Thread by @Finalysis20

A Thread on checklists to analyse a business based on @Gautam__Baid's book #TheJoysofCompounding
The book has explained the terms in a easy to understand language with less jargons. This thread is an attempt to summarise it.

https://twitter.com/Finalysis20/status/1367297463686549507

1. INCOME STATEMENT

Sales Growth:
- Higher is better
- High sales growth with no profitability = ×××
- Organic growth driven by internal accruals = ✓
- High growth driven by big-ticket acquisitions = Caution!

Gross Profit Margin(GPM):
- Focus on trend over the years
- Fluctuating cyclically = No pricing power
- High & stable = Possibility of economic moat

Interest Income (usually shown as other income):
- Should be atleast equal to Bank FD returns

Interest Expense:
- Low interest expense or high interest coverage ratio = Caution! {Interest cost could be capitalised}

Employee Cost:
- Must be in line with combined salary & benefits all employees.

Other Expenses:
- Unexpected rise during depressed market = Caution!

Taxes:
- Tax payout ratio should be in line with standard corporate tax rate
- If less then businees could have tax exemption or have accumulated losses

Net profit margin(NPM):
- Higher is better
- High sales growth with declining NPM = ×××

2. CASH FLOW ANALYSIS

Cash Flow from Operation (CFO):
- Higher is better
- CFO << Net Profit (PAT) = Money stuck in working capital

CapEx:
- CFO > CapEx = ✓
- High sales growth with less CapEx = Captial light business

Total Debt:
- Lower is better for non-finance business

Cash Balance:
- High cash balance with no to very less dividends = Caution!

Free Cash Flow(FCF):
- FCF/CFO = Higher is better
- FCF negative with high dividend yield = ×××
- Intrinsic value of business depends on FCF or cash that can be taken out to the business

3. RETURN RATIO ANALYSIS

Self Sustainable Growth Rate(SSGR):
- Sales growth > SSGR = Business using more resources than operations can generate
- Sales growth < SSGR = ✓

One of the best explanation of SSGR is found on @drvijaymalik's website.

Profit before tax(PBT)/average net fixed assets:
- Higher is better
- Earnings from tangible assets > Bank's FD rate = ✓

Pretax Return on Tangible Equity:
- Higher is better
- High pretax return driven by higher debt = Caution!

Return on Capital Employed:
- Higher is better

4. OPERATING EFFICIENCY ANALYSIS

Net Fixed Asset Turnover Ratio:
- Higher is better
- Indicates how efficiently businesses uses its fixed assets

Recievable Days:
- Lower is better
- Receivable days constantly increasing : ××× {Could be a case of fictitious sales}

Inventory Turnover Ratio:
- Higher is better
- Lower means business is accumulating lot of inventory which could mean sale of finished product is not happening. Risk of inventory becoming obsolete.

5. BALANCE SHEET ANALYSIS:

Net Fixed Assets:
- Sharp increase = CapEx program completion; could result in increased sales

Capital Work in Progress( CWIP):
- Sharp increase = CapEx program started

Share Capital:
- Ideal : constant over the years
- Buyback reduces share capital

- Bonus Shares: Increases share capital
- Increase without bonus shares = Dilution of existing shareholders.

Debt-to-Equity Ratio:
- Lower is better
- Low Debt-to-Equity Ratio but less cash = Caution! {Near term liquidity at risk, resulting in more debt}