User Tools
Balance Sheet Analysis
How to Analyze a Pro Forma Balance Sheet:
Some investor pitches and loan applications include a subset of a pro forma balance sheet for investors and lenders to review. Any investor or lender interested in performing due diligence will ask for a pro forma balance sheet. Offtoa performs an analysis of the balance sheet looking for the same properties that many investors and lenders look for; these are properties that often foretell a poor financial outcome for the company. The primary reason for surfacing these issues is to find solutions early and to prevent problems. The primary reason for using a tool like Offtoa to find these issues is so you can either:
- fix these problems rather than suffer the embarrassment of potential investors or lenders finding them, or
- understand why the problem is not a problem, so you are better prepared to defend yourself if a potential investor raises the issue. After all, you may not consider every problem that Offtoa raises to be a problem.
Here is a partial list of the kinds of problems that Offtoa looks for
- Current Ratio in Some Years Is Negative
- Current Ratio in Some Years Is Less than 1.0
- Current Ratio in Some Years Is Less than 1.2
- Net Working Capital in Some Years Is Negative
- Net Working Capital Below 10% of Annual Revenues
- Net Working Capital Over 25% of Annual Revenues
- Debt-to-Equity Ratio Much Greater than Industry
- Debt-to-Equity Ratio Much Less than Industry
- Inventory Turnover Too High for Industry
- Inventory Turnover Too Low for Industry
- Return on Equity (ROE) Too Low
- Accounts Receivable Too High for Industry
- Accounts Receivable Too Low for Industry
- Accounts Payable Too Low for Industry
- Accounts Payable Too High for Industry
Whenever Offtoa finds a potential problem, it highlights the symptom for you on the balance sheet, and offers a list of suggested solutions, each of which describes exactly which assumptions you need to change to fix the problem. However, don't just “fix” the problem by blindly selecting one of the suggestions. That will result in you having a set of financial statements that look good but have no basis in reality. Instead, make changes to assumptions that you believe are feasible and then change your business strategy to reflect the new plan. If none of the suggestions are feasible in your mind, then perhaps you don't have a viable company :).
Questions:
What is a good value for current ratio?
What is a good value for debt to equity?
What is a good value for return on equity?
What is a good value for net working capital?
What is a good value for inventory turnover?
What should I do if my accounts receivable days are very different than the industry average?
What techniques exist to reduce average days outstanding for payments you receive from customers?
So what of my accounts payable are different than the rest of the industry?
This is not so terrible as long as you understand exactly why it is so. Your A/P will not differ from your peer companies just because you think it will be. You must take specific strategic steps to make it so. Have you already negotiated payment terms with your vendors and suppliers? If not, you'd better stick with industry averages.
So what of my inventory turnover is different than the rest of the industry?
This is not so terrible as long as you understand exactly why it is so. Your turnover will not differ from your peer companies just because you think it will be. You must take specific strategic steps to make it so. Meanwhile, if you maintain less inventory than competition, you may run out of stock. If you maintain more inventory than competition, you risk spoilage or obsolescence. Be careful.
