Dollars and Sense: Balance sheet holds investment answers
By Barrett Cummings / Guest Columnist
As an investor, your main goal is to maximize the return on your investment. How do you know what companies to invest in to meet this objective?
The first step is to obtain a copy of the organization’s financial statements. Financial statements can be found on most company Web sites or by calling the company’s headquarters and requesting a copy of the annual report.
Next, become familiar with the type of information that appears on each financial statement. Then, analysis, using solvency and profitability measures, is required to ensure that your money meets the expected rate of return.
Solvency analysis measures the ability of a business to meet its financial obligations.
Common solvency calculations include working capital, current ratio, acid-test ratio and ratio of liabilities to stockholders’ equity.
Working capital is useful in evaluating a company’s ability to meet currently maturing debt. A more reliable indicator of solvency is the current ratio. The acid-test ratio measures the instant debt paying ability of a company. The ratio of liabilities to stockholders’ equity indicates the margin of safety for creditors and the ability of a business to withstand adverse business conditions. The numbers to calculate the above solvency measures can be found on the company’s balance sheet.
Profitability analysis focuses on the relationship between operating results as reported in the income statement and resources available as reported in the balance sheet. Common profitability calculations include rate earned on total assets, rate earned on common stockholder’s equity, and price earnings ratio.
The rate earned on total assets (ROA) measures the profitability of total assets without considering how the assets are financed. The rate earned on common stockholder’s equity (ROE) focuses on the rate of profits earned on the amount invested by common shareholders. The price earnings ratio indicates a firm’s future earnings prospects. Other profitability measures are earnings per common share (EPS) and dividends per share of common stock.
The above measures are only guidelines to use when choosing an investment. Detailed research and analysis should be done before making any investment choice.