Its a summary of Interpretation of Financial Statement. Good for those which are new in Value Investing and want to learn about accounting & Identifying company's with competitive advantage.

1. Submitted By: Amit Rohit
Warren Buffett
& Interpretation of Financial
Statements (Summary)

2. Chapter 1 – Two Great Revelations that made Warren the Richest
Person in the World
1. How do you identify an exceptional company with a
durable competitive advantage?
2. How do you value a company with a durable
competitive advantage?
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3. Chapter 2 – The Kind of Business that will Make Warren Superrich
 Graham was focused on finding companies trading at less than half of
what they value. It’s like buying a dollar for 50 cents.
 Never paying more than 10 times a company’s earnings (EPS) &
selling a stock if it was up by 50%.
 If it didn’t go up within two years, he would sell it anyway.
 Warren learned was that these “superstars” all benefited from some kind
of competitive advantage that created monopoly like economics,
allowing them either to charge more or to sell more of their product. In
a process, they made a ton more money that their competitors.
 If company’s competitive advantage could be maintained for a long time
(durable) the underlying value of the business would continue to
increase year after year.
 s3

4. Chapter 3 – Where Warren Start his Search for The Exceptional
Company
 Warren has figured out that these super companies come in
three basic business models.
1) Selling a unique product: Through the process of customer
need & experience, & advertising promotion, they have placed
the stories of their product in our mind (Owning a piece of the
consumer’s mind).
2) Selling a unique service: These companies are institutional
specific as opposed to people specific. In people specific firm’s
worker can demand & get a large part of the firm’s profits, which
leaves a much smaller pot for firm’s owners/shareholders. Firm
selling unique services that own a piece of the consumer’s mind
can produce better margins that firms selling products. (No R & D
Expense, No change of product, No Plant or machinery expense)
3) Low cost buyer & seller of a product or service that the
public has an ongoing need for: The key is to be both the low
cost buyer & the low cost seller.4

5. Chapter 4 – Durability is Warren’s Ticket to Riches
 It is this consistency in the product that creates
consistency in the company’s profits.
 If company don’t have to change its product then it will spend
less in R & D, Plant & Machinery, & which lead to less Debt,
less interest.
 Warren looking for consistency in financial statement
 Consistency in followings:
High gross margin,
Little or no debt,
Not to have spent large sum on R&D,
Earnings
 All these financial indicator help to identify durable
competitive advantage of company.5

6. Chapter 5 – Financial Statement Overview: Where the Gold is Hidden &
Chapter 6 – Where Warren Goes to Find Financial Information
Income Statement: How much earn & spend, using this
warren can determine company’s margins, its return on
equity.
Balance Sheet: How much money company have in
bank & how much money it owes. Indicators like amount
of Cash Company have or amount long term Debt
Company carry in its balance sheet.
Cash Flow: Track the cash that flows in & out of the
business. Indicators like cash from operations, Share
buy backs, capital expenditure
10K is company’s annual report; 8Q is company’s
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7. Chapter 7 – Income Statement & Chapter 8 – Revenue & Chapter 9
– Cost of goods Sold (Cost of Revenue)
 Three components: Earning, Expenses, & Profit or loss.
Sources of earning is always more important that the
earning themselves.
 One of the great secret to making more money is spending
less money.
 The cost of goods sold is either the cost of purchasing the
goods company is reselling or the cost of material & labour
used in manufacturing.
 Cost of Revenue is used when firm providing services rather
than products.
 We should always investigate exactly what the company is
including in its calculation of its cost of goods sold.
 This gives us a good idea of how management is thinking
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8. Chapter 10 – Gross Profit & Gross Profit Margin
Chapter 11 – Operating Expenses
 Company having gross profit margin of 60% or better have
competitive advantage.
 What create a high gross profit margin is the company’s durable
competitive advantage, which allows it the freedom to price the
products and services it sells well in excess of its cost of goods
sold.
 As a very general rule (and there are exceptional); companies with
gross profit margins of 40% or better tend to be companies with
some sort of durable competitive advantage.
 Companies with gross profit margin of 20% & below is usually a
good indicator of a competitive industry.
 We should track the annual gross profit margins for the last ten
years to ensure that the consistency is there.
 High research costs, another is high selling & administrative cost,
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9. Chapter 10 – Gross Profit & Gross Profit Margin
Chapter 11 – Operating Expenses
 Company having gross profit margin of 60% or better have
competitive advantage.
 What create a high gross profit margin is the company’s durable
competitive advantage, which allows it the freedom to price the
products and services it sells well in excess of its cost of goods
sold.
 As a very general rule (and there are exceptional); companies with
gross profit margins of 40% or better tend to be companies with
some sort of durable competitive advantage.
 Companies with gross profit margin of 20% & below is usually a
good indicator of a competitive industry.
 We should track the annual gross profit margins for the last ten
years to ensure that the consistency is there.
 High research costs, another is high selling & administrative cost,
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10. Chapter 12 – Selling, General, & Administrative Expense
Chapter 13 – Research & Development & Chapter 14_Depreciation
 In world of business anything under 30% (of Gross profit) is considered
fantastic business.
 Some company have durable competitive advantage that have SGA
expense in the 30% to 80% range.
 If company having SGA expenses more than 100% then we are dealing
with company in a highly competitive industry.
 If competitive advantage is result of some technological advancement,
there is always threat that newer technology will replace it.
 If company spend heavily on R & D expenses over the year then it will
always put their long term economics at risk.
 All machinery & Building eventually change over time.
 Buying machinery (1000 & 10 year life span) will on balance sheet
causes 1000 out of cash & adds that in asset side.
 Each year 100 will be subtracted from the machinery Asset side & add to
accumulated depreciation liability account.
 The actual cash outlay for machine will show up on the cash flow
statement under capital expenditure.
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11. Chapter 15 – Interest Expense (Finance Cost)
Chapter 16 – Gain (Or Loss) & Chapter 17 – Income before Tax (PBT)
 The more debt = more interest company have to pay.
 It is not tied to any production or sales process. It reflects to
the total debt that company is carrying.
 Competitive advantage companies have 10% or less
Interest cost of Total Operating Income. Percentage of
interest payments to operating income varies greatly from
industry to industry.
 When a company sells an assets (Other than inventory), is
the gain or loss in income statement.
 Other income is non-operating, unusual, & infrequent
income, warren believes that they should be removed from
any calculation of the company’s net earnings in determining
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12. Chapter 18 – Income Tax Paid & Chapter 19 – Net Earning (Profit after
Tax) & Chapter 20 – Per Share Earning (EPS)
 Some company might not paying enough income tax show
high net profit.
 Whether or not the net earnings are showing a historical
upward trend?
 Company with a durable competitive advantage will report a
higher % of net earnings to total revenue than their
competitors.
 There are companies that earn between 10% - 20% on total
revenue, which is just packed with business ripe for mining
long-term investment gold that no one has yet discovered.
 Over ten-year period that shows consistency & an
upward trend an excellent sign that the company in question
has some kind of long-term competitive advantage.
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13. Chapter 21 – Balance Sheet & Chapter 22 – Assets
Chapter 23 – Current Asset Cycle (Working Assets)
 Assets = Cash, Receivables, inventory, property, plant, and
equipments
 Liabilities = Current liability (Money that is owed within the
year), Non – Current liability (More than Year)
 Assets – Liabilities = Net Worth (Shareholders’ Equity or
Shareholders’ Fund)
 Current Assets = Cash & bank, Short term Investment,
Receivable (Sundry Debtor), Inventory
 Non Current Assets = Long term investments, Property Plant
& Equipment, Goodwill, Intangible Assets, Accumulated
Amortization.
 Cash -> (Buy) Inventory -> (Sell to Vendor) Account
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14. Chapter 24 – Cash & Cash Equivalents & Chapter 25 – Inventory
Chapter 26 – Net Receivable
 Company has three ways of creating a large stockpile of cash
 Sell new bonds or equity to public
 Sell an existing business or other assets that the company owns
 It has ongoing business that generates more cash than the business burn
 If we are earning more than we are spending, the cash starts to pile up & that
creates the investment problem of what to do with all the excess cash.
 To expand operations
 Buy entirely new businesses
 Invest in partially owned businesses via the stock market
 Buy back their shares
 Pay out cash dividend to shareholders
 Identify a manufacturing company with a durable competitive advantage, look
for an inventory & net earnings that are on a corresponding rise.
 Some companies will attempt to gain an advantage by offering better payment
terms – instead of 30 days; they may give vendors 120 days. This will cause
increase in sales & an increase in receivables.
 If company showing consistently a lower percentage of net receivables to
gross sales than its competitors, it usually has some kind of competitive
advantage.14

15. Chapter 27 – Prepaid Expenses & Chapter 28 – Total Current Assets &
the Current Ratio & Chapter 29 – Property, Plant, & Equipment
 Pay for goods & services that they will receive in the near future.
They are assets of the business.
 Current Ratio = Current Assets / Current Liabilities. Higher the ratio
is more liquid the company.
 Current ratio = Over 1 is considered good
 Current ratio = Under 1 is considered Bad (Company having hard
time meeting its short term obligations to its creditors)
 There are many companies with a durable competitive
advantage that have current ratio less than 1.
 Company that don’t have a long – term competitive advantages
are faced with constantly have to update their manufacturing
facilities to try to stay competitive.
 A company that has a durable competitive advantage doesn’t need
to constantly upgrade its plant & equipment to stay competitive.
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16. Chapter 30 – Goodwill & Chapter 31 – Intangible Assets &
Chapter 32 – Long Term Investments & Chapter 33_Other Long – Term
Assets
When ABC buys XYZ Company & ABC pays a price in
excess of XYZ’s book value, the excess is recorded on
ABC’s balance sheet under heading of goodwill.
If intangible assets are an internally developed then its
real value as an intangible asset is not reflected on its
balance sheet.
A company’s long – term investments can tell us a lot
about the investment mind – set of top management.
Do they invest in other business that has durable
competitive advantages, or do they invest in business
that is in highly competitive markets.
Other long term assets would be pre-paid expenses &16

17. Chapter 34 – Total Assets & Return on Total Assets & Chapter 35 – Current
Liabilities & Chapter 36 – Account Payable, Accrued Expenses & Other
Current Liabilities
 ROA = Net Earnings / Total Assets = %
 Determining just how efficient the company is in putting its assets to use.
 Warren has discovered that really high returns on assets may indicate
vulnerability in the durability of the company’s competitive advantage. (High
ROA = (may be) Lower cost of entry into its business)
 Current Liabilities = Account payable, Accrued expenses, Short – term Debt, Long
– term debt coming due, & other current liabilities.
 Account Payable = Money owed to suppliers (who gave goods & Service to
company on credit)
 Accrued expenses = Liabilities that the company has incurred but yet to be
invoiced for (Sales tax payable, wages payable, & accrued rent payable)
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18. Chapter 37 – Short – Term Debt & Chapter 38 – Long term debt coming
due & Chapter 39 – Total Current Liabilities
If we lend all this money long – term, Creditors gave
us money on short – term, but suddenly decide to not
to loan us any more money short – term. So we have to
pay back all that money we borrowed short – term.
Smartest & safest way to make money in banking is to
borrow it long – term & lend it long – term.
Companies with a durable competitive advantage
require little or no long – term debt to maintain their
business operations.
Higher the current ratio, the more liquid the company is.
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19. Chapter 40 – Long – Term Debt & Chapter 41 – Deferred income tax,
Minority Interest & Other Liabilities
Companies with competitive advantage often carry little
or no long term debt on their balance sheet. They are
self – financing when they need money.
Company that have enough earning power to pay off
their long term debt in fewer than 3 or 4 years are
good candidates.
Tax that is due but hasn’t been paid is deferred
income tax.
When company buy other company’s stock, it is added
into Long term investments. But when it buys more than
80% of company then it can shift the acquired
company’s balance sheet to its balance sheet.
Minority interest entry represents is the value of the
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20. Chapter 42 – Total Liabilities & Debt to Equity & Chapter 43 – Share
holders’ Equity / Book Value & Chapter 44_Preferred & Common Stock
 Help us to identify whether or not a company is using debt
to finance its operations or equity (which includes retained
earnings)
 Some company which have great earning power use its
earnings to buy back its shares
 Unless we are looking at a financial institution, any time
we see debt to equity ratio below 0.80 (The lower is better),
there is a good chance that the company is doing good
business.
 This is the amount of money that the company’s owners have
initially put in & have left in the business to keep it running.
 Preferred stock has a par value of 100 & it’s sold to the public
at 120 then 100 on preferred stock & 200 under in paid in
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21. Chapter 45– Retain Earnings & Chapter 46 – Treasury Stock & Chapter
47 & 48_ Return on Shareholders’ Equity
 Company’s earnings can either paid out as dividend or used to buy
back the company’s shares, or they can be retained to keep the
business growing.
 Buying back its own shares, it can do two things with them. It can
cancel them or it can retain them with the possibilities of reissuing
them later on. With the possibility of reissuing them later on, they
are carried on the balance sheet under treasury stock.
 ROE = Net Earnings / Shareholders’ Equity
 High returns on equity mean that the company is making good
use of the earnings that it is retaining.
 If the company shows a long history of strong net earnings, but
shows a negative shareholders’ equity, it is probably company
with durable competitive advantage. Because some companies21

22. Chapter 49– The problem with leverage & the Trick it can play on you &
Chapter 50– The Cash Flow Statement
 Leverage is the use of debt to increase the earnings of the company.
 Warren has learned to avoid businesses that use a lot of leverage to help them
generate earnings.
 The cash flow statement will tell us only if the company is bringing in more cash
than it is spending (Positive cash flow) or if it is spending more cash than it is
bringing in (negative cash flow).
1) Cash from Operating Activity: Net income + Depreciation & Amortization
2) Cash from Investing Activity (Capital Expenditures): This includes all capital
expenditures made for that accounting period. Capital expenditures are always
a negative number because it’s expenditure, which cause a depletion of
cash (Purchase of Fixed Assets, Sale of Fixed Assets, Purchase of Investment,
Sale of Investments, Interest received etc).
3) Cash from Financing Activity: Cash that flows in & out of a company because
of financing activities. (Payment of dividends, Selling & buying of company’s
stock, + Proceeds from Long Term Borrowings, - Repayment of Long Term
Borrowings, + Short Term Loans, - Equity Dividend Paid, - Interest Paid). When
company sell its shares to finance a new plant.
 If amount in cash flow is + (positive) then it’s adding into business & if –
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23. Chapter 51– Capital Expenditures (Investing) & Chapter 52– Stock
Buybacks (Financing) & Chapter 53– Right time to buy a fantastic
business
 Many companies must make huge capital expenditures just to stay in
business. If capital expenditures remain high over a number of years,
they can start to have deep impact on earnings.
 Company with a durable competitive advantage uses a smaller portion
of its earnings for capital expenditures for continuing operations than
do those without a competitive advantage.
 If a company is historically using 50% or less of its annual net
earnings for cap ex, it is a good place to look for a durable competitive
advantage.
 Warren pushes the board of directors of all the excellent companies to
invest in to buy back shares instead of increasing the dividend. It
increase EPS & share price. If company pay dividend, tax have to be paid
on dividend by investors.
 The lower the price you pay for a company with a durable competitive
advantage, the better you are going to do over the long – term.
 Buy in bear market & stay away in bull market. If these super business
trade at historically high price to earnings ratios (P/E Ratio) then23

24. Chapter 54– How warren determines it is time to sell
Chapter 55_Warren’s Revolutionary Idea of the Equity Bond
The first thing is when you need money to make an
investment in an even better company at a better
price.
The second is when the company looks like it is going
to lose its durable competitive advantage.
The third is during bull market, in an insane buying
frenzy, sends the prices on these fantastic business
through the ceiling.
Company with durable competitive advantage show
such great strength & predictability in earnings
growth that growth turns their shares into kind of
equity bond, with ever increasing interest payments.
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