HOW TO ANALYSE A BUSINESS INVESTMENT

To evaluate whether to buy or buy into a business,an investor should learn how to calculate economic indicators as we indicate in this blog,for they are windows into financial strength or weakness of a firm.

8 Indicators To Consider When Buying A Business For Investors.

    I) Gross Margin Percentage

   II) Net Operating Margin  Percentage

   III) Operating Leverage

   IV) Financial Leverage

   V) Total Leverage

   VI) Debt-To-Equity Ratio

   VII)Quick or Current Ratios

   VIII)Return On Equity

    I)Gross Margin Percentage

 This indicates the percentage of sales left after deducting the cost of goods sold —in other words, how much income remains to cover fixed cost (overhead) and to return cash to the owner/investor.Companies with low overhead can remain profitable with low gross margin percentage,but in general,the higher the maigin,the better the financial health of a company.

    Gross Margin Percentage= Sales-                      cost of goods sold÷Sales

       II)Net Operating Margin Percentage

This reflects net operating profitability of a business before taxes and interest on debts are deducted.The higher the operation margin,the stronger the company.

 Net Operating Margin Percentage=Earnings before interest and taxes ÷ sales

         III)Operating Leverage

This tells whether a business has enough revenue to pay fixed cost.“contributions” is the same as gross margin which is sales minus  cost of goods sold.The higher the operating leverage the better.

      Operating Leverage = Contribution÷Fixed cost

     IV)Financial Leverage

Together with operating leverage,this figure helps identify the total risk a company carries.“Total capital employed” is the amount of interest-bearing debt  added to the owners equity as a shareholder.

    Financial Leverage=total capital employed(debt+equity) ÷ shareholder's equity

      V)Total Leverage

This is the company's level of risk and indicates what effect a given change will have on equity owners.

   total leverage=operating    leverage×financial leverage

       VI)Debt-to-equity ratio

This measures a portion of the business financed by outsiders and the portion financed by insiders.Most companies maintain a ratio of one to one or less.

  debt-to-equity ratio =total liabilities (outsiders)÷total equity (insiders)

         VII)Quick or Current Ratios

This indicates whether a company has adequate liquid assets to pay it's liabilities in the comming year.If a ratio is less than one-to-one,the company could be in trouble.Two-to-one is a rule of thumb for a healthy company.

quick ratio=liquid assets ÷current liabilities

current ratio=current assets÷current liabilities

        VIII)Return On Equity

Perhaps the most important ratio,this indicates the return a company is making on shareholder's investments.Investors should compare the figure to the return on other options,such as stocks,to determine if the business is their best investment vehicle.

return on equity=net income÷average shareholder's equity

          Final Word

As a rule of thumb,wise investors uses these ratios to evaluate a minimum of three years of performance for a company.The overall direction of numbers should be considered in conjunction with the trend of the industry.