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WE HAVE WAYS TO MAKE MONEY TALK
A. ACCOUNTANCY
1. Whether you are buying or selling a business, you must familiarize yourself with
the basic financial concepts involved with evaluating a company.
2. The period of time during which income is obtained and expenses are accrued is referred
to as the company’s accounting period and are usually monthly, every 3 months (quarterly)
or yearly (annually).
3. Businesses operate on credit, money owed by the company to the vendor is called a payable
and money owed to the company by a client is called a receivable. Cash basis accounting is
therefore not sufficient as it does not include credit, instead revenue is defined as cash
received and expense as being when a cheque or cash is given for item or service. Limited
companies employ accrual accounting in which the company has receivable money coming in and
expense payable money going out.
4. Every financial discussion relating to a company should start with a financial statement.
5. which presents an overall, picture of company’s general financial health.
6. A financial balance sheet shows the financial status of a company on a particular day,
usually at the end of the fiscal period.
7. (Need a sample balance sheet).
8. The relationship between assets liabilities and net worth is:-
Assets = Liabilities + Owners Equity (Net Worth)
9. An income statement provides a standardized way of tracking income and expenses.
10. The income statement can be affected by changes in company operations, as
described below:-
- Increasing sales increases revenues. If
the cost of sales and fixed expenses remain the same, the company
will show an increase in net income.
- Decreasing the cost of sales, through the
addition of equipment or techniques that increase production
efficiency while keeping sales and fixed expenses constant,
increase net income.
- Decreasing fixed expenses while keeping everything else constant increases net income since none of
the gross margin is left over after fixed expenses are deducted.
11. Always read the fine print and study any extraordinary expense or income items shown on the
financial statements.
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B. COMPANY RATIO ANALYSIS
1. If you are buying or selling a company it is beneficial for you and a potential seller or buyer to
carry out a ratio analysis of a company to ascertain the companies attractiveness.
2. Debt analysis is important as it allows you to determine how much debt is too mush to prevent company collapse.
3. Firstly determine if the company has enough income to cover the interest due on its loans. This is known
as the coverage ratio and is the earnings before income tax divided by the total interest
paid on the debt:-
CR =
EBIT /TID
4. secondly, determine the debt-equity ratio. This provides a relationship between the amount of debt held by a company and
its total owners equity. It is useful to compare this ratio with other firms in the same SIC.
5. It is important to realize that you will have to add cash to the company after a purchase, especially if the company does
not always make enough cash to sustain its operations by itself. Two common ratios used for cash assessment are the Current
Ratio and the Quick Ratio, also called the Acid Test.
6. The Current Ratio analysis compares the amount of money owed within a 12 month period to the total assets that are assumed
to be convertible into cash within the 12 month period. The larger the ratio, the better off is the company with respect to
sustaining itself on a short-term loan. Well run businesses have values of 2 or higher.
7. The Quick Ratio calculation provides a means of ascertaining the ready cash available to a company. The Quick Ratio
is given by the following formula:-
( Current Assets – Inventory - Prepaid Expenses)/ Current Liabilities
8. Performing a Quick Ratio Analysis over a period of time that extends back say 2 years provides a trend of the companies cash
position. If the trend is upward you might be in clear water, if downwards there maybe hidden problems
from a cash flow standpoint.
9. To determine the overall performance of a companies credit collection performance carry out an Average
Collection Period calculation:-
Average Collection Period = Accounts Receivable/(Sales/365 days)
10. The ratio result of this calculation is an estimate of how long it takes to collect money
from credit customers.
11. Another important ratio to calculate if you are a buyer or seller of a manufacturing company is the Inventory Turnover Ratio,
a value above 4 indicates that the company turns over its inventory efficiently.
Inventory Turnover = Cost of Goods Sold/ Inventory Cost
12. The net profit margin provides an effective way of determining the profitability of a company with
respect to other companies.
Net Profit Margin =
Net Income After Tax/ Net Sales
13. Calculating the percentage of sales revenue that is spent on sales and marketing
activities tells you if the company is under or over spending its sales and marketing
dollars.
14. Marketing Percentage Costs = Total Sales and Marketing Costs/ Total Sales
15. No simple ratio determines the companies financial condition although it can indicate areas in need of further investigation.
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C. TAX IMPLICATIONS
1. Manage your company so that it remains financially sound and only then optimize for tax reductions.
2. If you are selling a business it is important to minimize the amount of tax you pay on
the sale price of the business.
3. Make sure that enough cash is secured from the sale to pay any taxes that will be assessed.
4. Work to classify as much of the income from the sale as capital gains so that it qualifies for more favorable tax treatment.
5. Whenever possible avoid double taxation, where income is taxed at both the corporate and the personal level.
6. Buyers usually want to structure a deal so they maximize the income (reporting) by their.
7. company as shown on the financial statements.
8. Sellers want to structure deals so that as much as possible of the sale price is taxed at capital gain rates.
9. Purchases that involve the transfer of stock from the buyer to the seller might be free if transferred in compliance with the
Inland Revenue Code Section 368 rules. 3 types of transactions, A, B and C have their own requirements to ensure that the
transfer is tax free, although this needs to be verified with your tax professional.
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