An annual account is hard to read for most of us. Even Finance Managers can occasionally experience difficulties when searching for specific details. Furthermore, sales departments may expect to receive some advice on the creditworthiness of new prospects. So how do you make a decision on the nature of these prospects? In order to swiftly get a snapshot of a company's financial position, you only have to check for a few key figures.
With these key figures in mind, you can check:
Working capital consists of current assets, including stocks, and excluding current liabilities. When the working capital is a negative number, the company has less cash to pay you. A ratio that works well here, is the quick ratio. A quick ratio is calculated by the sum of current assets minus the conditions, divided by the current liabilities. This should give you an indication of the relationship between debt and equity. If the ratio below 1, then be vigilant. It may still be a promising customer, but you are at risk of bad payments.
Cash flow is very important. Cash flow is all incoming and outgoing money in the organisation. Is the company able to make money, or does it need added money annually? Of course, there are valid reasons to have a negative cashflow, for example a fast growing company, a company in the innovation phase, or a company which has just received a few large investments. However, if this situation takes too long, a company can go bankrupt. Make sure you can explain all negative cash flows. A healthy company should have more income than expenses.
The balance sheet gives you insight into the liquidity and solvency of the company. How much equity has the business, what is the ratio of debt / equity and how much money does a company have outstanding with their customers (debtors)?
On the profit and loss account, you can see the company's profitability. Be aware that both gains and losses on paper are still no real profit. The money must actually enter the company before marked as profit. As written before:
"Profit is a matter of opinion, cash is a matter of fact."
Are you dealing with a larger or public company? Then you can check the annual account as well. Comment from the CEO or owner often give you a nice glimpse into the company itself and show how the company sees the market which type operate in. Next to this, it is just interesting to read.