Seeking Alpha

Determining a company's financial health is a very important step in making a decision whether or not to invest or to stay invested. There are many different ways to compute a company's financial health. In this test, I will be taking into consideration Visa's (V) profitability, debt and capital, and operating efficiency. Based on this criteria, we get to see sales, returns, margins, liabilities, assets, returns and turnovers.

Profitability

Profitability is a class of financial metrics used to assess a business' 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 Visa is making money and gauge the quality of the reported profits.

1. Net Income 2011 = \$3.650 billion

To pass, the company needs to have a positive net income. Visa passes.

1. Operating Cash Flow 2011 = \$5.456 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. Visa passes.

1. 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 = 8.87%

• ROA in 2011 = 10.5%

• Net income growth, 2010 = \$2.966 billion to 2011 = \$3.650 billion, a gain of 33.3%

• Total Asset growth, 2010 = \$33.408 billion to 2011 = \$34.760 billion, a difference of 10%

In 2010 to 2011, the company's ROA grew. Visa passes.

1. 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 2011 = \$5.456 billion

• Net Income 2011 = \$3.650 billion

To pass, the operating cash flow must exceed the net income. The company's operating cash flow exceed the net income. Visa passes.

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 is growing organically or raising cash by selling off stock.

1. 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 = \$33.408 billion

• Total Assets - 2011 = \$34.760 billion

• Total Assets Equals an increase of 3.89%

• Total Liabilities 2010 = \$8.397 billion

• Total liabilities 2011 = \$8.323 billion

• Total liabilities show a decrease of .01%

Visa's increase in Total Assets exceeded the percentage of Total Liabilities. Total Assets increased by 10.2%, while the total liabilities decreased by .01%. Having decreased its liabilities, Visa passes.

1. 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 firm's 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 = 2.50

• Current Ratio 2011 = 2.66

Visa's current ratio went from 2.50 in 2010 to 2.66 in 2011. This is well above the industry standard of 2.1 As the current ratio increased, Visa passes.

1. Shares Outstanding
• 2010 Shares Outstanding = 835.00 million

• 2011 Shares Outstanding = 812.00 million

To pass, a company's shares must increase less than by 2%. The company bought back shares. Visa passes.

Operating Efficiency

Operating Efficiency 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.

1. 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 = \$6.130 / \$8.065 = 76.0%

• Gross Margin 2011 = \$7.074 / \$9.188 = 76.9%

The gross profit margins increased slightly in 2011 over 2010. The gross margin went from 76% in 2010 to 76.9% in 2011. The gross margin increased. Visa passes.

1. 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 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 = \$8.065 billion

• Sales growth - 2011 sales = \$9.188 billion

• 12.2% sales growth

• Asset growth - Assets in 2010 = \$33.408 billion

• Asset growth - Assets in 2011 = \$34.760 billion

• Asset growth of 3.8%

As the Sales growth is exceeding the Asset growth, this implies that the company is making money on its assets. Visa passes.

Based on the above tests regarding profitability, debt and capital, and operating efficiency, Visa received a nine out of nine -- an excellent grade for financial health. As all aspects tested passed, there are no red flags raised about the company's financial health.

For further reading regarding my take on Visa, please take a look at "Increasing Revenues Drive Visa In 2012" and "3 Income Growth Companies With A History Of Increasing Yields."

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in V over the next 72 hours.