Financial Statement Analysis in Order

Financial Statement Analysis

In order to determine which companies excel at overall performance, some value must be assigned to the different ratios and performance measures. For example, Inergy has exceptional liquidity but offers a terrible return on equity. One way to settle the issue is to rank the firms in a few key categories and see which firm has the best overall ranking. This method will emphasize stability and consistency over excellent performance in any one single measure. For this exercise, current ratio, ROE, gross margin and receivables turnover will be used. These measures cover the key categories -- liquidity, investment returns, profitability and management efficiency. The debt/equity ratio has been excluded specifically because a firm's choice of capital structure is dependent on the industry; and these firms all have low levels of total debt/shareholder's equity.

The firms score as follows: Ferrellgas scores a 12, Amerigas scores an 11, Suburban a 7 and Inergy a 10. Before a final determination is made about which company is the healthiest, the results should be examined for red flags. For instance, there is no difference in rankings between operating margin and gross margin, proving the usefulness of the latter measure. There is a red flag, however, with respect to liquidity. The current ratio at Inergy is very high, but its interest coverage is the lowest of the four firms. This points to the company having a balance sheet loaded with cash but lacking in operating liquidity. Indeed, Inergy had a much lower current ratio in the previous fiscal year, indicating that the company has received an influx of cash that is unduly inflating the current ratio for this fiscal year. In general, the company is not as liquid as the current situation would indicate. This, however, only serves to strengthen the case that Suburban is in the best financial health of the four companies. Adjusting Inergy's score for liquidity, the company falls into last place. The order of the four companies is as follows: Suburban has the best financial condition; Amerigas the second-best, Inergy the third-best and Ferrellgas the worst. The reasons for the latter assessment are forthcoming in the next question, and are based on specific red flags beyond this particular analysis.

2. Perhaps the most controversial part of the analysis is the claim that Inergy has the weakest financial position of the four companies. Inergy has a strong cash position, but this is derived from operating activities. Prior to the debt and stock issues that have contributed substantial cash to Inergy, the company had the weakest balance sheet of the four firms. While it is encouraging that the company was able to raise capital, the effects of this capital raising should be taken into consideration when analyzing the overall financial health of the company. The debt issue also saw Inergy's debt increase by 55%, a much larger increase than any other company experienced.

Suburban has the best debt-equity ratio of any of these firms. Ferrellgas, for example, has a balance sheet that is 93.9% debt. The company has an acceptable current ratio, but has a very low amount of cash and its earnings do not cover the company's interest payments. This means that Ferrellgas is in risk of default. The company paid more in dividends last year than it earned in cash from operations. In short, Ferrellgas has an unsustainable burn rate. While Inergy had a poor financial position, it was able to tap into capital markets to alleviate any cash crunch -- Ferrellgas has yet to do this and of all these firms is the closest to default.

Amerigas is a mediocre performer among this group. While the company has very little cash and a low current ratio, it is earning enough to cover its interest. It is also paying less in dividends than its cash flow from operations, although it is probably paying too much given its earnings level and apparent need for capital expenditures. However, there are red flags with this company as well. For example, given its current cash situation, one would want to see an improving cash conversion cycle, and that is not the case as both inventory and receivables turn are worsening. It is also worth considering that Amerigas is less indebted than is Ferrellgas.

The company with the strongest financial position is Suburban. That company has a healthy balance sheet, good margins, good interest coverage and although it has a declining profit and revenue it has managed to keep its financial condition relatively healthy.

3. This does not appear to be a good industry in which to invest. Net incomes in the industry are declining, and most companies are also seeing revenue declines as well. Of the four companies in this industry, one is on the brink of default, another just received financing to continue, and a third is struggling. Only one company is performing well and even that company, Suburban, has financial weaknesses. It could be argued that if the outlook for the industry is good, then the firms in the industry might be trading at low stock prices, but on average, the industry trends do not look especially positive.