Working Capital Management, Cash Flow, & Accruals Analysis
How do you define value?
The answer probably depends on your occupation or how you play; (investor, owner, manager, banker, etc.) Do you use financial statements to evaluate a company's performance and draw your own conclusions? So, how do you define value?
I think people use intrinsic value to meet their own needs. How we go about finding value is very relative to who we are, what we do for a living, and what we believe is important. I want to share with you a way to look at a company's financial statements to uncover common areas that could classify as misrepresentation. But first, the public companies we invest in are required to submit financial data and information to the public in CPA format. Systematically defined and qualified under US GAAP guidelines. Even with these rules, and even more rules, and bureaucratic overload, the scandals and catastrophes continue and always will.
Our goal is to find out what the company is really doing under all of the accruals, deferrals, off-balance sheet shit, and hedging. We want to find the quality of earnings, find out how consistent the revenue is, how much cash is collected, and the bigger the company - the harder to sift through affiliates and SPE's to get the complete story. Quite often, a company does what is necessary to stay afloat in the eyes of the market, right or wrong, revenue and profit margins are king and short-term results dominate.
When we see companies re-state earnings more than once, we should investigate. Look closely. Look for comments that indicate an adjustment to a previous report or an error that created a material difference in the report.
Recently the blog Grumpy Old Accountants by Dr. Catanach, a professor in the School of Business at Villanova University, caught my attention. Check out his bio, history, and current work. He drills down and shows how specific companies report these incidents. Exception: He doesn't think they are just 'incidents'.
A good analyst should be able to breakdown a company's financial statements into values relative to the current economic environment. If a company has unearned revenue, the fact that the company has not received payment should be clear in the financials. Often the analysis pivots on what is real and what is reported to be real. Many banks and investment firms have the same purpose in their analysis and that is to assess the value of a business if it were going to be bought, sold, or liquidated.
I have a few worksheets that help highlight areas of interest where a deeper look may lead to further insight. But first, three very relevant questions for you to consider:
What type of business is being assessed?
What is the purpose for the analysis?
Do we have the proper data for an analysis?
The areas to be examined and uncovered depend on the type of business and the purpose for the analysis. It is important to use the appropriate numbers for an accurate analysis. The sheets are fairly straight forward regarding the inputs, but if you should have a question please ask.
