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Check firm's strength before investing in it

UREPORT
By Ndirangu Ngunjiri | June 21st 2016

Kenyan investors have been suffering from poor investment decisions due to lack for financial knowledge.

Kenyans obtained bank loans to buy shares, money that some are yet to recoup up to date. Even the mama mboga have participated in IPOs. But due to lack of investment knowledge, many were discouraged and sold the stocks at a very low price.

If you borrow money from a bank, you have to list the value of all your significant assets, as well as all your significant liabilities. Your bank uses this information to assess the strength of your financial position. It looks at the quality of the assets, such as your car and your house, and places a conservative valuation upon them. The bank also ensures all liabilities, such as mortgage and credit card debt, are properly disclosed and fully valued. The total value of all assets less the total value of all liabilities gives your net worth, or equity.

Evaluating the financial position of a listed company is quite similar, except investors need to take another step and consider financial position in relation to market value. Like your own financial position, a company’s financial position is defined by its assets and liabilities. A company’s financial position also includes shareholder equity. All this information is presented to shareholders in the balance sheet.

Current liabilities are the obligations the company has to pay within the coming year, and include existing (or accrued) obligations to suppliers, employees, the tax office and providers of short-term finance. Companies try to manage cash flow to ensure that funds are available to meet these short-term liabilities as they come due.

If we subtract total liabilities from assets, we are left with shareholder equity. Essentially, this is the book value, or accounting value, of the shareholders’ stake in the company. It is principally made up of the capital contributed by shareholders over time and profits earned and retained by the company, including the portion of the profit not paid to shareholders as a dividend.

A company’s financial position tells investors about its general well-being.

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