The following is a free preview of our Crack the Code: Use Financial Statements Like a Pro online seminar. You can still enroll -- class starts Monday, March 24!
One of the main reasons, if not the main reason, that many people's portfolios falter is that they're simply not particularly savvy investors. Too many don't realize that stock splits are no big deal, that a stock's price alone doesn't tell you much... things like that. Similarly, too many people have no idea what to do with financial statements -- those dense tables in the back of annual reports. Worse, they're usually too intimidated to even try to figure them out.
One of our goals in this seminar is to make sure that you're not among that group, because learning the basics of reading financial statements is really a lot easier than you probably think -- and our job is to make the learning as painless as possible, maybe even a little bit fun. Most importantly, we want to help you understand the information contained in financial statements and how to use it to become a smarter investor.
Why are financial statements so important? In general, stock prices are moved by such things as earnings and interest rates. If you can't read financial statements, you have no chance of figuring out how much money a company is earning, which means you're in the dark about one of the key drivers of stock prices. If you can read an income statement, you're on your way to thinking rationally about investing. Understanding financial statements is step one toward being able to separate the strong companies from the weak. Seizing valuable opportunities and avoiding costly mistakes will become a lot easier when you know the basics of analyzing a company's financials.
Right now, we'll begin to take a look at the three big cheeses in the world of financial statements.
Income statement -- This is a summary of revenues and expenses during a defined period of time (the "accounting period").
Balance sheet -- This is a list of what a company owes and what it owns at one point in time.
- Cash flow statement -- This explains the changes in a company's cash position during an accounting period.
We're focusing on these three because they contain the information you need to start making good decisions. Why do you need to pay attention to all three? Because you have to have the big picture. Investors who focus solely on the income statement, which details revenues and expenses, are only getting one-third of the picture. Many investors and members of the media put too much weight on net income and not enough on what's required to generate this bottom-line number. Don't make this mistake. Don't ignore the balance sheet and cash flow statement. Be prepared to dig further. We'll show you how to do just that.
We can't cover everything in one article, so we'll just start today, and we urge you to continue building your knowledge in our online seminar, Crack the Code: Use Financial Statements Like a Pro. In just eight easy steps, we'll show you how to make sense of financial reports and become a more informed, confident investor.
Compare, compare, compare
One of the first things to understand is that financial analysis is all about comparison, and you must have more than one set of numbers to make a comparison. This is why all financial statements include more than one year of results.
Comparison provides context. With the numbers on the financial statement, you can gauge how a company's performance has changed over time. You can also take these numbers and compare them to rivals in the same industry. These are the two types of comparisons you'll hear about frequently in the world of financial analysis.
Revenues and expenses
Now, let's define revenues and expenses. We'll talk about common-size income statements, and we'll talk about the importance of operating income. The importance of understanding revenue and expenses is self-evident, but we need to know what a common-size income statement is to make comparisons, and we have to know about operating income so that we can focus on a company's core business when thinking about earnings.
Once you understand these concepts, you will understand how to think about the income statement and how to work with it. For example, companies frequently want investors to ignore various charges when they report earnings. Does this make sense? It would be impossible to cover all the different scenarios, but we'll give you a sense of how to think about earnings when companies report them.
The income statement reports a company's revenues and expenses over a given period, called an accounting period. There are two primary accounting periods for investors -- quarterly and annually. We'll focus on annual periods because they provide a more complete view of a company's earnings cycle.
Companies frequently frame their annual accounting period around the natural business cycle. For example, inventories at retailers such as Wal-Mart
The income statement consists of revenues, expenses, and net income.
A company like Southwest Airlines
Here's a quick example:
Revenues = $1,000
Operating Expenses = $500
Taxes = $175
Net Income = $325
To get net income we have "netted out" operating expenses and taxes. On to revenues!
Revenues and sales are the same thing. This is what people are talking about when they refer to the top line. Typically, companies that offer mainly products, such as automaker Ford
Companies that sell products usually include another line item on the income statement. It's called cost of goods sold (or cost of sales) and represents how much it costs to buy raw materials and make the product. As an example, let's consider a candy manufacturer. Its cost of goods sold would include things like sugar, cocoa, and almonds, as well as costs for shipping the products to the factory, and the labor required to manufacture the candy.
One of the most basic measures of profitability is gross margin, which we calculate by looking at sales and cost of goods sold. Very often, products packed with intellectual property, such as microchips and software, have high gross margins. Use this formula to calculate a product company's gross margin:
(Total Revenues - Cost of Goods Sold) / Total Revenue
For example, let's say the Candy Co. sells $100,000 worth of candy bars in a quarter, and had cost of goods sold (COGS) of $49,900. You calculate gross margin like so:
Sales -- $100,000
COGS -- $49,900
100,000 - 49,900 = 50,100
50,100 / 100,000 = 0.5010
Multiply by 100 to convert 0.5010 to a percentage, and you get a gross margin of 50.1%
That's all we have space for right now, but we hope you'll see that learning the basics of understanding a company's financials is not all that difficult, and is essential to making good investing decisions.
We invite you to join us for Crack the Code: Use Financial Statements Like a Pro. Don't let not knowing how to get the facts put you at a disadvantage! In this seminar, you'll see exactly how it all comes together in a company's financial statements. Specifically, you'll learn:
- The three basic financial statements and how they are linked.
- How to determine whether a company is creating cash or consuming it.
- A wide range of useful financial ratios, from basic measures of profitability (such as the gross margin we discussed here) to basic measures of debt (such as the interest coverage ratio).
- Basic accounting concepts like accrual and cash-basis accounting, depreciation, and amortization.
All the way through, we'll make these concepts easier to understand and more useful by providing access to the latest annual financial statements of two companies we'll use as examples -- Southwest Airlines and microprocessor giant Intel
Crack the Code will make you a more confident, informed investor. Enroll today -- class starts Monday!