Before investing in a business, you’ll need to do a little bit of homework and determine its financial position. While this task may seem daunting, it’s actually quite easy. There are four things you should pay attention to most: sales, earnings, operating expenses, and assets and liabilities.
A business that’s able to grow its sales could be a worthwhile investment. If a company’s sales didn’t grow from the previous quarter, it might because the company performs better during certain times of the year. What matters the most is that sales are growing on an annual basis. If sales are increasing very fast, it may be more preferable to a business with moderate to slow revenue growth.
If a business’s sales are growing, then its earnings should also be increasing. If there’s no earnings growth compared to the last quarter, that doesn’t matter as much as year-over-year growth. If a company’s earnings are growing quickly, then it might be a better candidate for investing in compared to one with slow or moderate earnings growth.
Running a business means there are certain costs associated with it, such as employee salaries, office supplies, advertising and marketing expenses, and equipment costs. You can then figure out if these expenses are rising or falling with revenue if you calculate them as a percentage of sales. Operating expenses are expected to rise as a company grows. But if the costs as a percentage of sales is growing very quickly, then the business may have trouble keeping costs under control. If the costs as a percentage of sales decreases, then the company is likely going to be more profitable.
Assets and liabilities
You should also look at whether the company has a strong balance sheet. If the company’s assets (such as equipment, cash, GICs) are higher than its liabilities (such as debt), then the company is considered to have a strong balance sheet. If liabilities are higher than assets, then the company may still be in good shape but could face financial difficulty if operating expenses were to suddenly increase or if there’s a recession.
A company with a large amount of liabilities may get into trouble if it takes on more debt because it’ll have more to pay off in the future. That business may have to take on a loan with a higher interest rate, which means its payments will be higher. Investors who decide to provide a loan to a company like this are taking on additional risk. But they also have the ability to earn a better return on their investment because the interest rate on the loan will be greater. Higher risks can sometimes lead to higher rewards. Looking at a company’s sales, earnings, operating expenses, and assets and liabilities will give you a clearer picture of how well it’s performing. With that information, you can make a better-informed investment decision.