Haaaaaatschi 🤧 - Financial health in theory and practice 💸💸💸
Hi folks,
it continues in the program! And this time it will be about the financial health of a company. When is a company financially healthy? What figures can I use to determine this and where can I find them in the balance sheet and income statement? Which key figures result from this and how do I interpret them?
As if this were not enough dry theory, I will give you the practical example with $AUTO from my last article and original excerpts from their financial statement.
The article is definitely written in a beginner-friendly way, with a focus on the context of things.
Rightly you are now falling out in jubilation. From my last posts have always, in subsequent discussion round in the comments, many new food for thought, which then made it a few days later itself again in a post, which in turn has provided in the comments for new food for thought, which in turn ... You know what I mean.
The last post was my company introduction to the Norwegian warehouse technology specialist AutoStore. You can read it again here: https://app.getquin.com/activity/hkCUVRxQHh?lang=de&utm_source=sharing
Admittedly, you could argue that it was more of an introduction to the product than the company. @BASS-T I commented logically that I should go into more detail about the balance sheet and figures.
@RealMichaelScott gave additional impulses with his important key figures.
Thanks for this and all the other comments 🙏.
What have I done with it now? Well, sat down, learned to read the balance sheet and P&L and wrote this article as a final exam 🚀
Yesterday the master himself @TheAccountant89 put together a post on reading and understanding balance sheets, P&L and income statements. If you haven't already, be sure to read, like and leave a ccf! It's worth it!
Before it really starts at this point again the note that I have until a few weeks ago with P&L professionally still thought of "weight and volume check" and not "income statement" 😅 If gross blunders have crept in or I have something despite careful research and my opinion that I understood it, misrepresent, so please point it out to me, I will then correct it.
What do you expect?
Healthy is,
I. who is not ill
II. who can pay a lot himself (equity ratio)
III. who can pay off loans flexibly from own account (gearing)
IV. who can pay off loans through current income (dyn. debt ratio)
V. who plans correctly when spending money (goodwill ratio and depreciation)
I. Healthy is the one who is not sick
From a biomedical point of view, health is defined as the absence of disease. Clearly, if one leaves out the psychological, mental and social health of a person, what remains is physical health limited purely to functionality. Since one rarely finds mental and social aspects in profit-oriented companies, especially with regard to their finances and how they deal with them, we want to use the same definition of health to research the well-being of our company under consideration.
So: Is our patient dying? Does he only need a few (financial) injections? Or can he claim to be in top shape? Let's try to find out on the basis of the following key figures.
The whole thing happens in 3 steps per key figure. First, I will tell you a little bit about the theory, so to speak an introduction to the key figure under consideration. Why is it needed, what does it say and how is it calculated? For the formulas I mainly used Nicolas Schmidlin's book Business Valuation and Ratio Analysis oriented. I give it below as a source, but it served primarily to get an overview in the first place. Because I really wanted to understand every written word, I also did a lot of research on the internet. I will not reproduce or type anything one-to-one from the book here, but will reproduce my own words.
As a result, I have created a reusable Excel list from the chapters of the book, in which I only have to enter the values from the balance sheet and P&L, and which then calculates the most important key figures for my financial health.
Let's go.
II. equity ratio
Theory
The overview of a company's capital structure gives a first and, above all, quick insight into how the company finances its assets.
While on the assets side of a balance sheet we have all the assets of a company listed, on the liabilities side, we get all the necessary information about where the money for those assets comes from.
The company's capital is fundamentally divided into equity and debt. Equity, which is also known as book value or equity, comes mainly from the shares issued by the company.
The debt capital can be bank loans or issued corporate bonds.
The more equity a company has, the better it can pay off debts, make investments and cover costs.
This is why we investors strive to invest in companies with a high equity ratio, i.e. the proportion of equity in total assets, as this allows us to virtually rule out major liquidity bottlenecks and to know that our company under consideration can also be better maneuvered through times of crisis.
Practice
To calculate the equity ratio, we need once the values for the equity and the balance sheet totalwhich corresponds to total assets. Figure 1 shows AutoStore's "Statement of financial position" from Q3/2022, in which the following values are highlighted total equity for equity and Total Assets for the balance sheet total/total assets. We insert the values into the formula and calculate AutoStore's equity ratio.
(Equity / Total Assets) = Equity Ratio
(1.195,2 / 1.831,7) = 0,65 * 100 = 65%
Opinion
With an equity ratio of 65%, AutoStore is doing quite well. We can see from this ratio that AutoStore can act relatively independently when it comes to investing in the future. We have a reduced risk of insolvency and run less risk of running into over-indebtedness in the near future. However, the analysis of other key figures in the following points shows us that the equity ratio is only an initial assessment based on two values.
II Gearing
Theory
If the company borrows from banks, the loans are included in the balance sheet under interest-bearing liabilities or simply Financial liabilities. Liabilities are all obligations of a company to third parties. So if we have financial liabilities, it is nothing more than: Debt. And debts of course play a major role when considering financial health. We have already been able to determine the amount of debt indirectly via the equity ratio. Now it's a matter of how flexibly the company can pay off its debts. To pay off debt, the company can first fall back on its existing cash holdings. This is all the money that the company can loosen up in the short term and is generalized as follows liquid funds called. Now the gearing would like to try to clarify how the company can pay off the remaining debts with the help of its equity.
Practice
First, we need all the financial liabilities from the balance sheet. Figure 2 has all of these highlighted in blue. In the case of AutoStore, this includes the Non-current interest bearing liabilities (long-term interest-bearing liabilities), Non-current lease liabilities (long-term lease liabilities), interest-bearing liabilities (short-term) and lease liabilities (short-term).
In total, this amounts to USD 421.2 million.
We can now deduct from this the cash and cash equivalents (cash and cash equivalents). We have already read out the shareholders' equity in section I.
(financial liabilities - cash and cash equivalents) / equity = gearing
(421,2 - 147,2) / 1195,2 = 0,2292 * 100 = 22,92%
Opinion
In general, the lower the gearing, the lower the company's debt. According to [1], 10% - 20% is considered ideal. A company would be debt-free if it had more liquid assets than financial liabilities. With a gearing of 22% and an equity ratio of 65%, AutoStore's debt is low for the time being. If the company had to repay its debt in one fell swoop tomorrow, it would still be able to operate thanks to high cash reserves and equity. In my opinion, this is a solid outlook for the coming quarters.
III. dynamic leverage ratio
Theory
Let's imagine we have to pay off a loan to the bank and do so from our savings in our account. The whole thing would only make sense if, on the one hand, we are not completely broke afterwards and, on the other hand, we generate further income so that we can still afford something and continue to build up assets even after all debts have been repaid.
So what does that mean? Even if a company has low gearing, this ratio should also be considered in relation to the free cash flow. free cash flow of the company.
The free cash flow is the result of the operating cash flow minus the cash flow from investing activitiesboth of which can be read from the income statement. If the free cash flow is positive, the company has generated profits and increased its assets in the period under review. If the free cash flow is negative, the company is making losses.
It is therefore interesting for us investors to find out whether a company can repay its debts solely through profits generated and whether the low level of debt determined by gearing is confirmed when cash flow is taken into account.
The result of the calculation that follows immediately is the duration in years that the company would need if it were to use its entire free cash flow to repay its debt.
In addition, the dyn. debt-equity ratio can be an indicator for future capital increases. If the profit is constantly positive and can be used to repay debt, a capital increase in equity would thus become less likely.
Practice
We already know the financial liabilities and liquid funds, we now have to calculate the free cash flow to be determined. Sometimes it is listed directly, sometimes we have to calculate it. In the case of AutoStore, we need the Net cash flows from operating activities (operating cash flow) and the Net cash flows from investing activities (cash flows from investing activities) from the income statement in Fig. 3, which we subtract from each other.
(financial liabilities - cash and cash equivalents) / free cash flow = dyn. debt-equity ratio
(421,2 - 147,2) / 39,9 = 6,86
Opinion
At almost even 7 years, AutoStore's dynamic debt ratio is quite high, even critical according to Schmidlin. It would take 7 years to pay off the debt while profits remain the same. As a reminder, AutoStore has been profitable for the first time in 2022. The decisive factor will be the curve in which direction this ratio develops. Therefore, the dyn. leverage ratio is an important key figure for the next quarterly figures and the annual report coming soon, whether the positive development is confirmed. If profitability and free cash flow increase, the debt-equity ratio would decrease.
IV. Goodwill share and amortization
Theory
When it comes to financial stability, we naturally look mainly at the current situation, simply by counting on the figures for the past fiscal year or quarter. But there are also indications of what the financial health will be like in the future. One of them is to look at the goodwill written off in relation to equity.
What was goodwill again? If we buy up a company, we hope to achieve synergy effects, true to the motto that we can do more together than we can alone. However, since these synergy effects cannot be quantified by adding up pure assets, they appear in the balance sheet as a special item, goodwill.
Goodwill is therefore an amount that our company was willing to pay on top of the actual purchase price of the company we want to acquire.
The goodwill itself is not yet the problem, it could only become a problem if it turns out that the desired synergy effects do not materialize or do not materialize in the hoped-for form. What happens if this is the case? Then the goodwill has to be reduced, i.e. written off, which means that this sudden hole in the cash register has to be financed, and from what? Correct, the profit of the company, which we as investors definitely do not want.
That's why you read more often about a ticking time bomb of goodwill, because it simply represents a risk for investors, as profits could be diminished in the future.
Because goodwill itself has little significance as a pure figure, it is put in relation to equity. The question to be answered is to what extent possible write-downs are covered by equity. The lower the result here, the better.
Practice
The Goodwill can be found directly written out in the balance sheet. We already know the equity.
Goodwill / equity = goodwill share
996,2 / 1.195,2 = 0,8335 * 100 = 83,35%
Opinion
The goodwill ratio at AutoStore, there is no other way to put it, is definitely too high and not healthy. The only way the company can get down from 83% is to write off goodwill or to increase its equity, e.g. by issuing new shares. Both would be clearly negative from a shareholder perspective.
Conclusion - Financial Health AutoStore
Looking at today's situation, more precisely the situation in Q3/2022, AutoStore is in a good position at first sight. The equity ratio gives the company enough room to pay off debts and invest in the future, but the gearing in connection with the dynamic gearing ratio already gives us reason to believe that in the future it will be important to take a closer look at these values. The goodwill share is too high and to keep my personal risk-return ratio, as much as I like the product, AutoStore does not get beyond a smaller position in my portfolio.
On February 16, we'll have the Q4 numbers and thus the full year 2022. Thanks to our exposure to the balance sheet and cash flow, we now know what to look for, can draw a curve and make an investment decision based on that.
So it remains exciting.
Finally, I would like to know from anyone who has more of a clue than I do, if you would come to the same conclusion based on the numbers mentioned.
Thank you for reading ❤
Sources:
[1] Book: company introduction and ratio analysis - Nicolas Schmidlin. ISBN: 978-3800645640
#bilanzen
#guv
#financials
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#aktienanalyse
