Corporation Financial Statement Analysis & Financial Ratio Analysis

Corporations can be privately owned (and do not report earnings to the general public, only shareholders) or publicly owned (equity shares trade on a regulated exchange and the company is required to report earnings on a quarterly basis). In addition, many industries / companies may have some component of their operation that is regulated by a government agency.


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 (added to current liabilities).
  • 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: still to be collected after the end of the financial period
  • Accounts receivable with trade customers should be examined for quality. Large companies tend to extend supplier credit to small and medium-sized companies. However, this means that the large company that extended the credit also has to perform its own credit analysis and monitor of the small and medium-sized business. During a recession these extended lines of credit or products sold on 30 to 90 days terms can become suspect. It is also prudent for the large company should reduce the dollar amount of the credit line / sales terms to the small and medium-sized company.
  • Check the accounts receivable in days ratio to determine whether the collection period is lengthening/shortening to determine quality
  • Accounts Receivable from affiliated companies should be discounted.
  • Is the amount also being shown net of reserve for bad debts? (it is more conservative to present it this way).
  • 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 notes receivable.
  • Inventory: raw materials, work in progress, finished goods and inventory in transit; finished goods have greater value in liquidation, raw materials are merely commodities. 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. The historical and the depreciated value of tangible assets is not always the real value: every asset has some value and there is usually a secondary market for it somewhere. There are som third-party, on-line websites where one can determine the used / pre-owned value (being offered for sale) of an asset (exact type and age of the asset or a nearly similar asset).
  • 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 goodwill 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.


    Current Liabilities
  • Bank overdrafts: due within the current period.
  • Accounts payable - These could be short-term, supplier / vendor credit lines and favorable sales terms extended by a large company to a small or medium-sized business. During times of recession these lines / sales terms tend to be reduced in dollar amount or time, and sometimes they are terminated, which can place the small or medium-sized business under duress if bank financing is not available (which it probably will not be in a recession).
  • Notes payable - bank: borrowings utilized for working capital purposes.
  • Notes payable
  • Current Portion of Long-term debt: principal that is being amortized or a specific amount scheduled to be repaid.
    Long-term Liabilities
  • Notes Payable to banks: term loans or mortgages.
  • Long-term bond payable(s)
  • What is the schedule of repayment of the long-term debt? What is coming due within the next 6 months and 12 months?
  • Subordinated Debt

  • Stockholder's Equity / Investor's Capital / Shareholder's Capital

  • Common shares: initial equity issued by the company at commencement of operations.
  • Surplus/Additional Paid-in-capital: common shares issued at a later date in excess of par (stated price of the common share; Determined by sales price per share minus the stated par value per share).
  • Preferred shares: can be almost a debt-like financial instrument with a minimum percentage pay out legally required on an annual or periodic basis.
  • Reserves: restricted for any reason?
  • Subordinated debt
  • Retained earnings: net income (net of dividends paid) earned in previous years and added to capital to operate the company or used to purchase assets (the cash is used somewhere, there is no account or deposit with cash). An increase in Retained Earnings results in an increase in Equity
  • Treasury: shares purchased in either the open market or under agreement, "buy back," and held by the coprporation.

  • Income Statement

    Income (Sales, Gross Sales, Revenue, Total Revenue)
  • Primary manufacturing, product, fabrication, extraction sales (turnover)
  • Services provided and/or goods sold
  • Interest income: net? From the investment of excess funds or an additional operation conducted by the corporation? This item is usually presented in Other Income (Expense) below.
  • 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)
  • Less returns and allowances.
    Cost of Goods Sold
  • Direct charge(s) against the primary manufacturing/sales process. Can be determined by adding Beginning Inventory, Merchandise Purchases, and Freight Costs, and then subtracting Ending Inventory.
    Gross Profit
  • Total Income (Net sales) minus the Cost of Goods Sold
    Operating Expenses and Selling, Administrative and General Expenses
  • Personnel Compensation
  • Senior Management
  • Expenses necessary to run the company
    Operating Income (Net operating Profit; Operating 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 (considered a non-GAAP financial measure under the SEC?s rules).
  • 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.
    Depreciation Expense
  • If a company does not accurately depreciate an asset, either knowingly or unknowingly, then the net income result is higher or lower than it should be. If the company knowingly takes less depreciation then it is pumping up the earnings of the company. If the company applys too much depreciation then it is decreasing earnings. The analyst needs to look at what the historical depreciation has been and whether there heve been any recent capital expenditures (increases depreciation) or asset sales (decreases depreciation). If the company knowingly applys too much depreciation then it may be looking to push up earnings in a later period by applying the accurate (and lesser) amount of depreciation during that period. The amount of depreciation charged against earnings each accounting period is the based on the assumption of management. In addition, companies in a growth phase will have higher capital expenditures (acutal cash spent, which reduces earnings) than depreciation (non-cash item, which does not affect actual cash flow).
    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.
  • 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?

  • Vertical Analysis / Financial Statement Analysis

    Any item on the Balance Sheet or the Income Statement can always be compared to a sub-total or a toal amount. For instance, Cash = $43,000, Total Assets = $789,000. Thus, Cash represents 5.45% of Total Assets of the company. ($43,000 / $789,000 = 0.0545 x 100 = 5.45%). In addition, items in Assets, Liabilities and Equity can be compared to each other, and items on the Income Statement can be compared to the Balance Sheet.

    All of the mathematics involved in financial statement analysis is arithmetic. A ratio is just an indication that one number is being divided by another number.

    Operating Cycle

    The operating cycle is the duration of time required to convert a product or service order from a customer into an actual cash receipt.
    1. Product order received and the company invests its own cash, time and resources into purchasing raw materials, services, utilizing existing inventory, plant space and equipment to produce the product or service.
    2. Fulfill the terms of the sales contract by either initially shipping or completely shipping the product(s) or service in full or partial completion / assembly.
    3. Receiving partial payment during the process and / or extending credit to the purchaser on specific terms (net 30 days due, 60-days, discount for rapid payment, etc.) and creating an account receivable.
    4. Receiving full payment or collecting the account receivable, and creating cash (costs + profit) for the company.

    Cash Flow Analysis

    A simple cash flow is cash receipts minus cash disbursements. This may approximate what is happening in the Income Statement or in the cash account on the balance sheet, which results in a net cash position. The result may not always be a positive number as it will fluctuate with the operations / operating cycle of the company. Cash receipts consist of billed sales, advance payments from customers, work-in-progress payments, investment income. The ratio of an individual receipt item to total receipts would indicate which item is the greatest source of cash.

    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.

    Free cash flow, which is someties defined as net cash provided by operating activities of continuing operations in the period minus payments for property and equipment made in the period, is considered a non-GAAP financial measure under the SEC?s rules but is still an important financial measure for use in evaluating a company?s ability to generate additional cash from business operations.


    Under GAAP guidelines, a company's income statment includes non-cash items. The amount of the these items is derived by management's estimate, and what ever the company's auditors will agree to.

    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) Sales / Revenue minus Cost of Goods Sold (profit remaining after the cost of goods sold has been deducted from sales; Cost of Goods sold, or perhaps more accurately cost of sales, are the direct costs incurred to either make or produce a product or provide a service).

    Gross Profit Margin equals Gross Sales or Total Revenue or Net Sales (net of bad debt allowance) minus Cost of Goods Sold, divided by Net Sales

    (Profit Margin) Net Income divided by Sales or Net Sales.

    (Operating Profit Margin) equals Operating Profit divided by 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.

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

    Key Ratios for Examining Profitability

    Sales Growth Rate

    Sales in Period 2 - Sales in Period 1 / Sales in Period 1

    Then, multiply the number by 100 to obtain the percentage.

    Example: $2,450,000 (Period 2) - $1,750,000 (Period 1) = $700,000 / $1,750,000 = 0.400 x 100 = 40.0% growth rate.

    Gross Profit Margin / Gross Margin

    Gross Profit (Sales or Revenue minus Cost of Goods Sold) / Sales or Revenue

    Then, multiply the number by 100 to obtain the percentage.

    Example: $1,500,000 (Sales or Revenue) - $1,150,000 (Cost of Goods Sold) = $350,000 / $1,500,000 = 0.233 x 100 = 23.3% Gross Profit Margin. Thus, for every dollar in gross sales, the company earns 23 cents after direct production costs.

    If the margin is declining from period to period then:
  • Gross sales are decreasing and the cost of goods is stable or increasing.
  • The cost of production / raw commodities may be increasing while sales are stable or decreasing.
  • If the margin is increasing from period to period then:
  • The product or service that is in high demand, or highly regarded, by the customer base, and sales are increasing while the cost of goods sold is stable, decreasing or increasing at a rate lower than an increase in gross sales amount.
  • The cost of production / raw commodities may be decreasing while sales are stable, increasing or decreasing at a rate lower than the decline in gross sales amount.
  • A positive ratio, especially one that is high, indicates that the company is either not overpaying for materials and/or has a product or service that is in demand. The Gross Profit Margin is different for various industries.

    The converse ratio would be the Cost of Sales Ratio: Cost of Goods Sold / Sales or Revenue. Using the the numbers in the above example the ratio would be 76.7%. The ratio isolates direct costs / expense as a percentage of sales. Specific components of the cost of sales, for instance a sepecific commodity or employee labor, can also be measured as a percentage of sales.

    Profit Margin / Net Profit Margin / Return on Sales

    Net Income / Sales or Revenue (Net sales would be less any allowance for bad credit sales)

    Then, multiply the number by 100 to obtain the percentage.

    Example: $8,000 (Net Income) / $100,000 (Sales or Revenue) = 0.080 x 100 = 8.00%

    Measures the profit after taxes on present year sales. The higher the ratio, the better prepared the business is to handle downward trends.

    The ratio is also of value for estimating what the net income may be for the upcoming period. Example: If Sales are estimated at $130,000, then x 8.0% (0.08) = $10,400. However, the ratio needs to have been relatively stable over a several year period in order to be used a predictor.

    Return on Average Assets (ROAA)

    Net Income (annualized) after taxes (including realized gain or loss on investment securities) / Total Average Assets (assets at the previous fiscal year plus assets at this current fiscal year divided by 2) for a given fiscal year

    Then, multiply the number by 100 to obtain the percentage.

    Example: Net Income year 2 = $245,000; Year 1 Assets $1,850,00 + Year 2 Assets $2,245,000 = $4,095,000 / 2 = $2,047,500; $245,000 / $2,047,500 = 0.1197 x 100= 11.9%.

    This is a 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 indicate that the company is well managed, and has invested in an adequate group or type of assets in order to earn an adequate return. However, by using average assets, the ratio does not indicate whether the assets that produced the profit were acquired earlier or later in the year. If the assets were acquired later in the year then the upcoming year may see substantial improvement in profitability.

    If the company is a Subchapter S Corp. then the coporation is treated as a pass-through entity and is not subject to Federal income taxes at the corporate level.

    Return on Average Equity (ROAE)

    Net Income after taxes (including realized gain or loss on investment securities) / Total Average Equity (equity at the previous fiscal year plus equity at this current fiscal year divided by 2) for a given fiscal year

    Then, multiply the number by 100 to obtain the percentage.

  • Measures the ability of a company's management to realize an adequate return on the capital invested by the owners in a company.
  • This ratio is affected by the level of capitalization of the company.
  • Measures the ability to augment capital internally (increase net worth) and pay a dividend.
  • Measures the return on the stockholder's investment (not considered an effective measure of earnings performance from the company's standpoint).
  • In the long run, a return of around 15% to 17% is regarded as necessary to provide a proper dividend to shareholders and maintain necessary capital strength in the event of an earning decline.

  • Liquidity/Working Capital

  • Liquidity refers to a company's ability to convert an asset into cash. The faster the conversion the more liquid the asset. Illiquidity is a risk in that a company might not be able to convert the asset to cash when most needed. Moreover, having to wait for the sale of an asset can pose an additional risk if the price of the asset decreases while waiting to liquidate.
  • Is a measure of how much cash does a company have on hand for immediate use.
  • A company will have both on balance sheet liquidity and off-balance sheet sources of liquidity. On balance sheet will be actual issued debt, commercial paper. Off-balance sheet will consist of committed, unused bank credit facilities to support commercial paper.
  • What is the mix of debt according to maturity, rate structure (mixed versus floating rate), and currency?

  • Key Ratios for Examining Liquidity

    Working Capital (Net Working Capital)

    Current Assets - Current Liabilities

    This is an equation not a ratio, and it is a very rough / rudimentary equation as it does not identify and qualify the components of either of these financial accounts. In addition, the components fluctuate in value over the short term period, increasing or decreasing in tandem with the operations / operating cycle of the company. The belief is that as long as it is positive then the company has sufficient liquidity to cover its short-term obligations, cover any unforseen obligations, and still have sufficient liquidity to increase operations. However, it is not a good indicator as to whether the company really does have sufficient liquidity / ability to pay off its short-term liabilities. If the Current Assets are primarily accounts receivable and / or inventory then they cannot be converted into cash quickly, and if it really is not adequate to cover liabilities then any positive result would have to be discounted. One advantage is that it does not need to annualized or adjusted: it is a measurement as of the date of the balance sheet.

    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. A minimum of 1:1 is required, the industry standard is approximately 1.2:1, however as a rule of thumb, at least 2:1 is considered a sign of sound financial strength.

    Quick Ratio / Acid Test Ratio

    Cash + Cash Equavilents+ Receivables / Current Liabilities

    Measures the extent to which a business can cover its current liabilities with those current assets readily converted to cash (the ability to cover short-term liabilities without the need to convert inventory into 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 Ratio

    Cash + High Quality Marketable Securities / Current Liabilities

    Interest Coverage

    Income Before Taxes + Interest / Interest Expense

    Computes the number of times ordinary income before interest and taxes covers interest payments.

    Activity / Turnover / Operating Efficiency

    Activity ratios measure how assets are utilized. They are closely related to liquidity as they indicate how quickly assets are being utilized to create cash receipts and how quickly the company pays its short-term liabilities.

  • 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.
  • It also measures 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 at purchase but not collect sales for 30 to 90 days.
  • The loanger it takes a company to convert inventory and accounts receivable into the cash the greater the need is for the company to have sufficient current assets in relation to current liabilities.

  • Key Ratios for Examining Activity / Turnover

    Accounts Receivable Turnover Ratio

    Net Credit Sales (Sales on Credit) / Average Accounts Receivable (Accounts receivable at the beginning of the period + accounts receivable at the end of the period / 2)

    The ratio measures how often a credit sale / account receivable is created and then collected during the period.

    A receivable is essentially an interest-free loan by the company to the customer. Thus, it is an asset that is not earning a return (in addition, the company already had to pay for the materials, sub-assembly or services in order to produce the product or service). Thus, the faster the the receivable is turned over, the faster the company has received the cash plus profit back to cover the cost of producing the product or service.

    Please note: the numerator must be Credit Sales or Net Credit Sales (usually net of returns). If the company sells a product or service for cash then no receivable was created. Thus, the numerator cannot be Gross Sales, Net Sales or Sales. It is only when a company extends credit for 30, 60 or 90 days that a receivable is created.

    Average Day Sales on Credit

    Net Credit Sales (Sales on Credit) / 365

    The ratio measures the Sales on Credit (creation of an accounts receivable) on an average day during the year.

    Number of Days Receivables Ratio

    Accounts Receivable / Average Day Sales on Credit (Sales on Credit / 365)

    The ratio measures the duration of time necessary to convert a receivable into a collection of cash. The end of the year figure must be representative of the entire year in order for it to be "average".

    Inventory Turnover Ratio

    Cost of Goods Sold / Inventory

    Example: $1,750,000 (Cost of Goods Sold) / $450,000 (Inventory) = 3.9x

    The ratio measures how often inventory is created and then reduced (through production) during the period.

    Average Day of Cost of Goods Sold

    Cost of Goods Sold / 365

    Example: $1,750,000 (Cost of Goods Sold) / 365 (days in a year) = $4,794.52

    The ratio measures the Cost of Goods Sold on an average day during the year. This is a production expense the company incurred on any given day.

    Number of Days Inventory Ratio

    Inventory / Average Day of Cost of Goods Sold (Cost of Goods Sold / 365)

    Example: $450,000 (Inventory) / $4,795 ($1,750,000 Cost of Goods Sold / 365) = 93.8 days

    The ratio measures the duration of time necessary to convert an investment in inventory into sold goods. The end of the year figure must be representative of the entire year in order for it to be "average".

    Total Asset Turnover Ratio

    Sales / Total Assets

    The ratio measures how much of the asset side of the balance sheet, and the money invested in the mix of assets, results in sales.

    Capitalization / Leverage / Coverage

  • The company's equity base is considered of high quality if it consists primarily of common equity, with small/moderate goodwill, and small/moderate preferred equity with high percentage/dividend rates, and low subordinated debt. Capital formation can be strong if the company has a high return on equity and modest dividend payout to shareholders resulting retained earnings growth.
  • Reliance on debt financing and the nature of the assets being financed; and the relation of debt to equity capital (the company's use of borrowed funds in relation to the amount of funds provided shareholders).
  • Borrowed money carries interest costs and the company must generate sufficient cash flow to cover interest and principal payments, thus low to moderate leverage is viewed as more favorable.
  • Croporate debt is no longer just secured and unsecured creditors. There are now several levels of debt holders, each earning a specific interest rate to match the level of risk in lending to the company and being in a subordinated position: senior creditors (first lien), second lien, mezzanine, senior subordinated, subordinated. Shareholders (equity) are last in the hierarchy of claims against the assets of a company.
  • Loan covenants usually specify that financial ratios (for instance, interest coverage or the ratio of a company's earnings to its interest payments) must be adhered to or the company will be in breach of the loan agreement.
  • Gearing, which is the term used in the United Kingdom, for the ratio of total debt to equity in the balance sheet of a company (net debt as a percentage of shareholder's funds). A highly geared balance sheet is one where the level of debt is high in relation to the equity base of the company.

    "Debt" and "Total Liabilites" are not exactly identical even though they are used interchangeably. Total Liabilites includes Debt, but Debt does not include deferred or accrued items, pension obligations.

    Remember: if lease obligations are not included on the balance sheet then the Leverage / Solvency ratios are understated.

    Key Ratios for Examining Leverage

    Debt Service Coverage

    Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA; or some other cash flow measure) / Debt Service Costs (interest, scheduled amortization, fees)

    Measures annual cash requirements to meet interest and repayment obligations on debt and provides an indication of the company's ability to pay.

    Liabilities To Equity

    Total Liabilities / Total Equity

    Debt To Equity Ratio

    Total Debt / Total Equity

    This is a quick measurement of leverage. Includes all short-term and long-term interest bearing debt, including commercial paper, bonds and bank borrowings to Equity.

    If greater than 1.0x, then the capital provided by lenders exceeds the capital provided by owners.

    Long-Term Debt To Equity Ratio

    Total Long-Term Debt (Total Debt less Short-Term Debt) / Total Equity

    Long-term assets are usually financed with long-term debt. this debt includes plant and equipment term loans, and commercial real estate mortgages. The lower the ratio, the less income / cash flow the company must pay on interest payment and scheduled principal amortization, and refinancing costs. Conversely, the bank does receive and depreciation expense tax benefit.

    Debt To Tangible Equity Ratio

    Total Debt / Tangible Equity (Stockholder's Equity minus Intangibles)

    Capital Structure Ratio (Financial Leverage Ratio)

    Long-Term Debt / Long-Term Debt + Stockholder's Equity (Capital)

    Then, multiply the number by 100 to obtain the percentage.

    Example: $23,750,000 (Long-Terml Debt) / $78,450,000 ($23,750,000 Long-Term Debt + $54,700,000 Stockholder's Equity) = 0.3027 x 100 = 30.3%.

    Indicates how much of capital is borrowed funds. The higher the ratio the more the company is relying upon borroweed funds. The greater the amount of debt the more the company must have sufficient cash flow to service the debt (interest payment and scheduled principal amortization or maturity). In addition, it may preclude the company's ability to borrow additional financing at a later date. The ratio is different across various industries, and the stage of development of the company.

    Debt to Assets Ratio

    Total Debt / Total Assets

    Then, multiply the number by 100 to obtain the percentage.

    Example: $4,950,000 (Total Debt) / $14,030,000 (Total Assets) = 0.3528 x 100 = 35.3%.

    Indicates how much of assets is funded by borrowed funds. The ratio is different across various industries. However, one must look at the composition of the debt: the more the amount of debt is short-term the more the assets are financed by debt that is repayable wihtin one year or less. Thus, the assets must generate sufficient income to repay debt. The higher the Debt to Assets ratio, particularly in excess of 50.0%, the more the demand is for the assets to be very profitable in the short-term.

    Specific components could be broken out, for instance, Fixed Assets divided by Total Debt.

    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.

    Management Structure

    Management are the administrators and stewards of the company on the behalf of the investors / shareholders. They are hired for their skills and experience to maximize the value of the company on the behalf of the shareholders. Overall, one is looking for very well experienced industry professionals. One is also looking for some longevity of the management as employees of the company. However, there is nothing wrong with the hiring of new persons to replace a departing employee, or with hiring new persons with desirable skills or experience in order to improve operations or expand the company's business or product line into a new area.

    Corporate governance is the concept of monitoring the effects that the decisions of the senior management of the company have made with regard to the financial health of the company, the preservation of the shareholder's investment, the working conditions for lower level employees, the local natural environment, the customers of the company, and other stakeholders (local community). Senior management is responsible for providing the Board of Directors with prior notice and some type of measurement of what may transpire from major decisions managment has made or is planning to make with regard to the operation of the company.

    The real success of any company is not just reflected in the stock price or the financial statements. The real measure is the public perception of the company by many different and separate groups, and senior management has the responsibility for developing that public perception.

    Legal Issues

    It is not unusual for companies to be the plaintiff or defendant in a legal action, and have the pending litigation reported in the financial statements of the company. Often, the company will indicate that it has set reserves aside to cover, wht may be in their best estimate, any potential monetary award or fine that the company may be held liable for. It can sometimes be difficult to determine just waht the true liability may be and if the reserves are sufficient to cover the potential liabilitiy.

    In the United States, federal legislation mandates that class action suits can be moved out of a state court system to the federal court system. This is viewed as a positive development for businesses as some state courts / counties were deemed hostile to business.

    If a company is publicly traded, and is listed on public equity exchanges in more than one country, and a legal challenge is filed that the company defrauded its shareholders, then the company can possibly be sued in any country where its shares are publicly listed.