Finance

4 Important Financial Metrics To Check Before Investing In A Business

To determine whether a particular business is safe for investment, you need to do a detailed financial analysis of the company. And this can take up a lot of time. But if you want to do a quick basic financial analysis of a company, then checking the following four metrics will get the job done and give you a good enough idea of whether a business is worth investing or not.

P/E Ratio

The first thing to check is the P/E ratio, known as the Price to Earnings ratio. As the name suggests, the ratio divides the price of a single share of the company with its earnings per share. Considered as the valuation of a stock, a higher figure will indicate that the share price is too high and that you should desist from investing in the company right now. However, a lower figure is an invitation to invest. You should also check the current P/E ratio of a share with its historical ratio to get a better idea of what the current valuation of a company means.

Liquidity

The next metric to consider is the liquidity of the business. Is the business in a position to cover every debt it has taken from its own assets in the short-term?  If not, then that can indicate a serious liquidity crisis in the business. And investing in such companies is a big no-no. Look at its short-term debt obligations and any other debts that will become due within a year. Compare it with the assets owned by the company. This will give you a good idea of how liquid and safe the business is. Investment firms such as Arthur Penn Pennant Park always do a liquidity analysis of a company before investing in them.

Important Financial Metrics

Operating Cash Flow

You should also look at the cash flow of the business. And according to Pennant Park, what you must really focus on is the operating cash flow. Where is the business getting its cash from? If it is through the sale of its products, then that is a sign of healthy cash flow. But if the sales of the company are down, and the cash flow is mostly due to other factors like taking new debts, the sale of stocks etc., then that is definitely a cause for concern.

Earnings Growth

Finally, check the income statement of the business and calculate its earnings growth. This will help you determine whether the company is increasing its revenues or not. It is recommended that you do an earnings analysis that goes back at least 10 to 15 years of the company’s operations. If you see a relatively consistent growth over the years, then that is an indication of a well-managed business.  But if the historical data shows that the earnings have fluctuated wildly over the years and that the current jump in earnings is only a cyclical increase, then that is a business that you should ideally not invest in.