This document provides an overview of how to read and understand key financial reports and metrics that are used to analyze the financial performance and condition of public companies. It discusses things like the balance sheet, income statement, cash flow statement, financial ratios, and investment strategies. The key elements covered include the components and purpose of the main financial reports, important accounting concepts and terms, and various ratios used to evaluate areas like liquidity, management performance, profitability, and stock valuation.

1. HOW TO READ FINANCIAL REPORTS

2. PUBLIC COMPANIES MUST REPORT THEIR FINANCIAL CONDITION Government wants stable financial markets Securities and Exchange Commission Investors want accurate information All financial reporting must conform with Generally Accepted Accounting Principles (GAAP)

3. ACCOUNTING Double entry system Designed as a double-check Double entries consist of debits and credits Do not think that “debit” is always bad and “credit” always good Depends on which side of the balance sheet you are on

4. Various Types of Accounting Financial accounting Cash Accrual Cost Tax Managerial

5. Cash Accounting Record transactions as cash flows in or out. Most individuals operate on cash accounting basis.

6. Accrual Accounting Record transactions as revenue and expenses accrue. Haven’t paid December bills. In cash accounting wouldn’t record expenses until paid, but in accrual accounting would. Expenses have accrued.

7. May Also Choose Time Basis Calendar Year Fiscal Year-- any twelve-month period July 1--June 30 September 1--August 30

8. Types of Financial Reports Cash Flow Statement Balance Sheet Income Statement Annual Report

9. Cash Flow Statement Net amount of cash taken into the business during a given period and the cash paid out during that same period.

10. Inflows & Outflows sales borrowed funds investment proceeds from investors purchases operations interest taxes dividends

11. Cash Flow Statement two things not told by cash flow statement: profit financial condition or position of the business at the end of the year

12. Balance Sheet Two sides must balance

13. Balance Sheet Assets The “own” side Liabilities + Equity The “owe side”

14. Assets Current Non-current

15. Current Assets Cash Accounts Receivable Inventory Anything likely to be converted into cash, sold exchanged or expenses (used and then charged as an expense) in the normal course of business -- usually a year

16. Fixed Assets Leasehold improvements Intangible assets Goodwill Patents and trademarks Notes receivable after one year Other investments Misc. assets that are not current

17. Not everyone agrees on classifications Credit analysts view prepaid expenses as a noncurrent asset. Accountants view prepaid expenses as a current asset. Accountants and Internal Revenue auditors frequently disagree on classification of transactions.

18. Liabilities Current and Long-term

19. Current Liabilities Debts and obligations that are coming due within one year Credit card debt

20. Long-Term Liabilities Debts and obligations that are not coming due within a year. Student loan The monthly payments for the year are current liabilities but the principal and interest due are not current.

21. Equity Shareholders’ equity. Retained earnings.

22. Shareholders’ equity Interest of shareholders in the company.

23. Retained earnings Money the company keeps for itself rather than being paid out in dividends to the shareholders.

24. If a company is insolvent and owes more than it owns . . . Equity will be a negative amount. Negative amounts are shown in ( )

25. Income Statement

26. Other names for an income statement: Profit and loss statement Operating statement Earning statement

27. Income statement Reports the results of operations over a specified period of time.

28. Income statement Summary of how much the business has taken in and paid out -- its profits.

29. Income statement Revenues Costs and expenses Operating income Income before taxes Income taxes Net income Earnings per share

30. Non-operating Income or Expenses Incomes, gains or losses from other investments Gains or losses on the sale of fixed assets Special payments to employees Interest expense is a non-operating expense

31. Net income after taxes The bottom line

32. Dividend Distribution of earnings to shareholders.

33. Dividends Prorated by class of security Preferred stock Common stock May be paid in money, stock, scrip or, rarely, company products or property

34. Depreciation Bookkeeping entry that reduces income without reducing cash. May be combined with cost of goods sold. Non-cash expense. Added back to net income to determine company’s cash earnings.

35. Cash flow from operations Net income + depreciation

36. Amortization conversion of intangible long-lived assets into expenses over a number of accounting periods

37. Don’t be Fooled Revenues ≠ Profit Profit not only concern Management has three tasks: earning profit controlling company’s financial condition cash flow, preventing “cashouts”

38. Basic Financial Ratios (Balance Sheet Ratios) Percentages that provide understanding.

39. Vital Signs Or How to tell if a company is healthy. (Fundamental Analysis)

40. Ratios to evaluate . . . Short Term Stability (Liquidity) Long Term Stability Management Performance Profitability Stock Prices

41. Evaluating Short Term Stability (Liquidity) Current ratio Current assets / current liabilities Quick ratio (Current assets - inventory) / current liabilities

42. Current ratio Current assets divided by current liabilities. Indication firm is sufficiently liquid Enough working capital to ensure that firm can meet its current obligations and operate comfortably Short-term solvency

43. Extra liquidity can held in a recession Receivables might be slow Inventory can lose value Businesses do make mistakes in purchasing or marketing

44. Too much liquidity not good Want to be lean and mean Want to use cash resources efficiently Could indicate shrinking operations May be vulnerable to a take-over attempt

45. Current ratio Manufacturing -- 1.5 to 1 to 2 to 1

46. Quick ratio Also known as the acid-test ratio Current ratio excluding inventory Cash, Receivables / current liabilities Test: what if sales stopped

47. Quick ratio Assuming no negative trends in year to year comparison Ratio of .50 to 1 or 1 to 1

48. Evaluating Long Term Stability (measuring capitalization) Debt to equity Total liabilities / total stockholders’ equity Debt to total assets Total liabilities / total assets Long-term debt to total capitalization Long-term debt / (long-term debt + stockholders’ equity)

49. Times interest earned (earnings before taxes + interest charges) / interest charges Fixed charge coverage (earnings before taxes + interest charges) / (interest charges + lease payments)

50. Evaluating Management Performance (measuring activity) Inventory Cost of goods sold / inventory Average collection period Accounts receivable / (annual credit sales/360 days) Fixed assets turnover Net sales / net fixed assets Asset turnover Net sales / total assets Operating profit margin Net operating profit / net sales

51. Evaluating Profitability Net profit margin Net income / net sales Return on equity Net income / total stockholders’ equity Operating profit margin Net operating profit / net sales

52. Net Profit Margin Net income / net sales Measures overall efficiency Success in managing operations Borrowing money at a favorable rate Investing idle cash to produce extra income Taking advantage of tax benefits

53. Return on Equity Net income / total stockholders’ equity The bottom line measured against the money shareholders have invested

54. Operating profit margin Net operating profit / net sales Measures firm’s operating efficiency

55. Evaluating Stock Prices Price-earnings ratio Market price of common share / earnings per common share Market-to-book ratio Market price of common share / book value per share Dividend pay-out ratio Dividends per common share / earnings per common share

56. Price/Earnings Ratio current market price / earnings per share earnings per share (EPS) net income for year / number of shares of stock

57. A few helpful terms.

58. EBITDA Earnings Before Interest, Taxes, Depreciation and Amortization EBITDA is not a measure of cash flow. Is an indicator of company’s financial performance (revenues - expenses).

59. Trailing Twelve Months Previous 12 months As opposed to the past calendar year

60. INVESTMENT STRATEGIES

61. Two Types of Analysis Fundamental Technical

62. Fundamental Analysis Sales (revenues) Profitability Earnings per share (higher is better) Return on Equity (higher is better) Stock is reasonably priced P/E ratio (lower is better) New or unique Leader in some aspect Superior in some way

63. Technical Analysis Chart the stock price

64. Most Important Rule to Know diversify