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 considering Consolidated Edison's (NYSE:ED) profitability, debt and capital, and operating efficiency. Based on this criteria, we get to see sales, returns, margins, liabilities, assets, returns and turnovers.
Profitability is a class of financial metrics that are used to assess a business' ability to generate earnings, compared with 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.
- Net Income 2011 = $1.062 billion
To pass, the company needs to have a positive net income. Consolidated Edison Inc. passes.
- Operating Cash Flow 2011 = $2.239 billion
Operating Cash Flow is the cash generated from the operations of a company, generally defined as revenue 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. Consolidated Edison Inc. passes.
- 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 = 2.75%
ROA in 2011 = 2.70%
Net income growth, 2010 = $1.003 billion to 2011 = $1.062 billion, a increase of 5.88%
Total Asset growth, 2010 = $36.348 billion to 2011 = $39.214 billion, an increase of 7.89%
In 2010-2011, Consolidated Edison's decreased from 2.75% to 2.70%. Consolidated Edison does not pass.
- 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 = $2.239 billion
Net Income 2011 = $1.062 billion
To pass, the operating cash flow must exceed the net income. Consolidated Edison passes, Operating Cash Flow exceeds net income.
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.
- 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 = $36.348 billion
Total Assets - 2011 = $39.214 billion
Equals an increase of 1.08%
Total Liabilities 2010 = $25.074 billion
Total liabilities 2011 = $27.565 billion
Equals an increase of 1.10%
Consolidated Edison's increase in total assets was less than the percentage increase of total liabilities. Total assets increased by 1.08%, while the total liabilities increased by 1.10%. As the total assets did not exceed the total liabilities, Consolidated Edison does not pass.
- 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 = 1.45
Current Ratio 2011 = 1.22
Consolidated Edison's current ratio went from 1.45 in 2010 to 1.22 in 2011. As Consolidated Edison's current ratio decreased, Consolidated Edison does not pass.
- Shares Outstanding
2010 Shares Outstanding = 268.41 million
2011 Shares Outstanding = 269.69 million
To pass, the company's shares must increase less than by 2%. Consolidated Edison shares increased by 0.44%. Consolidated Edison passes.
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.
- 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 = $8.029 billion/ $13.325 billion = 60.21%
- Gross Margin 2011 = $8.349 billion/ $12.938 billion = 64.53%
The gross margin increased from 60.21% in 2010 to 64.53% in 2011. As the gross margin Increased, Consolidated Edison passes.
- 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 = $13.325 billion
Sales growth - 2011 sales = $12.938 billion
2.95% sales decrease
Asset growth - Assets in 2010 = $36.348 billion
Asset growth - Assets in 2011 = $39.214 billion
Asset increase of 7.89%
As the sales growth did not exceed the asset growth, this implies that the sales did not keep up with the asset growth. Consolidated Edison does not pass.
Based on the nine tests that Consolidated Edison received on profitability, debt and capital, and operating efficiency, the company achieved six passes out of nine-this is a strong grade for financial health. Consolidated Edison Incorporation declined in its ROA, working capital, the asset turnover and the TL/A and Asset Turnover aspects of the test. The ROA implies that management was less efficient at using its assets to generate earnings, the TL/A ratio implies that more of the assets acquired in 2011 were financed by debt than in 2010. The working capital implies the company does not have as much liquidity as the year before, the while the asset turnover aspect of the test implies that the sales did not keep up with the asset growth in 2011. None of these declines were major or raise any red flags but these are some of the areas to watch going forward. Based on the nine tests, overall, the company is showing good results with six passes out of nine.
This shows that Consolidated Edison is very profitable, and very efficient. Based on the nine tests, overall, the company is showing strong results.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.