I recently wrote a guest blog piece for Duedil.com on how to get the most from reading a set of abbreviated accounts. It is reproduced in full below:
Although all companies are required to file accounts with Companies House, small companies need only file abbreviated accounts that often comprise nothing more than a simplified balance sheet.
This post covers a few tricks to get the most from this limited information, which I picked up screening potential acquisition targets for clients.
Bear in mind that these are only estimation techniques and should never be relied too heavily upon.
Here is a mocked up set of abbreviated accounts for you to work through:
The profit and loss reserve includes all the accumulated profits of the business to date that have not yet been distributed to shareholders in the form of dividends.
Therefore these accounts tell us that the business made profits of at least £3,924 (£14,363 – £10,439) in 2011 plus whatever dividend was taken out.
Sometimes a note to the accounts will say the amount of dividend taken. If, for example, a dividend of £40,000 was taken then we would know with a high degree of confidence that the company made profits of £43,924 during the year.
The opposite applies if the profit and loss reserve decreases year on year. Let’s assume that there was a negative reserve of £5,456 in 2010 and £10,535 in 2011 (not unusual for a startup). We can mine quite a bit of information from this.
First we know that over the lifetime of the businesses the losses to date have totaled £5,456. We also know that because a loss making company can’t take a dividend the actual loss in 2011 was £5,079.
We know that when the accounts were drawn up there were debtors of £16,717. Broadly this means that customers owe the business this amount of money.
If you are looking at the accounts of a company in a similar industry to you, you can probably assume they give broadly similar payment terms to customers. Perhaps you allow all customers to pay in 30 days but they actually pay in 45 days. This would mean that £16,717 represents 45 days worth of sales. A bit of maths (£16,717 / 45 * 365) tells us that annual sales are about £135,593.
When doing this beware the impact that cash sales (not included in debtors) or seasonal sales (the debtors might reflect an unusually busy time of year) could have!
Estimating sales growth
We already think £16,717 represents 45 days of sales, if the equivalent debtors for 2010 of £10,276 also representds 45 days of sales then we can work out a growth rate. These accounts suggest that sales have grown an impressive 63% year on year.
Estimating profit margins
The creditors number should tell us the amount of money due to suppliers of the company (though it may also include loans).
If we also assume suppliers are paid on 45 day terms then the company earns a profit margin of 39% (sales of £135,593 – expenses of £83,260 = profit of £52,333. Then £52,333 / £135,592 * 100). Note that this gave us another idea of the profits earned. Perhaps a dividend of more than £40,000 was taken?
If all this is correct then profit margins decreased year on year (from 46% in 2010), which could be because the company reduced prices to increase sale volume.