Analysis of investing activities is an aspect of financial statement analysis that is very important in the successful implementation of business analysis. This is a continuation of the financial analysis / financial statement analysis article. I broke it down so that you won’t get bored reading it.
Investing activity is one of the three functions of financial manager in a company. It involves judicial utilization of a company’s finance in the most favourable manners. The fact that businesses invests in assets will suppose that analysis of investing activities is simply- the analysis of assets such as receivables, inventories, properties, equipment, and intangibles.
The essence of doing this is to get a better understanding of a company’s performance and financing requirements. Please note that performance evaluation is not purely based on the analysis of investing activities.
Receivables represent economic value due to a business as a result of past actions. We have accounts receivable and notes receivable. While accounts receivable relates to money from the sale of products and services, notes receivable are cash or cash equivalent that is in written form- a kind of promissory note. A useful information about; collection risk, genuineness and securitization of receivables (e.g. factoring) is all we need in this regard. Review the opinion of the independent auditor of the financial statements to be rest assured that these variables are within acceptable range. Note however that the financial statements will not reveal all of the above.
Other likely sources of information are:
- Activities of similar businesses- examine the receivables of similar businesses.
- Trade journals
Make sure you compute and investigate trends in average collection period of receivables and compare it with the ‘custom’ credit term of the industry. Also, pay close attention to receivables that are renewals of prior accounts or notes receivable, a lot has been hidden here in the past.
Inventories are goods that a business deals on. They are part of the current assets. The valuation of inventories has significant impact on profit and figures in the statement of financial position of a company. Your objective here is to be sure that acceptable inventory costing method is used. IFRS (international financial reporting standard) favours the use of FIFO (first in first out). This can easily be ascertained by reviewing the auditors’ report of the financial statements.
ANALYZING PROPERTIES AND EQUIPMENT
These are tangible assets of a business that are fixed in nature. When I say fixed, I mean those assets that span more than one operating business cycle. Most of the analysis that needs to be done here have to do with assets utilization. You get this by calculation relevant ratios. Other areas to be looked are; capitalization, allocation and impairment. Certain standards need to be followed in these regards. You will find out if there is significant deviation by simply looking at the auditor’s report in the financial statements.
Analyzing intangible assets
Intangible assets are the collection of those rights, privileges, and benefits of ownership or control. As the name implies, the value of intangible assets are not easily ascertained so, estimates are used to get a proxy of the intangible assets. Some examples of intangible assets are: goodwill, patents, trademark, copyrights, business name (brand), exploration right, licenses, designs, special inventions, etc. The introduction of the word “pageviews” as a valid ground to make projections is what I still don’t understand.
My standard advice is to tell people to treat intangibles with suspicion. The reason for this is that intangibles are characterized with uncertainties and risks. Make sure you understand the intangible assets and exercise a high degree of caution. What I recommend in most cases is that you isolate goodwill from the other information in the financial statements while doing your analysis. My argument is based on the premise that auditors always have difficult time while dealing with goodwill. Look at the; competition, valuation and disposition of goodwill with an eagle eyes.
You are doing all these to ensure that you get a working understanding of how the business will invest your money- under the assumption that you are an investor or potential investor. Activities that does not have any clear economic value added prospect should be removed from whatever forecast that is made and then the effects on the overall financial position of the company reconsidered. Caution should be the watch word when the net effect is negative. The next aspect of financial statements analysis that we are going to be looking at is the operating activities