Studying the Financial Health of Businesses in the Midst of Brexit
As you already know, Britain will officially leave the EU on March 29, 2019. Until then - and especially after then - it'll be important for investors to keep an eye on the health of UK-based businesses to see what (if any) impact it has on their financial standing.
Understanding the Brexit Impact
We're currently on the verge of something catalytic, yet have to wait for the inevitable to arrive. We know Britain is leaving the EU, but we have to wait for it to actually happen.
The short-term effects of Brexit have been felt for the last couple years. The long-term implications have yet to be realized. Will the entire business world take a hit? Will certain sectors shrivel up? Will others experience rejuvenation? Will the regulatory and risk environment shift?
At this point, there are a lot of questions and few answers. Contradictory speculation from a variety of so-called experts is all we have to work with. And while we don't know exactly what to expect, here are some areas that UK-based businesses will want to pay attention to:
- One thing we know is that there will be extreme volatility in the hours and days after Brexit. How long it will take to level out remains to be seen, but businesses should be prepared.
- There will be high exposure to currency risks. This could affect value and funding levels for different companies.
- Pension scheme funding levels will be vulnerable to significant changes in interest rates, which could have significant financial ramifications.
- Companies in certain industries – such as financial services – will experience far greater volatility than those in other niches – such as retail.
The KPIs to Keep an Eye On
From an investor's perspective, it will be challenging to block out the noise that comes along with Brexit, but it's imperative that you learn to look past these surface-level distractions and make objective evaluations.
One of the best ways to make objective evaluations is to look at key performance indicators – or KPIs.
"Obviously there are many types of KPIs, depending on the specific target and the best indicator to measure it," datapine explains. "The broadest distinction is to separate the different types into nonfinancial and financial KPIs. The second refers to all indicators that have to do with the cash flow, debt and assets of a company."
According to datapine, KPIs can be divided into several categories. These include quantitative vs. qualitative indicators, lagging vs. leading indicators, input vs. output indicators, and process vs. actionable indicators.
More specifically, you should be using the following KPI metrics to judge an organization's financial health and well-being
Operating efficiency. When attempting to understand a company's financial success, look to its operating efficiency. The best indicator of operational efficiency is the operating margin. You can calculate this by taking the operating income and dividing it by net sales revenue.
Liquidity. The simplest definition of liquidity is the amount of cash and easily convertible assets a company owns (in comparison to its short-term debt obligations). In other words, if the business needs money to do something, how much leverage does it have?
Working capital ratio. A company's working capital ratio can be calculated by taking the company's current assets and dividing that number by its current liabilities. If a company has current assets of $10 million and current liabilities of $1 million, that's a 10:1 ratio (which is extremely healthy).
Return on equity. One of the key metrics investors look at is their return on equity. This is an indicator of how profitable their capital is in the businesses they're investing in. This can be calculated by taking the company's net earnings, subtracting the preferred dividends, and dividing the resulting number by common equity dollars.
Adding it All Up
There's no foolproof method for evaluating a company's financial health and well-being – especially in the midst of Brexit. However, if you ground your evaluations in objective metrics, you'll be less prone to making emotional decisions that are based in the heat of the moment.