planning for your future business needs.

Forecasting and Your Business

It is important to develop and maintain a running forecast model of your business, one that incorporates trends (in sales, COGS, and overhead) as well as other information (addition of a significant new customer, loss of a substantial current customer, anticipated large changes in raw material prices and/or other expenses, or a new building lease, for example). This will help you estimate your upcoming needs for cash and give you the time to adequately prepare.

Connecting Your Financial Statements

You need to have an income statement model. This projects sales based on expected items or services sold and the prices received, as well as expected gross and net margins. Then, tie your income statement to a projected balance sheet and statement of cash flows. You should also consider a running working capital forecast as well as a capital expenditure forecast.

Being able to anticipate future capital needs months in advance can go a long way to improving your company’s performance by allowing you the time to seek out the best terms (in cost of capital as well as other terms). Such a forecast will help you establish credibility with prospective lenders and investors as well as provide an easy means of communication with them.


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Forecasting and Your Business

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Forecasting and Your Business

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