Questions to answer in the report:
- Evaluate Enron’s profit, leverage, and cash flow performance during the period 1998-2000.
- Evaluate Enron’s long-run financial performance. Does the data reflect Enron’s transformation from a pipeline company to a trading company?
- What is your assessment of Enron’s earnings quality?
- Evaluate Enron’s financial leverage at the end of 2000.
- Enron’s stock price traded around $62.72 per share at the end of April 2001. Do you think Enron was worth that much?
The purpose of this case study is to determine whether there were any early warning signs of Enron’s collapse. It is more of a qualitative analysis rather than ratio calculations.
For example, question 1, the key is to determine whether Enron’s profit was growing at the same rate as its revenue. You may look at items on income statements about revenues, operating incomes, and so on, to see whether Enron was making profit as it was supposed to. Digging deeper into the sources of income, you may find that earnings increase in 2000 was partly because of one-time gains such as gains on the sale of nonmerchant assets and stock issuance.
The common-sized balance sheet also shows some substantial changes, trade receivables, long/short term assets, liabilities all increased significantly. Similarly, you can find some evidence in the cash-flow statement. Leverage ratios can be used to estimate the cost of debt and WACC. And if you compare it with returns on assets, you will see that the cost was greater than return. These are all early warning signs of the worsening financial condition of Enron that have been overlooked.