- Analyze the Balance Sheet
The balance sheet provides information on a company’s financial health by helping you analyze the following:
- How much debt the company has relative to equity
- How liquid the business is in the short term (less than one year)
- What percentage of assets are tangible and what percentage comes from financial transactions
- How long it takes to receive outstanding payments from customers and repay suppliers
- How long it takes to sell inventory the business keeps on hand.
2. Analyze the Income statement
The income statement provides information on a company’s financial health by helping you analyze the following:
- How much revenue is growing over certain accounting periods
- The gross profit margin for goods sold
- What percentage of revenue results in net profit after all expenses
- If the business can cover its interest repayments on debt
- How much the business repays to shareholders versus how much it reinvests
3.?Analyze the Cash flow statement
The cash flow statement provides information on a company’s financial health by helping you analyze the following:
- The liquidity situation of the company
- The company’s sources of cash
- The free cash flow the company generates to further invest in assets or operations
- Whether overall cash has increased or decreased
4.?Financial Ratio Analysis
Some of the financial ratios we should evaluate.
- Current ratio:?The company’s ability to meet short-term obligations of less than one year
- Quick ratio:?The company’s ability to meet short-term obligations of less than one year using only highly liquid assets
- Gross profit margin:?The percentage of profit the company generates after direct cost of sales expenses have been deducted from the revenue
- Net profit margin:?The percentage of profit the company generates after all expenses have been deducted from revenue, including interest and tax from revenue
- Coverage ratio:?The company’s ability to meet its financial obligations, specifically to cover its debt and related interest payments
- Debt-to-equity ratio:?The percentage of debt versus equity that the company uses to finance itself
- Inventory turnover:?How many times per period the entire inventory was sold
- Total asset turnover:?How efficiently the company generates revenue from total assets
- Return on equity (ROE):?The company’s ability to use equity investments to earn profit
- Return on assets (ROA):?The company’s ability to manage and use its assets to earn profit.
Financial ratios should be compared across periods and against competitors to see whether your company is improving or declining, and how it’s faring against direct and indirect competitors in the industry.