timberland boots for toddlers How to read a company’s financials
If you have trouble the first few times you try to understand financial statements, don worry that normal. The more you read financial statements, the more comfortable you will become with the presentation, and the better able you will be to interpret what the statements are telling you. Most of the numbers in the financial statements don stand alone.
Each integrated report will have numerous footnotes that amplify on the numbers make sure you read these carefully. It also important to remember that to get a good feel for the company, you should look at it within a much larger framework.
CONTEXT: Put the company into a context that includes its industry, the economy, interest rates, the business cycle, etc. You might find that this year performance is much better, or worse, than the performance over the past few years. If so, look for reasons it may be that a company that supplies animal feed suffered a downturn during the drought. When you are reading a company financial statements, remember that public companies produce two types of numbers: unaudited and audited.
UNAUDITED: Unaudited numbers are sometimes called management figures. Note that not all numbers that companies release to the public have been reviewed by outside auditors. The three financial statements you are going to encounter are the income statement, the balance sheet and the cash flow statement. Here what you need to look for in each:
1. THE INCOME STATEMENT shows what the company generates in profits or losses during the reporting period, such as a quarter or year. Key information in the income statement includes:
Revenues, gross revenues, net operating revenues or sales: The company total sales or revenues during the period. This is often referred to as the line earnings: These are a measurement of a company earnings based solely on operational and capital investment activities. For a retailer, this category is what the company pays for the products it sells on its shelves. It is only the cost of the merchandise purchased for resale, not the cost of providing the service to customers. It is determined by dividing net income minus preferred dividends by the average number of common shares outstanding for the period.2. THE BALANCE SHEET is a snapshot of the company assets, liabilities and shareholders equity on the last day of the reporting period. The left side of the balance sheet lists the assets, or what the company owns. The right side lists the liabilities, or what the company owes, and the shareholders equity, or the funds invested in the company and retained earnings. The two sides must balance, so the balance sheet format is assets equal liabilities plus shareholders equity (A = L + E).
The balance sheet shows data from the two most recent years, which allows you to calculate changes from one year to another. Significant changes in any account must be examined and could be worth following up. The receivables category often shows an entry called allowance for doubtful accounts which presents an estimate of what the company expects will not be paid. It is essentially a bad debt estimate. Inventory is usually identified as being in one of three categories: raw materials; work in process; or finished goods. Preference shareholders are entitled to receive a fixed dividend before common holders, and have a priority in case the company is liquidated. Retained earnings or reinvested earnings: When a company makes profits, it can reinvest the funds or return them to the owners (stockholders) as dividends. Retained earnings (sometimes called accumulated undistributed net income) are profits that have been reinvested since the company was founded.
3. THE CASH FLOW STATEMENT shows how cash moved through the company over the year and lets you see if the company cash position increased or decreased. It presents data for the past three years.
Key components of the cash flow statement are:
Operating activities: This category focuses on what the company does as a business, and excludes investing and financing activities. The primary entry for operating activities is net income.
Investing activities: This reflects payments for acquiring and disposing of long term productive assets or businesses, and securities that are not considered cash equivalents. You will find it in the glossy pages of the annual report for a few companies. Free cash refers to the cash that is left after a company maintains its productive capacity by doing things such as modernising plants by purchasing new equipment or buying another business.
Free cash is obviously essential for a company ability to expand activities, pay down debt, etc. There is no one way to calculate free cash, although a common format involves subtracting capital expenditures from cash from operations.