Every project published on the platform has a key financial figures section. It includes the main financial indicators and ratios reviewed by October’s analysts when studying the company.
Not all of us are finance professionals. We created this tutorial to explain the financial indicators and how to interpret them.
The easiest way is to get to the heart of the matter with an example : let’s imagine a company called November (😉) borrowing €200,000 at 5% over 18 months.
For each project, we present some elements of the company's balance sheet in a table:
The balance sheet
The accounting period usually lasts 12 months and is a "picture" at a given time of a company's situation. The balance sheet is made up of equal assets and liabilities. To simplify, assets represent what the company holds while liabilities represent what it owes. On the assets side, we find in particular its fixed assets (land held by the company for example) and its current assets such as inventory or accounts receivable (the amount customers owe to the company). On the liabilities side, we find the common stock, provisions or debts. Common stock is part of a larger concept called equity: the equity represents a guarantee for investors because it allows a company to absorb losses. You got it: the starting point for financial analysis is accounting.
The income statement
Not all the figures presented in the table of the Project page come from the balance sheet. The turnover, the earnings before interest taxes depreciations and amortisations (EBITDA) and the net income are subtotals calculated from the income statement. This approach is complementary to the balance sheet approach.
The turnover represents the net sales generated by a business over a period of time. Therefore, it measures the attractiveness of a company's offer. It can be interesting to have a look at the turnover evolution but it does not give any indication of the company's ability to generate profits. For example, if the turnover increases significantly but the costs increase even more, the company will lose money.
To do this, we study the EBITDA. The EBITDA is a profitability calculation: if it is positive, it means the company generates enough turnover to cover all its expenses.
Finally, the net income is the last of the subtotals. It reflects if the company makes profit or loss and is expressed as a percentage of the turnover.
Companies have a sustainable but variable need for liquidity. The operating working capital requirements (OWCR) is the amount of cash needed by the company to pay its current liabilities. It can be positive or negative: if it is negative, it means that the company has no immediate cash requirement. The need for OWC varies over time but it is crucial. A company can go bankrupt even if it is solvent if it does not manage to get paid quickly enough by its customers. This is a key issue for companies, which must ensure that they generate enough cash to meet their deadlines on an ongoing basis. Some sectors, such as the toy sector, are highly exposed to seasonality. Going back to our example, in 2018, the working capital requirement of the November project in 2018 was 16 days (i.e. its cash requirement for 2018 corresponds to 16 days of turnover).
There is still one key concept to define: the net debt. Net of what? The net debt refers to the total debt of a company minus cash on hand, to obtain an image of the company's actual debt (because this cash could offset part of its debt). If the net debt is negative, the company possesses more cash than its financial obligations.
A lot of notions all at once? Rest assured, we are finished with the definitions. It is now time to move on to the interpretation part.
On the project page, you can find several financial ratios:
- The net debt-to-EBITDA ratio is a solvency ratio. Widely used in financial analysis, this ratio is simple to use and quick to calculate. It measures the company's ability to repay its debt based on its EBITDA. It shows how many years it would take for a company to pay back using all its EBITDA: in the table presented above, it would take 0.32 years to November to repay its debt with its 2018 EBITDA.
- The net debt-to-equity ratio is called the gearing ratio and measures the degree of dependency of a company on external financing. In our example, net debt represented 19.68% of the company’s equity in 2018. The lower the ratio, the better the company situation. Indeed, its equity represents a guarantee for creditors.
- Finally, let us look at the equity-to-assets ratio. In our example, shareholders' equity represented 44.2% of November's balance sheet total in 2018. Remember that equity is part of the company's liabilities and that assets are equal to liabilities. In this case, a higher ratio is preferred because high equity shows that the company's manager believes in its activity and look for capital, which represents a guarantee.
At the bottom of the Project page you will find a last key indicator, the FCCR (Fixed Charge Coverage Ratio) which represents the company's repayment capacity. The higher the FCCR, the greater the margin of safety. For example, a FCCR of 1.5 means that the company has a 50% cushion against its ability to repay.
- FCCR < 1 : insufficient profitability to cover debt repayment charges -> project rejected
- FCCR = 1 : profitability just sufficient to cover debt repayment charges -> presentation to the Credit Committee will be considered depending on the history and management of the company and contextual elements
- FCCR > 1 : profitability sufficient to cover debt repayment charges with a safety cushion -> presentation to the Credit Committee will be considered taking into account contextual elements.
Italian and Spanish projects
Some of the ratios used in the project analysis depend on its country of origin. In Italy, the table also details the EBITDA margin, current liabilities, current and fixed assets as well as short and long-term debt.
The EBITDA margin is equal to the EBITDA-to-sales ratio, that we have previously defined. The other elements are part of the balance sheet and provide a better understanding of the balance sheet structure.
Finally, the Dutch projects have the same number of ratios as the French projects. These differences comes from the different regulations in place in each of these countries.
That's all for the key figures 😴.
For the most courageous, we will conclude with some practical aspects:
- The financial analysis we propose is given as an indication, based on the information provided by borrowers.
- Based on this analysis, we contrast the figures with reality to get to know the company better. These quantitative and qualitative analyses are the basis for the projet rating and interest rate at which a company borrows. Here again, we will not dwell any more on this: for the curious, here is a tutorial on the project selection and rating.