by Chris Crabtree
The first thing that needs to be in place is an understanding of how to read your financial statements and how the statements compare to industry benchmarks.
To determine strength, I start with the balance sheet. I first want to know how leveraged the company is. The financial leverage of a company is the proportion of debt in the capital structure of a company as opposed to equity. Then I look at current assets versus current liabilities (current ratio), which is a liquidity ratio that measures the company’s ability to pay short-term obligations. The optimal measure depends on the type of business, but certainly lower leverage for the industry type is an indicator of strong financial condition and current ratios where current assets exceed current liabilities, thus a ratio greater than one.
When I turn my attention to the income statement I want to see that the company consistently generates cash flows that exceed debt obligations, year after year. Then I look for year over year trends in revenues, net income, cost of goods sold and expenses. Consistent revenue growth, steady expense category percentages as compared to revenue and consistent positive net income percentages as compared to revenue, are all signs that the company’s financial position is strong.
Answers provided by Chris Crabtree, Senior Vice President, Commercial Banking at Simmons Bank. He can be reached at 314-854-4516 or chris.crabtree@simmonsbank.com. The views and opinions expressed in this article are those of Chris Crabtree and are not endorsed by, and do not necessarily reflect the views of, Simmons Bank. Simmons Bank does not provide tax, accounting, or legal advice.
Submitted 2 years 85 days ago