You may have seen the section in a 10-k report, sometimes hidden way in the back, called “Summary of Significant Accounting Policies –Inventory Valuations”, and wondered what real effect it has on your investment. If the company you are following provides services, then this will have little bearing on net income; however, if the company is heavily reliant on producing or selling physical goods, then inventory methods can have a material (significant) impact on earnings. Read more…
The balance sheet is a snapshot of the company’s assets and how they are financed at any one-point in time. As a general exercise in valuing a company, it is important to look at its liquidity, the debt and equity composition, and quality of the underlying assets.
Some simple math can tell you very quickly if the company has a strong financial standing or if there may be serious risks ahead if the company ends up with losses in the future.
For liquidity, the current ratio (total current assets divided by total current liabilities) is very helpful in seeing how well the company can pay its obligation due in the next 12 months. A current ratio of 2 or higher is what I like to see in my investments. That way, I know the company is in good standings in case a line of credit is not renewed and requires immediate payoff, or they have a cushion in case they want to pay their accounts payable or current bills entirely. Another liquidity measure commonly used among value investors is total current assets minus total liabilities. This gives the investor an idea whether or not they can pay off debt if they so desire and assumes the long- term assets are paid for free and clear.
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