Sample Profitability Report For the period ending 12/31/2007 Provided By Jonathan Resnick, CPA An Accountancy Corporation Disclaimer The information included in the following comparative financial evaluation is presented only for supplementary analysis and discussion purposes. Such information is presented for internal management use only and is not intended for third parties. Accordingly, we do not express an opinion or any other form of assurance on the supplementary information. Report prepared for: The Best Engineers, Inc. Industry: 54133 - Engineering Services Revenue: $1M - $10M Periods: 12 months against the same 12 months from the previous year LIQUIDITY BORROWING PROFITS & PROFIT MARGIN ASSETS SALES EMPLOYEES LIQUIDITY Generally, what is the company's ability to meet obligations as they come due? Although the company's "quick cash" position has drifted down a little from last period, it is still very good. This means that the company's cash and near-cash accounts look strong as compared to its current liabilities. It also means that these highly liquid accounts comprise a healthy portion of the total current asset base. After all, these are the assets that will be used to pay the bills in the very near future. What is really positive here is that the "overall" liquidity position looks good as well. From a finance perspective, this means that the "current ratio" is very good. It also means that the company has thorough current asset support on the Balance Sheet. Moreover, note that the company's overall liquidity position was good last period too, so the company has now been strong for two consecutive periods. This is a positive result because trends are quite important in this area. This company has done good work with regard to liquidity. Here are some possible actions that management might consider if appropriate (these are ideas that might be thought about): • • • • Monitor the impact tax payments may have on cash. Keep enough money aside to be able to meet future tax obligations based on earnings. Set longer terms for Accounts Payable when possible. For example, increase a 30 day payment window to 60 days. Complete jobs on a timely basis. If completion takes longer than expected, soft costs such as penalties and lost business elsewhere can start to drain the money coming into the business. Monitor the amount of money that is being used for activities unrelated to the business. An example could be money taken out of the business on draws to principals. LIMITS TO LIQUIDITY ANALYSIS: Keep in mind that liquidity conditions are volatile and this is a general analysis looking at a snapshot in time. Review this section, but do not overly rely on it. Financial Indicator 12/31/2006 12/31/2007 $819,955 $1,000,949 Working Capital = Total Current Assets - Total Current Liabilities Explanation: This is the capital that finances continuing operations of the company. It is normally used to manufacture, sell, and receive payment for products and services. Working Capital shows the available liquidity resources after current obligations are met. The higher the better. Accounts Receivable Days 125.51 Days 121.46 Days = (Accounts Receivable / Sales) * 365 Explanation: This number reflects the average length of time between credit sales and payment receipts. It is crucial to maintaining positive liquidity. The lower the better. Accounts Payable Days 25.65 Days 33.05 Days = (Accounts Payable / COGS) * 365 Explanation: This ratio shows the average number of days that lapse between the purchase of material and labor, and payment for them. It is a rough measure of how timely a company is in meeting payment obligations. Lower is normally better. Inventory Days 0.00 Days 0.00 Days = (Inventory / COGS) * 365 Explanation: This metric shows how much inventory (in days) is on hand. It indicates how quickly a company can respond to market and/or product changes. Not all companies have inventory for this metric. The lower the better. Operating Cash Flow $356,917 $231,306 = Earnings before Interest, Taxes, Depreciation and Amortization (EBITDA) Explanation: Operating Cash Flow or Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA) is a key indicator of a company's ability to generate cash to meet obligations. This indicates the positive cash flow that a company generates from continuing operations. The higher the better. Operating Cycle 125.51 Days 121.46 Days = Accounts Receivable Days + Inventory Days Explanation: Operating Cycle represents the number of days between the time a product is added to inventory (if any) and the time when cash is actually received. The lower the better. PROFITS & PROFIT MARGIN Are profitability trends favorable in the company? Even though net profits have fallen from last period, this company is still performing reasonably well in this area. The net profit margin is fairly healthy and "in line" relative to the industry. Still, the company would probably prefer to increase net profits over time. Companies generally like to generate above average net profits in the business if possible. Keep in mind that the results analyzed here are quantified based on a thorough evaluation of industry norms. We look specifically at the net profit margin, which is the cents of profit extracted from each sales dollar. In a way, the net profit margin measures the company's managerial effectiveness. On another note, it looks like some of the data that was entered could be a "little unusual." What does a "little unusual" mean? It does not necessarily mean that the data is incorrect. It just means that it falls outside of what would be a typical combination of numbers. For this reason, it is a little difficult to make some other observations that we might ordinarily make. If you pull future reports, the analysis will be a little more detailed in this particular area. Profit and loss management is all about continually finding ways to change things in the business to improve profits. Managers might think about the following ideas/hints/tips: • • • • Make sure to properly integrate the IT systems that support your main functions. You may want to contact an IT consulting firm to help you with this process. Consider hiring subcontractors and/or consultants for any specialized work your firm is not fully qualified to perform. This will help you increase revenue, without realizing the high overhead costs associated with hiring extra employees. Generate accurate financial reports on a timely basis -- within 40 days of the end of the financial period. This will help ensure the usefulness of the data for examination purposes. Good financial reports are the backbone of management decisions. Establish a niche that sets the business apart from the competition. Determine the target audience for the firm and develop the niche around these ideal clients. Financial Indicator Operating Cash Flow Margin 12/31/2006 12/31/2007 12.32% 7.81% = EBITDA / Sales Explanation: This percentage indicates how much cash flow a company realizes from each dollar of sales. The higher the better. Return on Equity 0.00% 0.00% = Net Income / Total Equity Explanation: This measure shows how much profit is being returned on the shareholders' equity each year. It is a vital statistic from the perspective of equity holders in a company. The higher the better. Labor Cost Ratio 0.00% 0.00% = Payroll Expense / Sales Explanation: This measure shows what percentage of sales dollars are being spent on employees. The lower the better. SALES Are sales growing and satisfactory? Sales are the most basic component to analyze in business -- sales are usually up or down. In this case, sales volume is "about the same" as last period. This is not the desired result for this section, because companies want to see sales moving higher over time. The company should be building on its existing customer base at all times. Additional sales volume is required because expenses tend to increase over time. All expenses are ultimately "funded" from sales dollars. The positive component to results in this area is that fixed assets fell this period. Therefore, the company earned approximately the same level of sales on a lower asset base. In this way, the company drove more sales volume through each dollar of asset on the books, which is good. This is referred to as increasing "asset turns". Financial Indicator Sales per Employee 12/31/2006 12/31/2007 $131,635 $134,565 = Sales / Total Employees (FTE) Explanation: This measure shows the annualized sales being generated per employee. Fixed Asset Turnover 1.85 2.26 = Sales / Gross Fixed Assets Explanation: This asset management ratio shows the multiple of annualized sales that each dollar of gross fixed assets is producing. This indicator measures how well fixed assets are "throwing off" sales and is very important to businesses that require significant investments in such assets. Readers should not emphasize this metric when looking at companies that do not possess or require significant gross fixed assets. The higher the more effective the company's investments in Net Property, Plant, and Equipment are. BORROWING Is the company borrowing profitably? Any company needs to make sure it is borrowing effectively -- using leverage optimally. It is always important to monitor how effectively a company is using borrowed dollars. In this case, significant debt was added, but profitability went down from last period. Although it is possible that the company has invested in some resources that will generate profitability in the future, it could also be that the investment in debt has simply not been helpful. Even short-term debt carries some risk and should therefore return improved profitability. Additionally, net margins are down this period, which is not favorable when combined with lower profitability in dollars. On a general note, it is a good idea to meet with the company's bankers on a regular basis to keep the relationships strong and use them as strategic partners to optimize the company's use of debt. Financial Indicator Debt-to-Equity Ratio 12/31/2006 12/31/2007 0.32 0.32 = Total Liabilities / Total Equity Explanation: This Balance Sheet leverage ratio indicates the composition of a company’s total capitalization -the balance between money or assets owed versus the money or assets owned. Generally, creditors prefer a lower ratio to decrease financial risk while investors prefer a higher ratio to realize the return benefits of financial leverage. Debt Leverage Ratio 1.12 2.07 = Total Liabilities / EBITDA Explanation: This ratio measures a company's ability to repay debt obligations from annualized operating cash flow (EBITDA). Interest Coverage Ratio 20.05 26.91 = EBITDA / Interest Expense Explanation: This ratio measures a company's ability to service debt payments from operating cash flow (EBITDA). An increasing ratio is a good indicator of improving credit quality. The higher the better. ASSETS Is the company using gross fixed assets effectively? In this case, the company reduced its fixed asset load. At the same time, profitability fell as the asset base was lowered. This dynamic might not be unexpected; however, what is interesting is that profitability fell at an even greater rate than the rate of asset reduction. This may mean that the assets disposed of were previously helpful to profitability, or it might also mean nothing -- that assets and profitability fell at the same time by chance or due to other factors in the company. As always, it is important to watch for long-term trends before drawing strong conclusions. Still, it seems clear that eliminating assets has not improved profitability as of yet. Financial Indicator 12/31/2006 12/31/2007 Return on Assets 0.00% 0.00% = Net Income / Total Assets Explanation: This calculation measures the company's ability to use its assets to create profits. Basically, ROA indicates how many cents of profit each dollar of asset is producing per year. It is quite important since managers can only be evaluated by looking at how they use the assets available to them. The higher the better. Asset Composition 70.95% 73.15% = Total Current Assets / Total Assets Explanation: This ratio measures the proportion of current assets to total assets. A lower ratio would indicate that a company has significant investments in long-term assets and less flexibility in meeting short-term obligations. EMPLOYEES Is the company hiring effectively? Net profitability and employee trends are just as important as any other area to analyze in a business. In this case, the company is earning less profitability with about the same level of employees. This means, in effect, that the company's net profitability per employee statistic is now lower than it was last period, which is not a favorable result. Of course, this analysis is only based upon one period of change data, so managers should look to the future to make conclusive decisions about hiring policies. "Opportunities multiply as they are seized." -- Sun Tzu Financial Indicator Return on Labor 12/31/2006 12/31/2007 N/A N/A = Adjusted Net Profit before Taxes / Payroll Expense Explanation: This indicator represents the percentage of profit generated from each dollar invested in employee compensation. Profit per Employee $11,157 $6,805 = Adjusted Net Profit before Taxes / Total Employees (FTE) Explanation: This indicator represents the annualized amount of profit that each employee is generating. NOTE: Exceptions are sometimes applied when calculating the Financial Indicators. Generally, this occurs when the inputs used to calculate the ratios are zero and/or negative. A NOTE ON SCORING: Each section of this report (Liquidity, Profits & Profit Margin, etc.) contains a star rating which measures the company's overall performance in the area at the time of the report's generation. One star indicates that the company is below average or may possibly need improvement in the area. Three stars indicate that the company is about average for the area. Five stars indicate that the company is above average or performing quite well in the area. RAW DATA 12/31/2006 12/31/2007 $2,895,975 $1,255,097 $1,640,878 56.66% $0 $93,656 $17,799 $245,462 $245,462 8.48% $356,917 $0 $2,960,426 $1,382,925 $1,577,501 53.29% $0 $73,000 $8,597 $149,709 $149,709 5.06% $231,306 $0 $95,648 $995,806 $0 $1,169,425 $1,566,352 $1,648,212 $88,213 $349,470 $399,263 $128,788 $985,163 $0 $1,450,975 $1,311,808 $1,983,555 $125,213 $450,026 $479,595 22.0 22.0 Income Statement Data Sales (Income) Cost of Sales (COGS) Gross Profit Gross Profit Margin Payroll / Wages / Salary Depreciation Interest Expense Net Profit before Taxes Adjusted Net Profit before Taxes Net Profit Margin EBITDA Net Income Balance Sheet Data Cash (Bank Funds) Accounts Receivable Inventory Total Current Assets Gross Fixed Assets Total Assets Accounts Payable Total Current Liabilities Total Liabilities Number of Employees (FTE) READER: Financial analysis is not a science; it is about interpretation and evaluation of financial events. Therefore, some judgment will always be part of our reports and analyses. Before making any financial decision, always consult an experienced and knowledgeable professional (accountant, banker, financial planner, attorney, etc.).