Analysis of Balance Sheets

[Alaric]

If you look at an Investment Trust, a primary comparison is between net asset value and value of issued shares. Net asset value is usually pretty solid being the value of the invested assets.

Move sideways to a company with a variety of interests. You run into to intangible assets such as goodwill. As a filter, goodwill percent could make sense. A balance sheet that featured trade assets, cash, receivables even, is more reliable than one of "goodwill".

"Goodwill" helped make the Carillion balance sheet balance. In less than a year the net asset value to creditors is suggested to be around 1p in £ 1. Even the rats ( sorry accountancy firms) didn't want a part of the administration action.

[Dod101]

I think I can see the point you are making but Goodwill did not make the Balance Sheet balance; it could just as easily have balanced without the Goodwill and some would argue, have been more meaningful. Small sub contractors of Carillion cannot be paid in Goodwill, only hard assets such as cash or machinery or other assets which can be turned in to cash, which is I assume your point.

Dod

[scrumpyjack]

Almost any balance sheet can evaporate very quickly if trading deteriorates. I am always suspicious of goodwill as it usually arises where a company has purchased another business for a price higher than its net assets. It is an accounting 'balancing item' rather than a saleable asset. In theory it should be written down where the assets are not generating a return to justify it. Anyway it is cash that pays creditors, not net assets. It's almost always running out of cash that brings a business down.

Sometimes 'goodwill' really represents real but intangible assets like Brands which can have substantial value.

For Investment Trusts, obviously Net Assets is the sum of the market value of the shares held by the trust less any liabilities. But those shares can be in companies with loads of goodwill in their balance sheets!

[Alaric]

It's almost always running out of cash that brings a business down.

Very true. If as a potential investor you want to avoid the risk of another Carillion, isn't checking the quality of the Balance Sheet a useful additional filter? Whilst a review can and presumably did in the case of Carillion, write goodwill off with the stroke of a pen, with cash it actually has to be spent to not be available.

[Dod101]

It's almost always running out of cash that brings a business down.

Very true. If as a potential investor you want to avoid the risk of another Carillion, isn't checking the quality of the Balance Sheet a useful additional filter? Whilst a review can and presumably did in the case of Carillion, write goodwill off with the stroke of a pen, with cash it actually has to be spent to not be available.

I think that is the very fundamental point. Far more use than worrying about dividend coverage etc. Unfortunately these days having spare cash on the Balance Sheet is seen as being inefficient but without it or access to it via a line of credit any company can easily get into trouble. That is why Carillion was dead in the water when it started scrambling around for money to be raised literally any way.

Goodwill has succumbed to 'modern' accounting practises. Time was when goodwill was written off at the time of acquisition and a good thing too because unless it is a 'brand' goodwill can only be sold if the acquisition is traded on. But it is hardly a conservative practice and that is what we need to get back to although I doubt it will ever happen.

Dod

[Alaric]

Unfortunately these days having spare cash on the Balance Sheet is seen as being inefficient but without it or access to it via a line of credit any company can easily get into trouble.

Dividends have to be paid in cash rather than "goodwill". So if a filter is that a Company is maintaining and even increasing its dividend, that should be taken with a pinch of salt if it's notional assets that are financing it rather than cash profits.

[Dod101]

Unfortunately these days having spare cash on the Balance Sheet is seen as being inefficient but without it or access to it via a line of credit any company can easily get into trouble.

Dividends have to be paid in cash rather than "goodwill". So if a filter is that a Company is maintaining and even increasing its dividend, that should be taken with a pinch of salt if it's notional assets that are financing it rather than cash profits.

Maybe it would be better to say if it is notional profits rather than cash profits that are financing the dividend. Another test might be how close free cash flow gets to reported profits but that can sometimes be a not very straightforward calculation although there is plenty on the internet on the subject. Notice that the tobacco companies have something close to a 100% cash conversion rate.

Dod