Financial analysis made easy (and quick!) — Transcript

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1. 0:00[Music]
2. 0:07hi uh I'm Jean for V evaluation um I've
3. 0:10been running finance courses all over
4. 0:12the world now uh for the last 20 years
5. 0:13or so and people often ask me Jean is
6. 0:16there a quick 30- second way of actually
7. 0:18assessing a business of course there
8. 0:20isn't so but what I'll propose to you is
9. 0:23a quick shortcut that that you might
10. 0:25find helpful and I think to position
11. 0:28this clip you have to appreciate
12. 0:30when we get to that stage we've gone
13. 0:32through the business we've assessed the
14. 0:34business we know what it's about we
15. 0:37understand the industry and there's also
16. 0:39an important caveat in the sense that
17. 0:41the business has not changed it's
18. 0:43selling roughly the same things to the
19. 0:45same kind of people and that's kind of
20. 0:46important so with that in mind we've
21. 0:49gone through the accounts unearth
22. 0:50nothing sort of horrific or spectacular
23. 0:53so with that in mind let's proceed so
24. 0:56what we have here is a basic income
25. 0:57statement of profit and loss of a
26. 0:59business
27. 1:01what you expect to see is revenue sales
28. 1:03going up to a level that you can
29. 1:07understand as your cost of goods or cost
30. 1:10of manufacturer or cost of services go
31. 1:12up typically if possible and our
32. 1:15preciate is not always possible but by
33. 1:18and large you put up the cost to your
34. 1:20clients so what that means is the gross
35. 1:22profit percentage or the gross profit
36. 1:25margin which is gross profit Express as
37. 1:27a percentage of Revenue year on year
38. 1:30doesn't change much okay change by very
39. 1:33very small man amounts being
40. 1:35mathematics likewise as all your
41. 1:37overheads go up at least by inflation
42. 1:40and sometimes more you pass it on to
43. 1:42your client through through your prices
44. 1:44so this means that like the gross profit
45. 1:47the operating profit margin likewise
46. 1:50doesn't change from year to year or not
47. 1:52by much and by that we mean operating
48. 1:55profit as a percentage of Revenue as a
49. 1:57percentage of sales
50. 2:00Finance cost or interest implies you've
51. 2:02borrowed some
52. 2:03money and uh we'll come with that in a
53. 2:05bit that gives you profit before tax and
54. 2:08then taxation well obviously all
55. 2:10countries vary in the taxation regime
56. 2:14but because tax is roughly the same
57. 2:16percentage every year and if your
58. 2:18borrowings haven't changed too much for
59. 2:20the same rationale as the above two The
60. 2:23Profit after tax or the net profit
61. 2:25percentage and again Express as a
62. 2:28percentage of Revenue typically would
63. 2:30not change by much every year unless
64. 2:32there had been some changes in the
65. 2:35business so we have a profit well good
66. 2:39bad well good or bad in respect of
67. 2:44what visualizing a balance sheet and of
68. 2:47course the real balance sheets are not
69. 2:49presented in this format this is for
70. 2:51purposes of illustration we have
71. 2:53shareholders funds which is what the
72. 2:55shareholders have put in plus profit
73. 2:57which they've kept back over the years
74. 3:00there could be long-term liabilities
75. 3:02long-term borrowings and there could be
76. 3:04others and there could also or there
77. 3:06more likely to be some current
78. 3:08liabilities uh small shortterm
79. 3:10borrowings trade suppliers things like
80. 3:12that that's basically where what funds a
81. 3:16business and those funds will be
82. 3:18reinvested in fixed assets property
83. 3:20computer equipment Airline for example
84. 3:23aircraft for an airline company and they
85. 3:25would also have inventories and similar
86. 3:27things if uh for for most businesses so
87. 3:32when we look at the profit we ask the
88. 3:34question well profit good or bad for
89. 3:37whom and I guess one of our starting
90. 3:39points has to be the owners the
91. 3:41shareholders so in the first instance
92. 3:43the shareholders are going to say this
93. 3:45is our Capital this is what belongs to
94. 3:48us and it's made up typically of two
95. 3:50tranches the share Capital which they
96. 3:53physically invested and profits which
97. 3:55the company possibly would have kept
98. 3:57back over the years so some sometimes
99. 4:00this is called net asset value sometimes
100. 4:02this is called total Equity so I divide
101. 4:05the profit of the tax BS to give me
102. 4:08what's called the return on Equity so
103. 4:10the owners take a view as to what return
104. 4:12they've had on their
105. 4:14business but then they further say hang
106. 4:16on a second here not only as a
107. 4:18shareholder you have my money you've
108. 4:20also borrowed money and that is just
109. 4:23another form of capital so let me judge
110. 4:26your performance on the total capital
111. 4:29that you have which is a combination of
112. 4:32the shareholders capital and monies that
113. 4:35you may have borrowed the there are
114. 4:37wider issues here but we're keeping it
115. 4:39simple for the time being and we call
116. 4:41this return on Capital employed which is
117. 4:43the profit on all the capital at the
118. 4:46disposal of the business and that gives
119. 4:48you a inkling as to how well the company
120. 4:51is actually using its
121. 4:53capital so you've borrowed money how
122. 4:57much well how much Vis A what and one
123. 5:01expression of debt is what we call
124. 5:03gearing or financial leverage we compare
125. 5:06the total debt against the equity of the
126. 5:09company meaning how much have you the
127. 5:11owners put in and how much have you
128. 5:13borrowed we call this
129. 5:15gearing now there's no magic figure here
130. 5:20I think what matters is do we understand
131. 5:23why that business is borrowing can we
132. 5:26validate the presence of borrowings in
133. 5:28that business and unless you've had a
134. 5:31major acquisition a restructure
135. 5:33something extraordinary typically
136. 5:35businesses borrow for three main reasons
137. 5:38one is there a loss if there's a loss it
138. 5:42implies very simply expenses bigger than
139. 5:45Revenue someone has to fund that or
140. 5:48capital expenditure capital expenditure
141. 5:51meaning we need to replace fixed assets
142. 5:54and therefore we ask the questions what
143. 5:57have you bought why have you bought but
144. 5:59also how well you are using those assets
145. 6:03and one measurement there are a few
146. 6:05others we call return on assets which
147. 6:08which means just that which is profit
148. 6:11divided by total asset how well are you
149. 6:14utilizing the assets of the
150. 6:16business another question we would also
151. 6:19ask which would possibly necessitate
152. 6:21borrowings is what we call working
153. 6:23capital let's say we're dealing with a
154. 6:25buy and sell business it's probably
155. 6:27easier to visualize uh abama Stocker and
156. 6:30my inventories today and my stock and my
157. 6:32inventories sit on my shelves for about
158. 6:3530 days uh I make a sale and I give my
159. 6:38debtors my trade payables 30 days to pay
160. 6:40me I'm out of cash for 60 days from the
161. 6:44time I made the purchase to the time I
162. 6:46physically get cash from my client my
163. 6:48suppliers will come in they might give
164. 6:50me 30-day credit or 40-day credit but
165. 6:53for most businesses it creates an
166. 6:56imbalance I amount of cash for about 60
167. 6:59but I'm getting finan for about say 20
168. 7:0125 or 30 I have what's called a working
169. 7:04capital Gap and this would require
170. 7:07funding as well so we've established the
171. 7:10presence of borrowings I understand why
172. 7:12you borrowed and I guess the next
173. 7:14question we have to ask ourselves is can
174. 7:16this business afford those borrowings
175. 7:19now there are two there are a number of
176. 7:21ways of looking at
177. 7:23this going back to the profit and loss
178. 7:25income statement I have to pay the bank
179. 7:28interest or Finance cost how many times
180. 7:31is that covered by The Profit at least
181. 7:34is my interest safe on that level of
182. 7:37performance for the year that's one way
183. 7:40of looking at it a better way would be
184. 7:43to look at the cash flow of the business
185. 7:46essentially we are saying let me look at
186. 7:48all the cash in during a year and all
187. 7:51the cash out during the year what is it
188. 7:53driving cash what is absorbing cash and
189. 7:56hopefully in is bigger than out and if
190. 8:00not why and why are you funding yourself
191. 8:03because it is cash flow that repays debt
192. 8:06absolutely nothing else and we call this
193. 8:08liquidity and the cash flow of the
194. 8:11business not only will support that the
195. 8:14debt is capable of being supported but
196. 8:17also gives you a strong understanding of
197. 8:20the overall cash position of a
198. 8:22business so so in summary if you were to
199. 8:26write a financial report on a business
200. 8:28you might find the following struction
201. 8:29template very very helpful and we've
202. 8:31seen those themes already in this very
203. 8:33very short clip growth is the company
204. 8:36growing increase in Revenue how has the
205. 8:38company increased is that growth
206. 8:40sustainable can they keep growing like
207. 8:42that profitability is the company
208. 8:44profitable and we measure those in the
209. 8:47first instance of our margins we looked
210. 8:49at gross profit margin we looked at
211. 8:51operating profit margin we looked at net
212. 8:53profit margin and we concurred year on
213. 8:56year they shouldn't change by much so
214. 8:58that's one aspect the margins of
215. 9:01profitability the second aspect is that
216. 9:03profit is good for whom and viav what
217. 9:06well one first question is for the
218. 9:08shareholders to ask how well are you
219. 9:10making a capital work we call this
220. 9:13return on equity which is profit divided
221. 9:15by shareholders funds the shareholders
222. 9:17asking a very valid question are you
223. 9:19making a decent enough return on our
224. 9:21investment but then a second question is
225. 9:23posed in that he he here not only you
226. 9:26have our Capital you've also borrowed
227. 9:28money chances of
228. 9:30so I will judge your profit performance
229. 9:32on all the capital at your disposal and
230. 9:34we call this return on Capital employed
231. 9:37which is combination of what we've put
232. 9:39in I Equity plus debt what you may have
233. 9:42borrowed and we call this return again
234. 9:44on on on Capital employed so
235. 9:46profitability has two strengths margins
236. 9:50and utilization of capital of
237. 9:52shareholders and all providers of
238. 9:54capital which will be dead people so
239. 9:57company has borrowed money why could it
240. 10:00have borrowed money well one area we
241. 10:03call efficiency I chances are it's
242. 10:05invested in fixed assets it's invested
243. 10:08in assets how well are you utilizing the
244. 10:10assets at your disposal and one
245. 10:13measurement is return on assets the
246. 10:15second line of inquiry is appropo
247. 10:17working capital which we've seen already
248. 10:20is there a working capital Gap and if
249. 10:22there is is it satisfactory and does it
250. 10:24need to be financed and those those
251. 10:26those two lines of inquiry talk to us
252. 10:29about
253. 10:30efficiency so there has been borrowing
254. 10:32well this is what we refer to as
255. 10:34solvency how much have you borrowed no
256. 10:37magic figure we call this gearing or
257. 10:40sometimes financial leverage uh why have
258. 10:43we borrowed explained by a loss and or
259. 10:47working capital and or acquisition of
260. 10:50fixed assets or assets capital
261. 10:52expenditure and we have and we seek to
262. 10:55understand the presence of these
263. 10:56borrowings next key question can the
264. 10:59company afford these borrowings only
265. 11:01cash flow will tell us that and this is
266. 11:04where liquidity comes in where we look
267. 11:06at the entire cash performance over a
268. 11:08year and we look put very simply at cash
269. 11:11in and cash out and hopefully cash in
270. 11:13should be bigger than cash out if not
271. 11:16why not and how is the company actually
272. 11:18funding it its business on a
273. 11:20year-by-year
274. 11:21basis and finally you may be looking at
275. 11:24that business as an investor and the
276. 11:26last key point I guess is investment
277. 11:28attractiveness IE is that company worth
278. 11:31investing in given all the parameters
279. 11:33that you've just seen a VOA doesn't take
280. 11:36long does it
281. 11:38[Music]