Determining a company’s financial health is a very important step in making a decision whether or not to invest. There are many different ways to compute a company’s financial health, but in this test, I take into consideration Capital Product Partners LP (CPLP) profitability, debt and capital, and operating efficiency. Based on these three criteria we get to see sales, returns, margins, liabilities, assets, returns and turnovers.
Profitability is class of financial metrics that are used to assess a business’s ability to generate earnings as compared to its expenses and other relevant costs incurred during a specific period of time.
In this section, we will look at four tests of profitability. They are: Net Income, Operating Cash Flow, Return on Assets and Quality of Earnings. From these four metrics, we will establish if the company is making money and gauge the quality of the reported profits.
1. Net Income 2011 = $87.12 million
To pass, the company needs to have a positive net income. CPLP passes.
2. Operating Cash Flow 2011 = $56.54 billion
Operating Cash Flow is the cash generated from the operations of a company, generally defined as revenues less all operating expenses, but calculated through a series of adjustments to net income.
To pass the company needs to have a positive operating cash flow. CPLP passes
3. ROA – Return On Assets
ROA is an indicator of how profitable a company is relative to its total assets. ROA gives an idea as to how efficient management is at using its assets to generate earnings. Calculated by dividing a company’s net income by its total assets, ROA is displayed as a percentage. Sometimes this is referred to as “return on investment”.
ROA in 2010 = 2.36
ROA in 2011 = 7.28
Net income growth 2010 = $17.94 million to 2011 = $87.12 million a difference of 486%
Assets growth in 2010 = $758.25 million to 2012 = $1.196 billion a difference of 37%
In 2010 to 2011 the companies ROA grew. CPLP passes
4. Quality of Earnings
Quality of Earnings is the amount of earnings attributable to higher sales or lower costs rather than artificial profits created by accounting anomalies such as inflation of inventory.
Operating Cash Flow = $56.54 billion
Net Income = $87.12 million
To pass the operating cash flow must exceed the net income. CPLP Does not Pass
Debt and Capital
The Debt and Capital section establishes if the company is sinking into debt or digging its way out. It will also determine if the company growing organically or raising cash by selling off stock.
5. Total Liabilities to Total Assets or TL/A ratio.
TL/A ratio is a metric used to measure a company’s financial risk by determining how much of the company’s assets have been financed by debt.
Total Assets – 2010 = $758.25 million
Total Assets – 2011 = $1.196 billion
Equals an increase of 37%
Total Liabilities 2011 = $518.49 million
Total liabilities 2012 = $678.96 million
Increase of 24%
CPLP increase in Total Assets exceeded the percentage of Total Liabilities. Total Assets increased by 37%, while the total liabilities increased by 24%. CPLP Passes.
6. Working Capital
Working Capital is a general and quick measure of liquidity of a firm. It represents the margin of safety or cushion available to the creditors. It is an index of the firms financial stability. It is also an index of technical solvency and an index of the strength of working capital.
Current Assets / Current liabilities
Current Ratio 2010 = 3.82
Current Ratio 2011 = 1.11
CPLP current ratio dropped from 3.82 to 1.11, but 1.11 is still an acceptable number, as the industry standard is 1.8.
CPLP does not pass
7. Shares Outstanding
Current Shares Outstanding = 70.79 million
2010 Shares Outstanding = 38.72 million
To pass, the company’s shares must increase less than by 2%. CPLP Does not Pass
Operating Efficicncy is a market condition that exists when participants can execute transactions and receive services at a price that equates fairly to the actual costs required to provide them. An operationally-efficient market allows investors to make transactions that move the market further toward the overall goal of prudent capital allocation without being chiseled down by excessive frictional costs, which would reduce the risk/reward profile of the transaction.
8. Gross Margin: Gross Income / Sales
The gross profit margin is a measurement of a company’s manufacturing and distribution efficiency during the production process. The gross profit tells an investor the percentage of revenue / sales left after subtracting the cost of goods sold. A company that boasts a higher gross profit margin than its competitors and industry is more efficient. Investors tend to pay more for businesses that have higher efficiency ratings than their competitors, as these businesses should be able to make a decent profit as long as overhead costs are controlled (overhead refers to rent, utilities, etc.)
Gross Margin 2010 = $117.58 / $124.59 = 94.37%
Gross Margin 2011 = $118.59 / $132.32 = 90.91%
The gross profit margins decreased slightly in 2011 over 2010. The gross margin slipped from 94.37% to 90.91%. Even though it was a small amount, CPLP does not pass.
9. Asset Turnover:
The formula for the asset turnover ratio evaluates how well a company is utilizing its assets to produce revenue.
The numerator of the asset turnover ratio formula shows revenues which is found on a company’s income statement and the denominator shows total assets which is found on a company’s balance sheet. Total assets should be averaged over the period of time that is being evaluated.
Sales growth – 2010 sales = $124.59 million
Sales growth – 2011 sales = $132.32 million
6.0% sales growth
Asset growth – Assets in 2011 = $758.25 million
Asset growth – Assets in 2012 = $1.196 billion
Asset growth of 36%
As the Sales growth is exceeding the Asset growth this implies that inventory is being moved. CPLP does not pass
Based on the nine tests that CPLP received on profitability, debt and capital, and operating efficiency, CPLP received 4 passes out of 9.