Finance Corner By Chris Dickin MSc
About the author Chris Dickin MSc Chris Dickin is an independent cost reduction consultant and financial trainer, working for major companies throughout Europe, Africa, the Middle and Far East. He first trained as a Management Accountant with the Rolls-Royce Limited aerospace division in the UK. During that time, he qualified academically as a professional Accountant and he gained a Master’s degree in Financial Control. Over the next fifteen-year period, he gained a wide experience of UK Industry and Commerce, holding positions as an Accountant through to Financial Director in the finance function of several major UK companies. In 1970 Chris joined the University of Derby as a Finance lecturer. A 23 year academic career saw him progress to become the Assistant Dean responsible for resources in the Derbyshire Business School overseeing Degree and Professional courses.
Working as a Trainer in Finance, I get to meet Oil & Gas professionals from all parts of the industry; Engineers, Geologists, HR specialists. It always strikes me that when confronted with a set of company accounts, they all seem to ask the same question: What one thing should I look for in the accounts to tell me how the company is doing? Of course, it is not quite that simple as there just being the one thing, because there are whole ranges of related aspects that need to be compared. (Not least that we need to look at several years’ accounts and not just one sample set).
What one thing should I look for in the accounts to tell me how the company is doing?
Anyway, here is an attempt to narrow it down a bit for you and look at one vital metric from each of the three Accounting statements:
First the Balance sheet: How much borrowed debt capital is the company carrying? Get a feel for the volume of borrowed capital the company has upon which it must pay interest. Look in the current liabilities - how much short-term debt is there? Look in the long term liabilities - how much long-term debt have they got? What is the proportion of short term to long-term debt? (Short-term debt is usually the most expensive.) What is the proportional of the total short and long-term debt to the Shareholder’s capital? Whose money is at risk?
Next, look at the Income or Profit statement: Can the company service the debt that it has? How does the profit available look against the interest payable on borrowings? Look for the profit before interest and tax. Next look for the net interest payable (i.e. interest payable less interest receivable). Divide the profit by the net interest and calculate the number of times the net interest is ‘covered’. How safe is it? How many times does the profit cover the interest? Look for at least three or four times cover.
Finance Corner By Chris Dickin MSc
And finally the Cash Flow statement: Is the company generating enough cash to stay in business? Profit may be fine, but interest and debt repayments have to be paid in cash.
Is the company generating enough cash to stay in business?
Look for the cash inflow figure of ‘Cash generated from Operations’. Look for the cash outflow figure spent on renewing and expanding the Fixed asset investments. Calculate the net inflow and outflow. The resulting figure (positive or negative) is often known as the ‘Free Cash Flow’ - meaning the generated cash that is free after the company has covered it’s Capex and is therefore available to pay interest, loan repayments, dividends etc. Is there a good level of free cash? Sufficient to meet the interest? What if interest rates on the short-term borrowings are increased? Can the free cash flow cover the increased interest? Every company, NOC or IOC, has major customers, major suppliers, important service providers, sub-contractors, joint venture partners and associated companies. Ten minutes looking at the above three metrics from the accounts of such related organisations might just be a very useful exercise in the present debt laden business world!
AC CR EDITED