Researching the financial performance of a company is an essential task for entrepreneurs, investors, stakeholders, and financial analysts.
It provides valuable insights into a company’s stability, growth prospects, and overall health. Whether you’re considering an investment, evaluating potential business partners, or simply seeking a better understanding of a company’s financial status, mastering the art of financial research is crucial.
In this latest Covering the Bases post, we seek to provide a guide on how to best research the financial performance of a company.
UNDERSTANDING FINANCIAL STATEMENTS
To begin any kind financial research, it is absolutely vital to first understand the three primary financial statements:
- Income Statement: This report summarises a company’s revenues, expenses, and profitability over a specific period, typically a quarter or year.
- Balance Sheet: This statement provides a snapshot of a company’s financial position, displaying its assets, liabilities, and equity at a given moment.
- Cash Flow Statement: It details the inflow and outflow of cash during a particular period, categorised into operating, investing, and financing activities.
These three financial statements can be thought of as the fundamental building blocks of financial analysis, as they offer a comprehensive view of a company’s financial performance.
REVIEWING FINANCIAL RATIOS
Financial ratios are powerful tools for assessing a company’s performance. Some key ratios to examine include:
- Profitability Ratios: These ratios evaluate a company’s ability to generate profit, including metrics like net profit margin and return on equity (ROE).
- Liquidity Ratios: These ratios assess a company’s short-term financial health and its ability to meet its immediate obligations. Key ratios include the current ratio and the quick ratio.
- Leverage Ratios: These ratios gauge a company’s debt levels and financial risk. The debt-to-equity ratio and interest coverage ratio are examples.
- Efficiency Ratios: These ratios measure how well a company utilises its assets and resources. Common ratios include the inventory turnover ratio and asset turnover ratio.
COMPARATIVE ANALYSIS
Comparing a company’s financial performance with its competitors or industry averages is invaluable. This analysis can reveal strengths and weaknesses and help identify areas for improvement.
Additionally, historical data analysis allows you to track a company’s progress and trends over time.
MD&A
Publicly traded companies are required to include a Management Discussion and Analysis section in their annual reports. This section offers insights from the company’s management about its financial performance, challenges, and future plans.
Analysing this commentary can provide a deeper understanding of the company’s strategies and potential risks.
AUDITING FINANCIAL STATEMENTS
Ensure that the company’s financial statements are audited by a reputable accounting firm. Audited financials offer a level of credibility and assurance that the numbers are accurate and have been scrutinised by professionals.
If the financials have not been audited then you cannot assume that they are 100 per cent accurate.
NEWS AND EVENT ANALYSIS
Stay informed about recent news, events, and announcements related to the company. Major news, such as lawsuits, product recalls, or significant management changes, can have a substantial impact on a company’s financial health.
EARNINGS CALLS AND OTHER INVESTOR PRESENTATIONS
Listen to or read transcripts of a company’s earnings calls and investor presentations. These events often provide important insights into a company’s performance, strategies, and outlook, as well as the opportunity to hear directly from its leadership.
INDUSTRY AND ECONOMIC ANALYSIS
Consider the broader economic and industry context in which the company operates. Economic conditions and industry trends can influence a company’s performance significantly. Understanding these factors will help you assess the company’s financial performance more accurately.
CASH FLOW ANALYSIS
Don’t underestimate the importance of the cash flow statement. It offers a clear picture of how a company manages its cash resources. Analyse the operating, investing, and financing activities to understand the sources and uses of cash.
It is worth remembering that a company might appear profitable on the income statement but could face cash flow issues if cash isn’t managed effectively. This is especially true for start-ups and/or businesses requiring high levels of expenditure.
DEBT AND CREDIT RATINGS
Examine a company’s debt profile and credit ratings. A high level of debt or poor credit ratings can indicate financial stress. Credit rating agencies like Moody’s, Standard & Poor’s, and Fitch provide credit ratings that reflect a company’s creditworthiness.
DIVIDEND HISTORY
If you’re an income-oriented investor, studying a company’s dividend history is crucial. Consistent dividend payments and a history of dividend increases can indicate financial stability and a commitment to returning value to shareholders.
GROWTH PROSPECTS AND LONG-TERM VIABILITY
Assess the company’s growth prospects and long-term viability. Look at its competitive advantages, market share, and innovation efforts. Consider factors like industry disruption, technological advancements, and changes in consumer preferences that could impact the company’s future.
RISK ASSESSMENT
Evaluate the risks associated with the company. These can range from operational risks, such as supply chain disruptions, to financial risks, such as currency exchange rate fluctuations. Diversify your research sources, including annual reports, industry reports, and independent analyses, to build a comprehensive risk profile.
To help with this, our Premium members have access to more than 10,000 company and industry reports designed to help you better understand the competitive landscape. These reports are each approximately 5,000 words in length.
For more in-depth (20,000 word) analysis on these same companies, a PFD version report can be purchased from our report store.
COMPLIANCE AND GOVERNANCE
Scrutinise the company’s adherence to the various (and often shifting) regulatory requirements and corporate governance practices. Violations or governance issues can harm the company’s reputation and financial stability.
QUALITY OF MANAGEMENT
Assess the quality and track record of the company’s management team. Competent leadership is essential for executing strategies and navigating challenges effectively.
By understanding the financial statements, reviewing key ratios, and considering external factors like industry trends and economic conditions, you can gain valuable insights into a company’s financial health.
Remember that continuous monitoring and staying informed about the latest developments are essential for making well-informed investment decisions or assessing business partnerships.
Financial research is an ongoing journey that can lead to informed, confident decisions in the world of finance.