Assessing Company Value

When individuals are interested in purchasing, investing or working with a company it may also be a good idea to assess it’s financial status, using public information available through government sources, two documents can allow proper assessment. A statement of comprehensive income and a statement of financial position.

Company value calculations

Statement of comprehensive income

A statement of comprehensive income is a usually detailed report listing the inflows and outflows of capital of a business. They often include exceptional expenses and net profit for a business and subsequently can be difficult to follow but should provide a good understanding on how a business functions through the financial year.

Statement of financial position

A statement of financial position outlines the inventories, assets and equity a business has at the end of a year or season. It may also help to identify where most of a businesses cash is being spent or held in assets.

What are the benefits of these documents?

A statement of comprehensive income will help to identify the basic operations of a business, for example the yearly turnover. A company that makes more turnover than another, however may not be financially better or worse however as it can depend on how the money is used, fortunately there are many equations that can help us to define a standard for these figures that we can use to compare between businesses or yearly statistics.

Gross Profits

Gross profits allow us to determine how much profit a company makes after selling it’s products, this is already better than revenue as it shows that a company may be making a lot of revenue, but may be spending it all on sales. It is usually defined in the statement of comprehensive income.

Gross profit is Sales Revenue – Cost of Sales.

This figure is useful, but can be more effective when coupled with a percentage, as it is would allow us to compare for example previous years income, as below, it is for this reason we use the Gross Profit Margin to calculate a percentage.

Gross Profit Margin is (Sales Revenue – Cost of Sales) ÷ Sales Revenue. Higher is better.

BusinessGross ProfitGross Profit Margin
XYZ Telecoms$470,00051.32%
AB Telecom$460,00079.92%
AT TEL$430,00030.10%

As you can see from above the company XYZ Telecoms makes more money than AB Telecom however it is much more inefficient in it’s spending and therefore could reduce the cost of it’s sales to get higher returns. Note that although AB Telecom makes a higher Gross Profit Margin it does not make more money. Here is a breakdown of another Telecom company Telecomatic and they spend roughly 40% of their Revenue on sales, and therefore have a gross profit margin of 60%. In other words, if 40% is spent on sales, the company keeps the other 60% barring any other costs, like fixed costs.

RevenueCost of SalesGross ProfitGross Profit Margin
$100,000$40,000$60,00060%

Using gross profit and the gross profit margin is advantageous because it;

  • Enables you to calculate if spending on sales is too great.
  • Identify which company is better at sales spending.
  • Enables to identify if year on year a businesses spending on sales has been successful or not.
  • If there are two company chains, in two different locations with similar sales revenue, if they were to use different methods of advertising the sales profit margin would allow you to determine the best method based on the higher percentage.

However it does not;

  • Account for exceptional items or income.
  • Account for Fixed costs, such as machinery rent or leasing.

Operating Profits

Operating Profits are the next step of a businesses true income, operating profit accounts for overheads (expenses) that a business has to pay in order to function, expenses like factory ownership or employee pay and should easily be very close to a businesses true profit for the year if the business is new or homogeneous in nature. Operating profits however do not account for or should not account for;

  • Exceptional expenses, like purchasing new facilities or machinery.
  • Assets a business may hold of value.
  • Creditors.
  • Financial income or company dividend.

Operating Profit is calculated by Gross Profit – Overheads. Operating Profit Margin is calculated by (Operating Profit) ÷ Sales Revenue.

Yell TellThis year
Sales Revenue$848,100
Sales Expenditure$298,100
Gross Profit$550,000
Gross Profit Margin54.20%
Expenses$130,000
Operating Profit$420,000
Operating Profit Margin28.30%

Net Profit Margin

Lastly, for the comprehensive income sheet, the Net Profit Margin will show the overall effectiveness of the businesses expenditure. And represents how much raw profit a company makes based off its revenue, to put this into perspective its how much money is profit when multiplied by the turnover, so if a company’s net profit margin is 17%, and they turnover $1m a year, the company will have $170,000 unconditional capital left over at the end of the year barring complications.

The Net Profit Margin is calculated by Profit for the year ÷ Sales Revenue.

Factors Affecting Sales Forecasts

Sales Forecasts are charts and graphs, equations and educated predictions that allow businesses to predict future sales with a degree of accuracy.

  • Consumer Trends – People being proud of bargains and discounts. sales forecasts become harder to predict when consumerism changes.
  • Economic Variables – Recessions, Booms and Recovery.
  • Competitors Actions – loss leaders and pricing strategy may try to undercut you.
  • Digital Music for example, as become harder to predict as people have found new ways to obtain it illegally.
  • Fashion Items have an unpredictable life span.
Businesses use a range of forecasting tools to make forecasts

No single technique is reliable, but having multiple will allow you to better predict the future

Using sales forecasts may be useful but having data that is unreliable could mean that the forecast is not accurate. Making forecasts that are too long into the future could be considered extrapolation.

Extrapolation is cheap, although inefficient it gives a fixed perspective of what to expect which is better than nothing.

Planning for the worst allows companies to expect and anticipate failure. Very successful stable products cannot predict when sales will fall as their product is likely very price inelastic and customers are used to the product’s taste or function that changing it could make customers unhappy with the product. ‘Many financial measurements which are useful and valid in static situations are strategic traps in growth situations.’

sales volume over two years year end increase sales forecast shows volume

Failing to predict sales forecasts correctly

Failing to accurately predict sales forecasts may mean that a business could fail. Working capital is cash that is spent on the business, liquidity is not. Having a lot of working capital does not necessarily mean you are liquid. You may also have;

  • Contingency Finance (A financial Cushion)
  • Credit Periods yet to expire
  • An active Working Capital Cycle

That must be paid before you consider any additional finance as liquid that you can spend on anything.  Additionally when a business is in liquidation whereby they have had to cease trading there is still things that have to be paid off, and unfortunately for some employees, this may be unfair as it could mean a business cannot afford to pay them because they do not have the funds.

  1. The Tax Office must be paid, to cover the business from litigation.
  2. Shareholders must be paid dividends and the value of their shares.
  3. Employees must be paid their wages.

Some Key Terms

  • An Income Statement – Measures the business performance over a period of time, and may allow them to determine where forecasting was over-optimistic. It shows a companys revenue and total spending over a given period of time.
  • A Statement of Financial position is a snapshot of the business assets.
  • A Cash flow statement shows cash flow sources over a given period of time. It shows exactly how much a business has received and spent.