Financial Statements: The Ultimate Guide to Financial Statements Analysis for Business Owners and Investors by Greg Shields

Author:Greg Shields [Shields, Greg]
Language: eng
Format: azw3, epub, mobi
Published: 2018-08-24T00:00:00+00:00

The gearing numbers are important because they illustrate the risk/return profile of the company as an investment. If a company is growing fast, plenty of debt means that once the interest charge has been paid, the rest of the profit is shared out to a relatively small shareholder base. Returns to shareholders will be higher than they would without that debt. Just imagine you buy a house without putting any money down - you'll get every penny of any price increase once you've paid the interest bill. On the other hand, a failing company with high gearing may result in shareholders getting completely wiped out and the banks taking everything to pay off the debt.

If a company is liquidated with no debt, all the funds raised go to the shareholders. That doesn't always mean bankruptcy. Some investment companies, like REITs, are set up for a limited number of years, with the intention of returning cash to shareholders through an orderly liquidation at the end of the period.

Working capital ratios

Working capital ratios look at how well the company is managing its short-term assets and liabilities. Does it turn over stock fast, is it getting paid on time by its customers, and are its suppliers giving it enough credit?

Let's look at Sears again for inventory. Merchandise inventories are shown under current assets, and we compare those not with sales (which are marked up from the stock price, of course) but with the cost of goods sold (COGS). Average inventory divided by COGS is multiplied by 365 (the number of days in the year), so we get 2798 / 11349 * 365 = 90 days.

Inventory / COGS * 365 = days' stock

But we should refine that a bit, because the stock shown in the balance sheet is the inventory at the end of the year. We're more interested in the average inventory during the period, and the best way to estimate that is to take the starting stock and the stock at the end of the year, and average them out. That's 2798 + 3959 = 6757, which we divide by two to get 3378. If we recalculate stock days, we get 108 days.

We can do the same for trade receivables. Now, Sears has practically nothing, because as a retailer it's selling for cash (or checks or credit cards, which pay it the moment the transaction goes through), not on credit. Airbus, on the other hand, is selling to business customers and generally extends credit to those customers, so it won't get paid for a while after it makes a sale. Look under “current assets” to find trade receivables, and use total sales rather than cost of sales for the calculation. Again, you should ideally use the average level of receivables in the year, rather than just the year-end number. This gives you receivables days, or days' sales outstanding (DSOs).

Days' sales outstanding = Trade receivables / sales * 365

You can also calculate payables days by comparing trade current liabilities with the cost of goods.

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