The Top 10 issues to consider when analyzing an enterprise financially.

Originally Submitted on 9/22/97.

There are many ways to look at an enterprise. This list entertains an essential group of ways to examine an enterprise from a perspective and to create an objective evaluation of whether or not the enterprise is viable and meets your objective's needs.

1. SPECIFY OBJECTIVES!

Whether you are a banker, a lawyer, a financial analyst, an accountant, an investor or a business owner, you must specify at that outset WHY you are analyzing this enterprise and what goals or objectives are important in this analysis. This also includes your opportunity costs, your hurdle rates and your time horizon.

2. STUDY THE BUSINESS ENVIRONMENT.

Most analysis is not any good if you have nothing to compare it against. So start your analysis by discovering facts about industry benchmarks. What is the historical background of the industry. What idiosyncratic methods are used to determine facts in the industry and what makes the industry specific regarding financial benchmarks, operating benchmarks, accounting methods and so on.

3. DISCOVER THE CONTEXT.

This is critical. In what context does the industry function. Is it cyclical and affected by up turns or down turns in the durable goods? Does it respond to interest rate fluctuations. How interest rate sensitive is the industry. Does the industry or enterprise require certain aspects in the economy to be a certain way before it can be profitable. Does it depend on another industry such as computers depend on software and software depends on computers and such. What are the interrelationships between products and vendors, etc.

4. WHAT IS THE OUTLOOK?

What is the general condition of the economy and what is the outlook for interest rates in general? How do the projections of the overall business cycle fit into the scheme of things? Where are the product cycles in relation to overall maturation cycles in the industry and related industries.

5. WHAT IS THE REGULATORY ENVIRONMENT?

One of the biggest keys in certain business enterprises is how is the government regulating this industry? Is it possible that the government will start regulating this industry and will this enterprise be affected? Is the enterprise customers or vendors affected by government regulatory action that would have an adverse affect on supply or demand?

6. KNOW YOUR FIRM!

We need firm-specific knowledge about how it operates and what kind of management is in place. Is the management progressive or extremely conservative? Is the company an old line company with strong financial roots or is it a new growth company that makes it up as they go? All of these creates variability and with variability comes risk. Manage variability and you manage risk!

7. EMPLOYEES RUN THE COMPANY?

Remember this crucial aspect of enterprise. Does the company have good employee relations or are they managed through layers of hierarchy including having union representation. While not a judgement of good or bad, you must know what the employees are doing and how they intend to behave over a period of time. If there is great employee strife, then variability in outcomes is likely and consequently risk goes up.

8. NOW IT IS TIME TO DO THE WORK!

Analyze the financial statements. There are 4 basic statements you need with historical trends and data. The balance sheet, the income statement, the statement of retained earnings and the statement of consolidated cash flows. These statements along with the rest of the information you gather will provide you with a good look at the company and its history along with indications of the opportunities and possibilities.

9. RECOGNIZE THE LIMITATIONS...

Please understand that there are limitations to what you can know. Much of the data about enterprise is historical and while there are various points of reference and windows to the future which can point you in the right direction, there are some things you won't know and some things you can't know. However, the more you know, the more informed you will be in order to make judgements which reduce the risk of involvement.

10. SUMMARIZE IT ALL BACK TO THE OBJECTIVES!

You started with an objective. Now is the time to summarize all the roads back to that objective. Will you loan this company money, time, attention, your efforts, your security? Are the risks too large or are they manageable? Does the enterprise have a future bright enough for risk to be reduced to the point where you see clear to make an investment? This is where you need to be and ultimately if you have done your homework, analyzed the statements unscrupulously and started and ended with clear objectives, your decision will be easy!

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