Position Analysis (Balance Sheet Analysis) 700 words

Week 6 notes (700 words) in every single analysis ALWAYS mention what is the story behind the change!! Wide research!

IMPORTANT TO KNOW:

· You should talk about the most relevant measures for the company

· Don’t try to cover every SFP item

· Make sure you compare to previous years and competitors

· Did the Figure decrease?

· When mentioning the reasons, DO NOT say this (may, might, could) be due…be confident and sure!

· When comparing, tell the story (always mention why?)

· Save your word count and use a graph instead to show the trends (I,e, no need to say this went down by $xx and this went up by $xx. Straightaway dive into reasons and the story) see sample below!!

The key is to look at the major items, not all items!

· Talk about the ones that have moved the most

· Talk about large items in SFP amounts

· Br relevant in the industry most important figure

· Link to the bigger picture (how would this event affect other financial statements areas)

· Ignore insignificant balances

· You don’t need to do ratios (ie PPE)

· Tell the story

· conclude in each figure analyzed (is this good/bad and why)

· Be critical! Link it to other parts, think in double entry (how would this event affects other parts of financial statements)

· Fewer external sources on some items

· don't be afraid to talk about what they've spent all this money on, you might get into that again in the cash flow (next section) eg, they overspent in an item and are not sure that investors will be massively happy with that because it could have been spent on whatever.

Talk about DEBT even if there is no debt, mention that there is no debt. Explain if this is good or not. And why? Is it concerning or not? And why?

Show graphs: ratio

Calculate gearing, some will include leases, loans

If the figure is from the databases, sometime this is not accurate, so calculate it!

Is there convertible bonds? Will this dilute the shareholder

GEARING: = (Debt/Equity) or (Debt/Debt+Equity) you can use any!

How analyse:

· it's not just a case of, oh, that's got higher debt. So more worried! Yes, you could talk about that. But then talk about things like, Can they cope with their annual repayments? When is the debt due?

·  a lot of the businesses will probably provide an overly detailed breakdown of that figure, you can say this debt balance is made up of 7 different loans. Here’s the interest rates, here's when they all expire. And can kind of say,  I can see this is how much they're gonna have to pay every year, maybe even look at it, compared to a cash flow and go, actually, they should be fine!

· Has it moved in the year? what was debt used for? (this is relevant if the debt has significantly moved) say if the amount is worth it!

Who is debt with? (relevant for convertibles loans) if it is a standard loan from a bank then not relevant to talk about.

When is debt due to be repaid? Look historically, do they have a history of repaying? Or just negotiating. Is it one-off repay or renegotiated

Are there any debt covenants? Is there any risk they’re in breach of any covenants and they would lose that finance?

Level of interest each year, how is the risk of the co. is there any breach?

It is affected by leases?

Add more depth on the analysis, by incl. Interest cover

DEBT LEVELS:

Interest cover = operating profit/finance cost (if lower, more worried)

How it is affected by new loans or higher Interest Rate

As an investor, the lower interest cover, more worried

Example of Gearing Analysis:

NON-CURRENT ASSETS (PPE):

Only talk about if there’s been a significant change, or it’s key to the business!

· Has there been a significant change in PPE?

· If there’s been an increase, what assets have been acquired in the year?

· If there’s been a decrease, what assets have they sold and why?

· Watch out for non-current assets held for sale – if these exist, look at post-year events to see if they’ve been sold to work out the cash received

Use your judgement

Talk is there is a significant change, or its key to business.

Has there been an increase, what assets have they

Example of Non-current Asset Analysis:

NON-CURRENT ASSETS (Intangibles):

Only talk about if there’s been a significant change, or if they are key to the business!

· What intangibles are there in the business?

· Goodwill

· Brand names

· Patents/Trademarks

· Development costs

· Has there been any significant increase/decrease during the year?

· Has there been an impairment review?

· Consider expenditure on R&D – some may be expensed in P&L (Research&Development), some may be capitalised in SFP (development costs)

· What does the project relate to?

· Has it been finished yet?

· Has it been finished after year-end?

· Example of Intangables Analysis:

WORKING CAPITAL:

Key ratios:

Current ratio = Current assets/Current liabilities (shown as X:1)

Shows how many current assets the company has for each $ of current liabilities

Quick ratio = Current assets – Inventory/Current liabilities (shown as X:1)

Similar to above, but excluding inventory. Shows how the company could cover liabilities in a much quicker timeframe. Also known as ‘Acid test’ ratio

Current ratio = Current assets/Current liabilities (shown as X:1)

Quick ratio = Current assets – Inventory/Current liabilities (shown as X:1)

Both made up of 3 or 4 items, so what is the major reason for the movement? Is it inventory/receivables/cash/payables?

· Whichever it is, explain the reason those have moved

· If cash, come back to it in the analysis of cash flow

WORKING CAPITAL: (INVENTORY)

· Inventory turnover period = Inventories/COS x 365 (shown as X days)

· Or: inventory turnover (no. of times), which is COS/Inventory

· (shown as X times, how many times inventory is sold across the year)

· As always, consider the movement year on year, and compared to competitor!

· Increase in inventory turnover period suggests it’s taking longer to sell inventory – find out why

Inventory turnover period = Inventories/COS x 365 (shown as X days)

Or: inventory turnover (no. of times), which is COS/Inventory

(shown as X times, how many times inventory is sold across the year)

· Lack of demand?

· High year-end balance (gearing up for sales push of new product)?

· Consider type of inventory. Is there a Risk of obsolescence? About to launch new products?

· Does it make sense with the rest of the story?

· Example of Analysis:

WORKING CAPITAL – Receivables

Receivables collection period:

Receivables/Credit sales (or revenue) x 365 (shown as X days)

Shows how long on average it takes to collect the cash from customers. As always, if not significant and not moved, don’t talk about it!

· Irrecoverable debts? Look at post year-end, any write-offs?

· Have there been issues over recoverability in the year?

· Are there new customers/new markets?

· Is there a major customer demanding new terms?

Example of Analysis:

WORKING CAPITAL – Payables:

Payables payment period:

Payables/Credit purchases (or COS) x 365 (shown as X days)

Shows how long on average it takes to pay suppliers. As always, if not significant and not moved, don’t talk about it!

· Is this due to poor cash flow? Look at cash balance!

· Has there been a change in supplier?

· Has there been a change in supplier terms?

WORKING CAPITAL CYCLE

Working capital cycle = Inventory days + Receivable days – Payable days

Shows how long you wait before cash to come in versus when you have to pay

Working capital cycle = Inventory days + Receivable days – Payable days

Shows how long you wait before cash to come in versus when you have to pay.

Example:

Inventory turnover period = 30 days

Receivables collection period = 30 days

Payables payment period = 20 days

Working capital cycle = Inventory days + Receivable days – Payable days

Example:

Inventory turnover period = 30 days

Receivables collection period = 30 days

Payables payment period = 20 days

Working capital cycle = 30 + 30 – 20 = 40 days

This means the entity has 40 days between paying for the goods and getting the cash in from selling the goods.

OTHER ITEMS - INVESTMENT:

Investments – Areas companies invest spare cash to earn income, but not subsidiaries (would be shown in goodwill)

· Have they invested in anything significant and new?

· Look for joint ventures/associates

· Other investments – small shareholdings or items like bonds

· Have they received interest/dividends (look at investment income)?

· May be held at fair value, so revalued each year – if significant rises or falls in fair value, investigate why

OTHER ITEMS – PROVISIONS:

· Look at any potential provisions in liabilities

· Also look at contingencies to see any possible liabilities

· Discuss the risk associated with them

· Look to see if settled post year-end

Example of Analysis:

OTHER ITEMS – Entity specific or usual items:

· Think about anything that’s unusual or unique to your business!

· Netflix – content assets

· Travel – large deferred income deposits

Example of Analysis:

OTHER ITEMS – Penson liability:

Pension liability – Arises if the company pension scheme is underfunded

· Shows that the company is liable to make up a shortfall in the pension fund for its employees

· Discussed in week 4 and will be mentioned in week 8

· If discussing in part (c) don’t spend long on this.

· Normally made up of large numbers of annual payments rather than 1 large payment being due in the future (although could be included in gearing)

· Don’t get too bogged down in the technical pension disclosures

· Has it moved significantly in the year? If so, why?