Basically, the reference KPI is EBITDA. It captures how the basic business is doing, without considering non-recurring items, erratic taxes, or debt loads.
In addition to EBITDA, look at:
- Revenue/sales: it should be positive. But in case of very fast growth, keep in mind that it must be funded.
- Net profit margin: the higher, the better.
- Leverage (Net debt / EBITDA): it should typically be below 3 or 4 but can also differ depending on the sector.
- Liquidity: it includes cash and non-withdrawn confirmed credit lines.
- Debt-to-equity ratios: it should be analysed in the long term.
And don’t forget the Working Capital Requirement (WCR), a measure of the amount of liquidity that is trapped in the business at any time simply to maintain operations. It is calculated as the difference between short-term assets and short-term liabilities.
In the longer term, look at equity, debt-to-equity ratios and debt maturity profile. How is their access to credit?
Then, compare your findings to the industry average, and you have a picture of your partner’s financial viability.
On a practical level, don’t be too rigid in how you judge the data. There’s no such thing as a “good” or “bad” ratio. For instance, a trading company usually operates with low margins and a high debt burden leading to an elevated net debt-to-EBITDA ratio. However, this short-term debt is backed by inventories and buy/sell transactions. In the opposite, an industrial group will rely on long-term debt to maintain its machines and invest into heavy equipment.