Many people gamble their savings away under the disguise of making investment decisions. When we invest in the stock market, reallocation of funds occurs with the impatient losing their resources. However, beyond the attitude of patience, we need to make sound decisions based on high-quality business analysis. The question is – how do we analyze a company? How do we tell the viability of a company? Would I make a dividend on my investment?
While seated in the bus going through Lagos traffic, I logged in for my session and connected with corporate financial accounting. We looked at five crucial ratios to keep watch. First, activity ratios – it shows the efficiency of the firm’s operations and the firm’s management of assets? Do they have optimum capacity utilization? Second, the liquidity ratio – this is how well the firm is positioned to meet its short-term obligations? Are the available assets sufficient to support the current liabilities? Third, solvency ratio – how well is the firm situated to meet its long-term commitments? Can the owners’ equity support the long-term liabilities of the company? Fourth, profitability ratios – how and how much is the firm achieving its investment? Finally, valuation ratios – how the firm’s performance and financial position are related to its market value.
Knowing this, how can we analyze businesses and make rock-solid decisions? We can achieve this through horizontal, vertical, common-size statements, trend percentages, and ratio analysis. Horizontal analysis connotes comparing performance across different years. For instance, fixed assets in 2022 against 2021. Vertical analysis engages a component of performance against the whole set – for example, the ratio of fixed assets against a total asset in 2022 as against the same in 2021. Common size statement involves making analysis strictly in percentage points and not in fiat value. Trend percentages show changes in performance over a while. For example, the growth trend of sales from 2012 to 2022. Finally, ratio analysis is an expression of logical relationships between items in a financial statement of a single period. For instance, the percentage relationship between profit and total sales.
Now, seeing the key ratios to look out for and the various analysis to be done, we can boldly approach the financial statement of our desired company with confidence. We can pick up the financial statements of a company and in five to ten minutes confirm the strength or weakness of the balance sheet and the solvency or liquidity state of the company. However, beyond telling the state of these companies, we can understand why the company is in its current state, and with this, we can make moves to restore a seemingly dying company.
In conclusion, a clear understanding of the problem is plausible; however, we must fix the underlying issue causing the problem. Managers are not mere book-keepers and as a doctor diagnoses a patient, we should be able to diagnose a company from the entries on the statement of financial accounts and with our problem-solving skills accurately solve the problem. Going forward, when the annual financial reports are released, do not ignore them, pick them and as you read, see the company through the numbers.
Light, Love, and Life
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PERFORMANCE APPRAISAL