How to Analyze Your Financial Statements

 

Every company must draw up a balance sheet at least once during its 12-month financial year (generally at the end). The balance sheet is a summary document that presents the company's assets on a given date. This patrimony is composed, on the one hand, of the property owned by the company called the assets and, on the other hand, of its debts.

It is important to ensure compliance with the presentation standard concerning the form of the balance sheet, i.e. check that we have the following:

– The assets presented in descending order of liquidity (starting with the assets most easily convertible into cash). Thus, the appropriate order can be cash (cash, bank account, marketable securities, etc.), customer accounts, inventory (for those who have it), fixed assets

– Liabilities, presented in ascending order of due date (starting with debts with the shortest maturities to the longest). Thus, the appropriate order may be short-term bank loans (line of credit), accounts payable, long-term bank loans (mortgage)

– Shareholders' equity. You have to ensure that the balance sheet meets the equation: assets = liabilities + equity.

Originally, shareholders' equity is made up solely of contributions from the company director and, where applicable, from his associates. Over time, they will be supplemented by accumulated and undistributed results (and therefore left in reserves or carried forward). Equity measures the commitment of the owners of the company in relation to the other financiers of the company (banks, suppliers, States). If they are negative, the company's chances of survival are compromised. If they are balanced, the company remains exposed to the risk of sustainability and must take certain corrective measures. The low profitability of the company or excessive deductions with regard to the generated profitability is generally the cause of the insufficiency of shareholders' equity.

Analysis of the Balance Sheet by Management Ratios

This is a fairly familiar exercise for managers who use this analysis to make informed decisions. These ratios are decision support tools and often allow you to compare yourself with the market or competitors.

 The ratios generally used fall into four categories:

– Profitability ratios

– Operating management ratios

– Asset management ratios

– Funding management ratios

Profitability Ratios

– The return on invested capital ratio: This ratio indicates the profit made for each pound invested in the asset. It takes into account neither the method of financing the investment nor taxes.

– The return on shareholders' equity ratio: is calculated by dividing the net profit (after taxes) by the total shareholders' equity. This ratio makes it possible to evaluate the financial situation of the company.

Operating Management Ratios

– The net profit margin ratio: it is calculated from the net profit before extraordinary items. It basically reflects the company's profitability and highlights not only its business efforts but also its ability to keep operating expenses low.

– The gross profit margin ratio measures the amount the customer is willing to pay for a product or service beyond what it costs the company. It thus measures the added value.

– The ratio of total operating expenses: this ratio makes it possible to calculate the proportion of total operating expenses generated for each dollar of sale.

Asset Management Ratios

– Total Asset Turnover Ratio: This ratio indicates the relationship between total assets and net sales. It determines the overall efficiency of using assets to achieve sales, i.e. how many sales dollars were generated for every dollar of assets.

– The accounts receivable collection ratio indicates the average collection time for accounts receivable. It provides an overall idea of ​​the time it takes for the company to receive payment for goods and services sold.

– The Inventory Turnover Ratio indicates the average number of days it takes to turn inventory, with the goal being the minimum number of days possible.

– The fixed assets turnover ratio makes it possible to establish the relationship between sales and all net fixed assets, the objective being to generate a maximum of sales for a minimum of fixed assets.

Funding Management Ratios

– The ratio of financial leverage or structure measures the importance of borrowed capital in the company's financing by the shareholders.

– The debt ratio indicates to what extent the company uses debt to finance the acquisition of its assets.

– The working capital ratio: the working capital ratio or general liquidity ratio is thus useful for measuring the extent to which short-term assets can guarantee the repayment of short-term debts.

– The interest coverage ratio: this ratio informs creditors about the company's ability to pay interest costs on the debt before extraordinary items.

 

Visit the LookAfter My Taxes website for stress-free tax returns.