If you think that you found the right business you still have to evaluate the business itself. This article is the third in a series of articles of suggestions on how to analyze a company. You need to look at relationships on the financial statements such as
- professional fees increased dramatically. Does this mean that there is an undisclosed problem?
- if the business for sale is selling assets during the year, are these sales a normal part of the business or is the company selling assets to maintain profitability of the business in order to mask operating losses of the company if not disclosed yesterday.
- foreign exchange – if the company makes all its sales to the US from Canada and the sales are in US dollars. Let’s assume that the profit is 20% of the sales. If the exchange rate is 20%, it means that 100% of the profit of the company is a result of the exchange rate. If this exchange rate changes downwards, it will have a direct impact on the profitability of the company.
- foreign exchange – if all the companies supplies comes from a supplier in a foreign country, the profitability may be adversely reflected by the changes in the exchange rate. I saw a company who bought 100% of the raw materials from Sweden and one year, several years ago, the Sweden currency appreciated significantly and his profit margins nosedived. The owner was unable to pass on the changes in the exchange rate.
- if a company hedges their foreign exchange exposure by buying forward contracts, if you purchase the company, you may inherit their currency risk policy. If the forward contracts were made 6 months ago for delivery in 6 months, you may want to make sure that there are not significant losses incurred but not reflected in the financial statements because of bets going the wrong way.