There is a profit, yet cash has halved: analysing one company's balance sheet in eight tables (a financial analysis case study)

«Bo'stonliq Suv» LLC is a small company in the foothills: one bottling line, a store of preforms and caps, and two vans that deliver drinking water to shops and cafés. When the year was closed, the founder, Farhod, asked the financial analyst, Malika, one question: "The statements show 204 million soum of net profit, yet our bank account holds half the cash we had at the start of the year. How can that be?" Malika looked for the answer in two documents: the balance sheet and the statement of financial results.

Assumptions: the company name and all figures are hypothetical and compiled by the author. Amounts are in thousand soum. To keep the calculations simple, VAT is not shown separately and corporate profit tax is a notional amount. The three-digit numbers in brackets are line codes of Appendix 1 (balance sheet) and Appendix 2 (statement of financial results) to the Regulation approved by Order No. 181. For turnover indicators the year is taken as 360 days, and the average balance = (start of year + end of year) ÷ 2. The benchmarks in the tables are rough benchmarks commonly cited in practice, not mandatory norms: they are not presented as a requirement of any law or standard and they vary by industry.

What happened during the year?

From the statement of financial results (for the year):

• Net revenue (010): 3 600 000
• Cost of goods sold (020): 2 700 000
• Gross profit (030): 3 600 000 − 2 700 000 = 900 000
• Period expenses (040): 576 000, of which selling expenses 324 000, administrative expenses 192 000, other operating expenses 60 000
• Other income from main activity (090): 12 000
• Profit from main activity (100): 900 000 − 576 000 + 12 000 = 336 000
• Interest expenses (180): 96 000
• Profit from general business activity (220) and profit before corporate profit tax (240): 336 000 − 96 000 = 240 000 (no extraordinary items)
• Corporate profit tax (250), notional amount: 36 000
• Net profit (270): 240 000 − 36 000 = 204 000

Key events of the year:

• A new bottling and packaging line that was being installed at the start of the year (capital investment 120 000) was completed with a further payment of 360 000 and put into service as a fixed asset worth 480 000.
• A long-term bank loan of 300 000 was taken for the line.
• Dividends of 72 000 were paid to the founder.
• Depreciation: 240 000 on fixed assets and 6 000 amortisation on intangible assets. No fixed assets were disposed of.

Table 1. Where is the property?

Asset structure. Share is relative to the balance sheet total; growth is relative to the start of the year.

Shares are rounded to one decimal place, so the sum of the rows may differ from the total by 0.1. Opening up current assets makes the picture clearer. Within inventories, production stocks (150) rose from 180 000 to 228 000, work in progress (160) from 6 000 to 12 000, and finished goods (170) from 96 000 to 150 000 (+56.3%). Within debtors, amounts owed by customers (220) grew from 270 000 to 420 000 (+55.6%), while advances paid to suppliers (260) fell from 36 000 to 24 000. Within cash, the cash desk (330) did not change at 6 000; the settlement account (340) dropped from 114 000 to 54 000.

What it means. Current assets grew by 26.3%, but the growth is not in cash: it is in water sitting in the warehouse and in customers' debts. Let us convert them into days: one day's revenue is 3 600 000 ÷ 360 = 10 000, one day's cost of goods sold is 2 700 000 ÷ 360 = 7 500. Customer debts at year-end equal 420 000 ÷ 10 000 = 42 days of sales (at the start of the year 270 000 ÷ 10 000 = 27 days). Finished goods equal 150 000 ÷ 7 500 = 20 days of cost of goods sold (at the start of the year 96 000 ÷ 7 500 = 12.8 days).

What the manager does: draws up a list, by name, of the customers whose debt has grown and of the products that are piling up in the warehouse. The fall in the share of non-current assets from 70.4% to 66.7% is not alarming: it is not because the new line failed to arrive but because current assets grew faster.

Table 2. Whose money paid for this property?

Structure of equity and liabilities (sources).

The balance has been checked: at the start of the year 1 296 000 + 1 092 000 = 2 388 000, at the end 1 428 000 + 1 260 000 = 2 688 000, and both equal total assets. Retained earnings came to 696 000 + 204 000 − 72 000 = 828 000. The long-term loan is 360 000 + 300 000 − 120 000 = 540 000: the 120 000 due next year has been moved to balance sheet line 750.

What it means. The debt structure has shifted in a good direction: the short-term bank loan halved, and the line was financed with long-term money. But liabilities (+15.4%) grew faster than equity (+10.2%).

What the manager does: keeps the loan schedule at hand: every year 120 000 moves from the long-term part to the current part and must be repaid that year.

Table 3. What condition are the fixed assets in, and how hard are they working?

Condition indicators are calculated for two dates, efficiency indicators for the year (in the last column).

Average initial cost is (2 400 000 + 2 880 000) ÷ 2 = 2 640 000, average net book value is (1 536 000 + 1 776 000) ÷ 2 = 1 656 000. The wear and fitness ratios always add up to 1: 0.36 + 0.64 and 0.38 + 0.62.

What it means. 38.3% of the equipment's cost has already been charged to expenses. During the year, equipment twice as expensive as the annual depreciation was put into service (480 000 against 240 000), and yet the wear ratio rose: the old equipment is ageing. Fixed asset turnover of 1.36 means each soum of fixed assets (at initial cost) produced 1.36 soum of revenue for the year; capital intensity is the inverse: one soum of revenue required 0.73 soum of fixed assets. The month in which the line started affects a simple average; for a more accurate result, the average of monthly balances is used.

What the manager does: next year compares fixed asset turnover with this year. The new line was meant to raise revenue; if turnover falls, the line is not fully loaded, and the number of shifts and downtime need checking.

Table 4. Is there enough working capital of its own?

Own working capital is the part of long-term sources (equity and long-term borrowings) left for current assets after non-current assets have been covered.

It is no coincidence that the two calculations give the same result. In the balance sheet 130 + 390 = 480 + 490 + 600, so 480 + 490 − 130 always equals 390 − 600. The first answers the question "how much long-term money is left for current assets", the second "how much of current assets remains after current debts are paid".

What it means. At the start of the year it was minus 24 000: all current assets and part of the non-current assets rested on short-term debt. By year-end it reached 174 000 and covers 45% of inventories. But the narrow version is a warning: equity alone does not even fully cover non-current assets (−366 000). The situation was fixed by the bank loan, not by profit.

What the manager does: bears in mind that as the loan is repaid, own working capital will shrink again, and sets dividends after checking this table.

Table 5. Can the company pay its short-term debts?

Liquidity ratios.

The benchmarks are rough benchmarks commonly cited in practice, not mandatory norms.

Current ratio. At the start of the year 0.97: even if all current assets were turned into cash, they would not cover current debts. At year-end 1.24: each soum of current debt is matched by 1.24 soum of current assets. Better, but Table 1 showed that the additional current assets are mostly inventories and customer debts. To reach the lower edge of the benchmark (1.5) with current liabilities unchanged would require 720 000 × 1.5 = 1 080 000 of current assets, i.e. another 186 000. Closing this gap by filling the warehouse is the wrong way.

Quick ratio. We exclude inventories because they are hard to sell quickly. It rose from 0.58 to 0.70, but the source of the rise is customer debt. Some analysts also exclude advances paid: then (708 000 − 282 000 − 36 000) ÷ 732 000 = 0.53 and (894 000 − 390 000 − 24 000) ÷ 720 000 = 0.67. Whichever version you choose, apply it every year.

Cash ratio. The most serious signal is here: a fall from 0.16 to 0.08. The 60 000 in the bank account and cash desk does not cover even the sum of the nearest payments, wages payable (60 000) and payables to the budget (48 000), i.e. 108 000.

What the manager does: draws up a weekly payment calendar and cuts customer debts. If customer debts were brought down to 30 days of sales (30 × 10 000 = 300 000), 420 000 − 300 000 = 120 000 of cash would be released. Cash would then rise to 180 000 and the cash ratio to 180 000 ÷ 720 000 = 0.25. The current ratio would not change, since a debt merely turns into cash: that is why drawing conclusions from a single ratio is dangerous.

Table 6. How dependent is the company on debt?

Financial stability indicators.

The benchmarks are rough benchmarks commonly cited in practice, not mandatory norms. In fact both benchmarks express one idea: if more than half of the assets are funded from own money, debt is smaller than equity.

Autonomy. 53.1% of the assets are funded from the company's own funds, the remaining 46.9% from debt. It fell slightly because assets grew on the back of the loan.

Debt-to-equity ratio. Each soum of equity is matched by 0.88 soum of debt (0.84 at the start of the year). The trend calls for caution: one more large loan could push this ratio above 1.

Interest coverage. Profit from main activity is 3.5 times interest expenses. In other words, interest takes 28.6% of profit from main activity (96 000 ÷ 336 000).

What the manager does: before a new loan, recalculates these three indicators for the position after taking it; keeps part of the profit in the company to strengthen equity.

Table 7. How many days does money sit in inventories and debts?

Turnover indicators, a 360-day year.

Supplier payables are divided by cost of goods sold because the example does not give purchases for the year separately; if purchases are known, dividing by them is more accurate. With 365 days the day counts get slightly longer; what matters is using the same basis every year.

What it means. From the day preforms are bought to the day the customer pays, money is on the road for 79.3 days on average, and suppliers "lend" 57.6 of those days. The company itself has to finance 21.7 days. The average looks fine, but the year-end position from Table 1 (customer debts 42 days, finished goods 20 days) shows a worsening trend. Drinking water is a seasonal product, so an average based on two winter dates can hide the reality: recalculating with monthly balances is useful.

What the manager does: instead of "shortening" the cycle by delaying payments to suppliers, reviews payment terms with customers and the winter production plan. A supplier's patience is not unlimited.

Table 8. How much profit did the capital earn?

Profitability indicators (for the year). Average assets are (2 388 000 + 2 688 000) ÷ 2 = 2 538 000, average equity is (1 296 000 + 1 428 000) ÷ 2 = 1 362 000.

ROA. Every 100 soum of property at the company's disposal earned 8.04 soum of net profit during the year.

ROE. Every 100 soum the founder invested and left in the company earned 14.98 soum of net profit for the year. ROE is higher than ROA because part of the assets is funded by debt: debt magnifies profit relative to the founder's capital, but in a loss year it magnifies the loss too.

Return on sales. Out of every 100 soum of revenue, 5.67 soum of net profit remains. On the way from the 25.00% gross margin to the net margin, the biggest "eater" is period expenses: 576 000, i.e. 16.0% of revenue.

ROE can be split into three parts (the DuPont method): ROE = return on sales × asset turnover × equity multiplier. Asset turnover is 3 600 000 ÷ 2 538 000 = 1.42, the equity multiplier is 2 538 000 ÷ 1 362 000 = 1.86. Check: 5.67% × 1.42 × 1.86 = 14.98%.

What the manager does: raises ROE not by piling on debt but first of all through return on sales (period expenses) and asset turnover (inventories and customer debts). Growth through debt increases the risk shown in Table 6.

Where did the cash go, and what should the manager do?

A simplified calculation for Farhod's question (not the format of the official cash flow statement, only an illustration of the logic):

• Net profit and depreciation: 204 000 + 240 000 + 6 000 = 450 000
• Increase in inventories: −108 000; increase in customer debts: −150 000; decrease in advances: +12 000
• Increase in payables to suppliers, the budget and employees: 24 000 + 6 000 + 6 000 = +36 000
• Cash from operating activity: 450 000 − 108 000 − 150 000 + 12 000 + 36 000 = 240 000
• Payment for the line: −360 000
• New loan +300 000, current portion of the loan repaid −120 000, short-term loan reduced −48 000, dividends −72 000: total +60 000
• Result: 240 000 − 360 000 + 60 000 = −60 000, i.e. cash fell from 120 000 to 60 000

The answer: the profit did generate cash, but 258 000 of it (108 000 + 150 000) got "stuck" in the warehouse and in customer debts, while the line was only partly covered by the loan. Malika proposed the following plan to Farhod:

1. Cut customer debts from 42 to 30 days of sales: 120 000 of cash is released and the cash ratio rises to 0.25.
2. Align winter production with the sales plan: bring the finished goods stock back from 20 days at year-end to the start-of-year level (12.8 days).
3. A weekly payment calendar: set aside cash in advance for wages and budget payments (108 000).
4. Set dividends after checking own working capital and the loan schedule: 120 000 of the loan is repaid every year.
5. Track the load of the new line month by month: next year fixed asset turnover should not fall below 1.36.
6. Review period expenses (16.0% of revenue) and interest expenses (28.6% of profit from main activity) item by item.

And one limitation: this analysis rests on two dates in a single year. Ratios are a signal, not a verdict. A full conclusion only comes from comparing them with previous years, with similar companies in the industry and with monthly data.