10 Things to Check on Financial Statements
10 Things to Check on Financial Statements
This article gives you a quick and hopefully not too dirty way of looking at a company’s financial statements, and will give you an idea of how they are doing. This won’t qualify you as an accountant, but it may help you understand what the Finance Director is talking about.
When we say Financial statements, what we’re referring to is the company’s Report and accounts, usually found on the website of large public companies, or at Companies house in the UK.
1. The Auditors Certificate – should be the first quick check. This is usually found at the front of the Accounts and needs to say that the figures have been calculated on a going concern basis and that the Auditors have based their figures on a ‘true and fair’. Look out for any ‘qualifications’ which could indicate financial problems
2. Sales – or Turnover, Revenue. On the Profit & Loss Account, look at the trend as much as the current year
3. Profitability – the Gross Profit and Operating Profit will tell you if they are selling for more than it is costing, but what are the percentages against sales (Margins)? And the trend?
4. Return on Capital Employed – What are they making financially from what they have? If they were not doing what they do, would the money be better elsewhere? The Capital Employed is usually made up of Shareholders Funds (Share Capital plus Reserves, e.g. retained profits). ROCE is found by dividing the Operating Profit by the Total Capital Employed. This percentage needs to exceed the cost of capital (how much it cots to borrow/what return the shareholders expect). So if overall interest rates are at say 5%, the company’s ROCE should be some way above that. Oh – Return on Net assets means the same thing.
5. Working capital position – a quick look at the ratio between current assets and liabilities gives the overall situation, but how are stock, debtors and creditors? What are the trends here? Above all - what is the situation with cash flow? Can they pay their bills?
6. Retained profits – the bottom line. What is retained compared to what is distributed to shareholders via a dividend?
7. Gearing – the ratio of debt to equity, also of debt to total capital employed. If too high they will be answerable to the lenders. If low, should they borrow to invest?
8. Exceptional Items – if there, what do they represent? How much impact do they have in relation to the rest of the P&L?
9. Notes – there may be plenty of these, but even quick look may be revealing. Have a look at exactly what assets the company has, both fixed and current. Employees may find the bit about Directors Remuneration of interest. Some company reports have many pages of these notes, but they are usually indexed from the P&L and Balance sheets.
10. Finally….
What’s not there? – what is the context that this business operates in? The Report and Accounts don’t always make comparisons with competitors or other companies. And of course you are only looking at the financial situation from a historic perspective. Other things to consider – the company’s market and market share – what are the trends. And what are the connections with the financial statements.
Remember, the money is only one part of the story. But it’s a part of the story for every organisation.
Phil Ingle
June 2009 updated December 2010