In this blog post, I take a look at 5 factors you should be watching in the upcoming ASX Reporting Season in August 2022. These factors will help you analyse a company’s annual report in rapid time.

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For my example, I’m using fan favourite Xero Limited (ASX: XRO) as my case study.

1. Is my company growing?

Using the Statement of Profit & Loss, otherwise known as the Income Statement, you can see if a company is growing sales revenue or not. As we know from recent Live sessions, consistent long-term growth is the most important factor for the best-performing companies in the world.

Source: Xero annual report

Tip: Go inside Selfwealth >> Company page >> Ratios >> Growth Rates >> here you can see a company’s five-year average revenue growth rate.

2. What’s the debt versus cash position? 

Source: Xero 2022 annual report

Comparing the cash versus debt position of a company can give you an insight into the financial risks facing a business. Debt is often called “interest-bearing liabilities” and it can be split between “current liabilities” and “non-current liabilities”.

While having debt isn’t always a bad thing, during a market crash or a recession is when the financial strength of companies are really tested. In a recession, the strong will thrive while the weak fall behind.

Above, you can see that Xero has quite a bit of debt ($NZ884 million) but it has more cash than debt. So long as it has enough cash flow to service the interest repayments, it should be okay.

Keep this figure in mind as we move through the next two points…

3. Have costs got better… or worse?

Xero 2022 annual report

In the 10 years leading up to 2022, many companies were binging themselves on low-cost debt as interest rates fell. This coincided with rising stock prices. Basically, company Chief Financial Officers looked like rockstars for little effort!

Ultimately, many companies have been able to grow their share prices despite actually being quite poor businesses. Now, in 2022, as inflation and interest rates rise, shareholders are coming knocking. Companies are being exposed.

Most of us are now demanding leaner business models and profitability — which eventually leads to bigger dividends.

Back on Xero’s income statement, shown above, we can see that Xero’s revenue grew by $248 million, which is very strong. However, its operating expenses (sales & marketing, research & development, and general admin costs) were up $258 million. This means Xero spent more money to support its business during the period.

Usually I would say this is bad — ideally, we want revenue growing faster than costs — but I know Xero is deliberately investing heavily back into its business for future growth. The difference between Xero and most other companies which promise riches in the future (but never deliver) is that Xero has an incredibly impressive 10-year track record of growth. It’s not acquiring other companies just to cook up growth (which is dangerous) — it’s growing organically by adding more customers than competitors.

You can see Xero’s long-term (5 year) revenue growth has averaged 30% per year — that’s impressive!

Tip: be very careful of companies that promise future growth yet keep incurring wider losses.

4. Is the company cash flow positive or likely to be so in the next year?

Xero 2022 annual report

Over on the cash flow statement (“Statement of Cash Flows”) you can see the cold hard cash being sloshed around, inward and outward, of a company.

I always check the cash flow statement of a company (unless it’s a bank) when I do a results pulse check. The reason: cash flow is much harder to fake than profit & revenue (where accounting estimates get in the way).

Because the economy is going through a tough time, ideally we want our companies to be generating positive cash flow. Companies that are generating positive cash flow are less likely to rely on bankers (for debt) or shareholders (for capital raisings) to fund their expansion plans.

I believe many ASX companies, especially “growth-ey” style companies, will be exposed during this reporting season. Many of them will show bloated income statements (see point three) and weak operating cash flows (“net cash from operating activities”).

In the top one-third of the chart above we can see that Xero’s core business generated NZ$236 million of cash. That’s great!

However, it sent $430 million out the door for investing activities. Much of this (NZ$205 million) was consumed by “capitalised development costs”, which is where Xero incurs some of its technology development costs. And it also appears to have paid for a big acquisition or two (NZ$185 million).

Further down the page, you can see how this impacts Xero’s cash balance — all things considered, it spent $NZ255 million of cash during the year.

Shareholders, like me, will be expecting Xero to turn things around in the future — to keep increasing cash inflows and curbing the outgoings (for investing).

5. Does management have a clear focus on the future?

Xero 2022 annual report

There is no ‘section’ of an annual report for ‘clear focus on the future’, so you’ll have to read:

• The Chairperson’s report (inside the annual)

• Managing Director / CEO’s report (inside the annual)

• Investor presentation (published separately)

• Investor webinar/conference call (where management takes questions and explains the investor presentation)

For Xero, if I boiled it down to one thing it would be the chart above.

Xero is constantly spending cash for future benefit. Normally, I would be very sceptical of any management team that says ‘we know we’re spending lots of cash right now… but trust us, it’s all for the future benefit’.

However, Xero has an impressive track record and its customer Lifetime Value (LTV) makes sense: Xero expects to make more money in the future from its current customers — which is reflected in a high ‘lifetime value’.

For me, Xero has a clear vision of the future. While it’s spending more to build industry-leading products and grow its business, it’ll likely generate more cash flow in the future as a result. That said, as you can see from the financial results, investing is often open for interpretation. 

Summary

At Rask, our investment checklist has 42 separate items to check – and that’s before the proper research begins! However, if this is your first ASX reporting season, our 5-part checklist here will be sure to help you get a quick read on a company’s financials.

Be sure to tune into Selfwealth Live every Wednesday night, where I explain company results in real-time.

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