Investigating a Potential Employer: Using Financial Metrics to Protect Your Future

By Markets Fool.com

There is much to consider before you decide to join a company. Of course it is important to understand the company culture, the workload, management style, performance expectations, pay and benefits. But you will also want to be sure that a prospective employer is viable. To help you gauge how strong your continued employment and even potential for career growth is within the company, you may want to know about these financial metrics.

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Reviewing the financial statements of a prospective employer can give you a better sense of its profitability and ability to grow. You want to ensure that the company is able to stay afloat and fulfill its financial obligations, but you also want to see that it has a solid business plan to keep pace with competition and evolve with changing times.

If you are at all concerned about career growth, these metrics can be very telling. For example, if a company's earnings are growing and its lines of business are expanding, it shows that there is opportunity for top performers to move up the corporate ladder on the wings of that growth.

While this is more applicable to publicly traded companies with regular SEC filings, you may be able to obtain information on private companies through sources on the Internet or from the company itself.

Once you have a prospective employer in mind and access to their financials, here are a couple of solid indicators to help you decide whether this is a good career move for you.

Considering financial solvency: current assets and liabilities
A company's ability to cover its short-term liabilities with liquid assets indicates how well they can weather a market downturn or cyclical lows while they continue making payments to suppliers, creditors, and -- more importantly -- its employees. You can quickly gauge a company's solvency with these two ratios:

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Current ratio
This is the ratio of a company's current assets (cash and other liquid assets) to its current liabilities (short-term loans, accounts payable, upcoming debt obligations). You can find this information on the company's balance sheet in an annual or quarterly filing. Look for the "total current assets" and "totalcurrent liabilities"line items.

Current ratio = total current assets / total current liabilities. If a firm has current assets of $1 million and current liabilities totaling $750,000, then the current ratio would be 1.33 (that's $1 million / $750,000). A current ratio greater than 1.0 indicates that a company has enough liquid assets to cover its short-term financial obligations. In terms of this metric, the higher, the better: Firms that carry significantly more current assets than current debt are less susceptible to default and liquidation risk.

Quick ratio
The current ratio can be further refined to removethe least liquid assetsfrom the equation, which provides a clearer sense of a firm's ability to cover its short-term obligations. This is called thequick ratio. It only takes into consideration the assets that are most easily converted into cash, typically excluding inventory since it is difficult to liquidate a warehouse without significantly discounting its contents.

Quick ratio = (cash & equivalents + short-term investments + accounts receivable) / current liabilities. These can all be found on the balance sheet, but it is worth noting that some companies do not carry short-term investments on the balance sheet. Don't panic if you can't find it. It simply means they don't have any. Let's say the firm above reports having $700,000 in cash, $100,000 in short-term investments, $100,000 of accounts receivable, and the same $750,000 of current liabilities. The equation would look like this:

Quick ratio = ($700,000 + $100,000 + $100,000) / $750,000 = 1.2

The outcome is a much more conservative estimate of a liquidation scenario. Whereas current ratio was a comfortable 1.33, quick ratio is slightly less comfortable at 1.2. Again, higher numbers are better, especially when excluding assets that are arguably less accessible in a pinch.

Evaluating operating metrics
You want to make sure that the company is profitable -- or, if it is a growing start-up, that it at least has the ability to achieve profit. You should look at multiple periods of data to get a sense of how the firm is growing in terms of earnings and its ability to generate cash flow.

Profitability can be measured in a number of ways, but the simplest approach is to look atgross profit. This is, quite simply,revenueminusexpense(or cost of sales).If a company earns revenue of $1,000,000 and incurs $600,000 cost of sales, then its profit is $400,000. Gross profit is calculated as a percentage:

($1 million -- $600,000) / $1 million = 40%.

This information can be found on the income statement (or statement of earnings). Look fornet revenuesandcost of sales. This information is also pre-calculated and provided on financial websites.

Another thing I like to look at is the cash flow statement, which gives a better sense of how well the firm generates and uses cash. Mature companies often generate more cash than they can realistically spend, so they reward shareholders with dividends and buybacks. Strong cash generation can also be an indicator of a firm's ability to pay employee bonuses. Bonus pools sometimes have cash earnings targets, so a strong uptrend in cash earnings would be a positive thing for employees. Unfortunately, this is not a universal fact, and in most cases, bonus-funding is a secret sauce known only to upper-level executives.

The cash flow statement has three components that lead into the bottom-line cash balance:

  • Net cash provided by operating activities: This is cash generated by (or used for) the core business of the firm. It starts with net income and accounts for the cash impact related to running the business.

  • Net cash provided by investing activities:This is cash the firm uses for (or earns from) investments. This accounts for things like capital expenditures, acquisitions, or proceeds from the sale of investments.

  • Net cash provided by financing activities:This is cash used to service debt or equity. If the firm issues or retires debt, pays dividends, or repurchases stock, it is recorded here. These are all uses of cash.

The net result of these components is thecash balanceor thechange in cash and cash equivalents. Look at multiple time periods to get a feel for the safety level of that cash. Some companies or industries are more cash-rich than others for various reasons. Some industries are more capital-intensive than others and require frequent investment to maintain and grow capacity. It's important to account for this when evaluating the health of a company's cash flow.

Conclusion
Armed with this information, you're likely to impress the person interviewing you, assuming your findings lead you to pursue the opportunity. The level of data required may seem daunting at first, especially when you're evaluating multiple opportunities or when you're unfamiliar with financial statements. Fortunately, a lot of this data is populated in financial websites, so you won't necessarily have to download lengthy SEC filings to get the information you need.

The job hunt itself is time consuming, and I understand why people might find this level of due diligence to be excessive. But we're talking about your career and your ability to have a rewarding employment experience. To me, it has always seemed worth the time I invested.

This article originally appeared on Get Rich Slowly.

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