Understanding How to Look at a Business

Understanding whether a business is doing well or poorly, is not a transparent thing. A company can be making a profit on paper, but have all of its equity locked up in inventory or plant and equipment. One of most dangerous phases for a business is after it has gotten through the initial start-up phase and is now trying to expand. If they borrow a too large loan and have trouble earning enough to pay it back they could go bankrupt very quickly. To understand how a company is doing, start by looking at the operating cash flow.

This immediately tells us how regular operations can finance the everyday operations of the business. Remember your available cash is extremely important. How much of that cash is not tied up in capital expenditures? This is the free cash flow. This is operating cash flow minus the cash invested in capital expenditures. Next look at sales - the investment cash flow, we want to see how much the company is spending on investment. If a company is not raising enough cash through the operating cash flow to cover their investments, they will have to go to financing or get financing equity capital. That’s when companies raise cash flow from the capital markets. It can be safer for a company to raise capital from investors or even run an IPO (Initial Public Offer), though there is the danger of the owner of the company losing control of the company at least partially. If you are selling parts to a computer company, or other company operating in the IT sector for example, you want to help them understand their customers. When trying to sell to such a company, you will gain a great deal of credibility if you discuss the operating strategies of similar companies in the industry.

You have to look over their industry and how they relate to and compare to other companies in their industry. This will allow you to understand the possible challenges that company is dealing with. It is important to look beyond the current operating challenges and try to broaden the scope of what a business is facing.

Once you have identified the specific industry, you want to understand the competition in that industry. It is important to understand how specific companies line up in the competitive space. It may be appropriate to look at the individual operating trends of the competitors in the industry. Oftentimes, poor performing markets cut across the competitive landscape, hurting all of the companies competing.

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