No company analysis would be complete without looking over the balance sheet. In today's tech-laden world, equity investors focus on intangible assets-a moot point for Investors Capital because the company hasn't developed proprietary technologies or processes.
Typically, says Twaddell, investors have comments or questions when it comes to intangible assets. At the broad-brush level, if the company shows a large amount of intangible assets, it's generally perceived to indicate a significant commitment to creating or maintaining a technical edge. However, the investor may question or challenge the way a company capitalizes research and devel-opment (that is, the degree to which the company treats these expenditures as assets, as opposed to treating them as expenses, which reduces net income). "If a company is too aggressive in its capitalization policies," says Twaddell, "securities regulators or the company's own certified public accountants may someday force a reclassification of the expenditures and, in the process, deliver a big hit to earnings."
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Next, many investors look at inventory to see what the growth trend is relative to sales. If it's crept up over time, and there's no big sale on the horizon, the investor may feel the company has lost touch with changes in the sales cycle. The investor also looks at the number of days sales are tied up in accounts receivable, which is calculated by dividing receivables by net sales, and dividing that quotient by 365. "If the figure is creeping up over time, it could indicate several things, but the investor may question if management is putting the right amount of effort into collecting cash due the company," says Twaddell.
Investors Capital's business precludes inventory, which is a plus in investors' eyes because inventory eats capital and causes problems when not managed well. Investors Capital also scored well in accounts receivable because receivables are paid in less than 30 days-a far cry from the 90 days companies that have to deal with big chain retailers typically wait.
When they move on to the liabilities side of the balance sheet, investors zero in on the accounts payable section. Specifically, investors want to know how many payables are more than 60 days old. "If it's a significant amount, it can be a problem," says Twaddell, "because investors will see a significant portion of the proceeds being eaten up just to keep vendors happy. That can be a real deal-breaker."
Investors also look for any term loans. In general, says Twaddell, their comfort with the loans varies directly with the term. Therefore, if you have significant liabilities due in one or two years, the investor may recoil. If the term is three to five years, the loans will be less of an issue. Debt-free Investors Capital had the ideal scenario.
Any term loans payable to founders cause problems for entrepreneurs who aren't flexible. "From the equity inves-tor's point of view, it's a losing proposition to pay [founders] off because there's no growth associated with it," Twaddell says. "If founders insist on getting paid off, it can kill a deal."
Next, investors check the equity section of the balance sheet to see whether it's negative or positive. At the end of each year, the net income or net loss gets posted to the equity section. If a company has lost money year after year, the equity account will be thin. "By looking over the equity section of the balance sheet," says Twaddell, "investors can get a sense of how close to the edge-or how healthy-a company is."