How to assess a company's operational and financial risks - Cryptocurrency exchange platform

Today, let’s discuss how to assess business operational risks and financial risks.

In the stock market,

many investors feel fear when stock prices fall,

they start to overthink,

worrying about whether the company will go bankrupt, etc.

I have mentioned multiple times on programs that,

a decline in stock price does not necessarily mean risk.

Stock prices are actually the result of transactions between buyers and sellers.

The real risks investors should be wary of

stem from deterioration in the company’s operations or financial condition.

For value investors,

a drop in stock price can actually signal an investment opportunity,

because it provides a larger margin of safety,

allowing them to buy high-quality company stocks at lower prices.

What investors should truly focus on is whether the company’s operations and finances are stable,

not just watching the stock price.

After we have conducted in-depth research on the company’s operational and financial status,

when facing a stock price decline,

we won’t feel fear,

and may even adopt a strategy of buying more as the price drops.

This is very similar to our mindset when shopping daily,

when purchasing a product,

of course, we hope for the biggest discount.

The common saying “buy stocks as if buying a company” reflects this principle.

In stock market investing,

many retail investors often stumble into “traps,”

leading to severe financial losses.

The reason is,

they lack sufficient understanding of the company’s operational status.

To avoid this,

we must learn to use financial statements as a tool

to identify companies with operational risks.

Next,

I will approach this from the perspective of a doctor diagnosing a patient,

guiding everyone on how to analyze financial data to identify risks in business operations.

First, we need to understand clearly,

the only cause of a company’s bankruptcy is its debt.

Specifically,

when a company faces the maturity of bank loans,

bonds, and other debts that it cannot repay,

it may lead to bankruptcy.

In fact,

these debt risks are not unforeseeable,

by studying the company’s financial statements,

we can understand its true operational condition in advance.

Specifically,

we can look at whether the company’s short-term book net assets

are sufficient to cover those maturing debts.

This information

can be found in the company’s balance sheet.

Typically,

we focus on loans or bonds due within one year,

because these are the main financial pressures the company faces in the near term.

If the company’s net assets cannot cover the upcoming debts,

it indicates the company is at risk of bankruptcy.

It is important to note that,

the net assets I am referring to here

do not include inventories,

unless these inventories are highly valuable

and can be quickly liquidated,

such as stocks,

gold, etc.

Similarly,

long-term accounts receivable also need careful consideration,

as these receivables may have already become bad debts.

Additionally,

we need to refer to the net cash flow data in the cash flow statement,

if the company’s annual net cash flow

is insufficient to pay loans or bond interest,

then the company is essentially critically ill,

like a stroke patient,

who could suffer a heart attack at any time.

For such high-risk companies,

we should avoid them as early as possible.

Some companies, during operations,

due to insufficient book assets,

have to resort to financing methods

such as issuing bonds,

raising additional stock,

bank loans, etc.,

which often leads to an increased debt burden.

For these companies,

we must stay highly alert.

They are like patients with impaired hematopoietic function,

frequently relying on external blood transfusions (financing),

these measures cannot fundamentally improve their operational condition,

and such dependence is unsustainable.

Usually,

the reasons for a company experiencing “insufficient blood supply” or “heart attack” are twofold:

one is due to entering a recession phase,

such as companies in structurally declining industries like offline retail,

which face overall industry shrinkage due to “aging and decline.”

The other is like young people running recklessly,

these young companies expand desperately without guaranteed cash flow,

ultimately leading to a breakdown of their capital chain,

examples of which are numerous in the market.

Therefore,

do not think that “insufficient blood supply” only happens to the elderly,

in fact,

it often occurs in the “young” who are running at full speed.

Companies are very similar to people,

a person’s body begins to age after fifty,

and may die at eighty or ninety,

this is a slow process.

Similarly,

when a company’s revenue stops growing,

or even declines year by year,

and cash flow becomes insufficient,

it often indicates that the demand for its products or services is declining.

There are many reasons for this decline.

It could be due to excessive market competition,

where companies fight for limited market share,

leading to price wars,

which compress profit margins.

It could also be that the overall industry demand is shrinking,

market saturation or changing consumer preferences.

Regardless of the reason,

it results in a gradual reduction in the company’s goods or services,

which is a slow process.

All this information will be reflected in the company’s revenue.

We should early on avoid companies entering structural decline.

Another type of company,

has a large and increasing accounts receivable,

and for such companies,

we also need to be cautious.

These companies may be “pseudo-strong.”

Like an elderly person trying to hide aging through plastic surgery or other means,

they look young on the outside,

but internally have lost sustainable development capability.

Such companies may face huge bad debt risks in the future,

so,

in investments,

we should try to avoid these “pseudo-strong” companies.

Some companies continuously increase operating costs and expenses,

and we should also try to avoid these.

Because their situation is like a patient’s blood lipids gradually rising,

and neglecting exercise,

leading to rising operating costs.

The problems of such companies are often caused by poor management or lack of a strong competitive moat,

resulting in a gradual loss of competitive advantage.

When these companies face difficulties,

they often increase advertising or investment efforts,

trying to turn the situation around.

However,

these measures do not effectively translate into profit growth,

and may further increase financial pressure.

Some companies suffer from insufficient market demand for their products or services,

directly leading to a shortage of net cash flow.

In the initial stage,

they can still raise funds through issuing bonds,

bank loans,

or issuing stocks.

If the company relies on financing for a long time,

and borrowing still cannot improve its operational condition,

its financial risk will intensify.

Over time,

it becomes very difficult to borrow money through bank loans or bonds.

This is like an aging patient,

relying on oxygen or blood transfusions to temporarily stay alive,

these measures are only temporary solutions.

If transfusions or oxygen therapy do not improve the situation,

the patient will suffer a heart attack and die—meaning the company faces a liquidity crisis or even bankruptcy due to a broken capital chain.

Some companies, under intense competitive pressure,

have to frequently seek financing or loans.

However,

this continuous demand for funds

causes investors to gradually lose confidence,

becoming unwilling to invest further; even banks may demand early repayment of loans.

All these factors eventually lead to a break in the company’s capital chain.

Although from short-term financial statements,

the company’s revenue may still be growing,

and operational conditions seem relatively stable.

But in reality,

it is very difficult for the company to continue operating,

this phenomenon is especially prominent among many emerging companies.

A company’s life cycle is very similar to a human’s,

they all go through youth,

adulthood,

middle age,

and old age.

When a company enters old age,

external support (blood transfusions, oxygen) cannot improve internal conditions,

and it will die,

which is a slow process.

As long as we carefully analyze the “case”—financial statements,

we can have a clear understanding of the company’s current life cycle.

The above is based on the perspective of a doctor diagnosing a patient,

to illustrate the risks faced in business operations.

I hope all investors can use financial analysis as a tool,

to avoid companies with operational risks.

Learning financial knowledge is not difficult,

even someone with only elementary school education can learn it.

Just patience and focus are enough.

Financial analysis may not always help you find a great company,

but it can definitely help you eliminate those garbage companies.