Warren Buffett: “If you must take one class in college learn accounting! It was the most helpful class I took. Financial accounting is the secret sauce for successful investing…simply put accounting is the language of business….”
if someone told you that by learning some financial statements you could unlock untoward riches by learning how a business performed, and how it is performing and some hints into how it will perform in the future…which could leave you with an enormous amount of money…wouldn’t you put a tremendous effort into learning everything you could about the subject? Good luck…and may you have a great success in all you do.. G_d Bless you in your efforts…
If you’re looking at a business with an interest in investing in it, you need to read its financial reports. Of course, when it comes to the annual report, you don’t need to read everything, just the key parts. Combining the annual report with some of the financial reports a corporation files with the Securities and Exchange Commission (SEC) can help you figure profitability and liquidity ratios and get a better sense of cash flow.Key Parts in an Annual ReportAnnual reports can be daunting, and you may be relieved to know that you don’t actually need to scour every page of one. The following parts best serve to give you the big picture: Auditor’s report: Tells you whether the numbers are accurate and whether you should have any concerns about the future operation of the business Financial statements: The balance sheet, the income statement, and the statement of cash flows; where you find the actual financial results for the year Notes to the financial statements: Details about potential problems with the numbers or how the numbers were derived Management’s discussion and analysis: The higher-ups’ breakdown of the financial results and other factors that impact the company’s operationsThe rest is fluff.Key Securities and Exchange Commission ReportsReading Financial Reports for Profitability RatiosYou read financial reports to get a sense of a company’s financial position and how viable it is in the marketplace. You can test a company’s money-making prowess using the following important formulas. Price/earnings ratio compares the price of a stock to its earnings. A ratio of 10 means that for every $1 in company earnings per share, people are willing to pay $10 per share to buy the stock. Price/earnings ratio = Market value per share of stock divided by Earnings per share of stock Dividend payout ratio shows the amount of a company’s earnings that are paid out to investors. Use it to determine the actual cash return you get by buying and holding a share of stock. Dividend payout ratio = Yearly dividend per share divided by Earnings per share Return on sales tests how efficiently a company is running its operations by measuring the profit produced per dollar of sales. Return on sales = Net income before taxes divided by Sales Return on assets shows you how well a company uses its assets. A high return on assets usually means the company is managing its assets well. Return on assets = Net income divided by Total assets Return on equity measures how well a company earns money for its investors. Return on equity = Net income divided by Shareholders’ equity The gross margin gives you a picture of how much revenue is left after all the direct costs of producing and selling the product have been subtracted. Gross margin = Gross profit divided by Net sales or revenues The operating margin looks at how well a company controls costs, factoring in any expenses not directly related to the production and sales of a particular product. Operating margin = Operating profit divided by Net sales or revenuesReading Financial Reports for Liquidity RatiosIf a company doesn’t have cash on hand to cover its day-to-day operations, it’s probably on shaky ground. Use the following formulas to find out whether a company has plenty of liquid (easily converted to cash) assets. Current ratio gives you a good idea of whether a company will be able to pay any bills due over the next 12 months with assets it has on hand. Current ratio = Current assets divided by Current liabilities Quick ratio or acid test ratio shows a company’s ability to pay its bills using only cash on hand or cash already due from accounts receivable. It doesn’t include money anticipated from the sale of inventory and the collection of the money from those sales. Quick ratio = Quick assets divided by Current liabilities
Interest coverage ratio lets you know whether a company is bringing in enough money to pay interest on whatever outstanding debt it has. Interest coverage ratio = EBITDA divided by Interest expenseReading Financial Reports for Cash Flow FormulasYou’re interested in a company, so you’re reading its financial reports. Part of the test of a viable operation is having enough cash to keep the company going.
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