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Author: jmls Big gold star, 5000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 3916  
Subject: Reading Financial Statments FAQ v. 0.2... Date: 5/24/2000 2:07 AM
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Dear y'all,

This is my second attempt at a FAQ for this board. I've tried to address the previous round of suggestions, and have separately posted the income statement, balance sheet and cash flow statements. Thanks to RooCat, wallstgal and blackmare for helpful suggestions. I shall request a link to this "for lack of anything better", as well as not knowing the next time the spirit will move me :)

I have not actually come up yet with a glossary, this shall have to wait for the next edition :) Certainly suggestions on what to cover there would be useful.

As always, more suggestions are appreciated, either on the boards or Emailed directly to me.

Lleweilun Smith

1. Q. This financial stuff sounds scary. Why should I bother?
2. Q. What information is available on publically traded companies?
Where can I find it?

3. Q. What information is available in these reports?
4. Q. What are the main sections in the financial sections?
5. Q. What is "accrual" vs. "cash" accounting?
6. Q. What is the format of the income statement?
7. Q. What is the format of the "cash flow" statement?
8. Q. What is the format of a balance sheet?
9. Q. Where may I read more about this stuff?

1. Q. This financial stuff sounds scary. Why should I bother?

A. When one buys a share of a company, one is buying minority ownership in the corporation. Most of us would treat buying into a limited partnership very seriously, and so should treat share purchases with the same amount of thought.

Hopefully, by the end of this FAQ, the reader should know where to find financial information on publically traded corporations and have some idea of what the three main statements - the income statement, the cash flow statement, and the balance sheet - look like. I (the FAQ author) am still learning how to read and understand financial statements, but they no longer intimidate me, and I believe I know where to look to find more information. It is my hope that with some work the reader will learn to not fear and even love the numbers.

In addition to this FAQ, please also see the Fool's series on reading an annual report. Wallstgal linked all of the articles at

http://boards.fool.com/Message.asp?id=1010034000445001

Also, the Fool's School has several articles on reading financial statements. See for example Randy Befumo's "How to read a balance sheet", at

http://www.fool.com/school/valuation/howtoreadabalancesheet.htm

In addition to "Reading Financial Statements", here are a few boards who often discuss "fundamental" analysis (including details of financial statements):

Ahlgren Economics

http://boards.fool.com/Messages.asp?id=1380065000000000

Boring Stocks

http://boards.fool.com/Messages.asp?id=1030002000000000

Security Analysis -- the book

http://boards.fool.com/Messages.asp?id=1380848000012004&sort=id

2. Q. What information is available on publically traded companies? Where can I find it?

A. There are of course many news items available on most publically traded companies. One good resource for finding them is excite.transium.com.

In this FAQ we concentrate on the financial information all US companies must provide. All companies put out an annual report, a 10K (like an annual report with less photos and more legalese), quarterly reports (10Qs), as well as current reports (8Ks), proxy statements (DEF 14As) and a few others. We focus mainly on the annual reports, 10Ks, and 10Qs, all of which have similar formats.

These reports are available in several places. First, many companies' web sites will allow you to download their annual report, often in Adobe PDF format. Also the companies usually have an email or phone number, where you can request information be mailed to you (usually they have a standard "investor's packet" with the latest annual report and 10K, as well as 10Qs and some news clippings). 10Ks, 10Qs and other forms are available on a bunch of websites. My favourite is www.freeedgar.com, others include www.edgar-online.com and the "SEC" link at quote.fool.com.

3. Q. What information is available in these reports?

A. The annual report is broken up into a few sections. There is usually a letter from the CEO, who talks about how great the company is doing. In this letter, "outstanding" means "good", "good" means "average", and "challenging" means "bad".

Afterwards there is a spiel about all the wonderful stuff this company produces, with wonderful photos of products and people made happy by them.

Further back, on somewhat cheaper paper, is the "management's discussion" as well as financial results. It is these which we focus on here.

10Ks look much like annual reports except there aren't glossy pictures and there is more "legalese". 10Qs have the financial section, except they are not for a full year and are unaudited. Quarterlies are important to be sure, but many companies experience significant seasonal fluctuations.

4. Q. What are the main sections in the financial sections?

A. They are the income statement, the balance sheet and the cash flow statement. Also there is a statement of stockholder's equity, and there are several footnotes. Many companies have a "selected financial data" section and perhaps a 5 year or a 10 year review. Without belittling them (especially the footnotes, where much important information may lie), we focus on the three statements.

5. Q. What is "accrual" vs. "cash" accounting?

A. Many beginners think that "income" means "receipt of cash". This is true for example in a lemonade stand. However, this isn't true with businesses in general. Income is recognized upon shipping of goods, regardless of when cash is received; cash is recognized upon receipt of cash, regardless of when goods are shipped. In a lemonade stand, cash is received immediately and goods are shipped immediately; but this isn't true for many businesses.

One major cause for difference is companies' use and acceptance of credit. Example: furniture company XYZ sells $100 worth of furniture, but has a "don't pay for one year" offer going. Income is recognized after the furniture is shipped; cash is recognized when the payment actually occurs, one year later.

Another source of discrepency between "income" and "cash" comes from purchases of property, plant and equipment. Example: company XYZ buys $500 worth of property for a new location. This would not affect the income statement; but it would represent an outflow of $500 in the cash flow statement.

In general, differences between the income statement and the cash flow statement show up in some fashion on the balance sheet. In the first example, after the furniture is shipped but before cash is received, there would be a $100 entry under "accounts receivable" added to the balance sheet. In the second example, there would be a $500 entry under "property, plant and equipment" added to the balance sheet.

One should pay attention if there are large divergences between the income and cash flow statements. The Rule Makers use the "flow ratio" to measure this. A more sophisticated measure is "return on invested capital"; more information may be found in the Fool's "Return on Invested Capital" article at http://www.fool.com/school/roic/roic.htm. Other
sources of information include the the Boring board and The Quest for Value by Bennett Stewart.

6. Q. What is the format of the income statement?

A. http://boards.fool.com/Message.asp?id=1030024000330000&sort=id

7. Q. What is the format of the "cash flow" statement?

A. http://boards.fool.com/Message.asp?id=1030024000331000&sort=id

8. Q. What is the format of a balance sheet?

A. http://boards.fool.com/Message.asp?id=1030024000332000&sort=id

9. Q. Where may I read more about this stuff?

A. The Fool maintains a link to many glossaries at

http://www.fool.com/community/resource/education.htm

Here's a short bibliography.

How to Read a Financial Report: Wringing Vital Signs Out of the Numbers, 5th Edition --- John A. Tracy

Easy-to-understand, step-by-step treatment of financial statements.

Keys to Reading an Annual Report (Barron's Business Keys) --- Welton, Friedlob

Another easy-to-understand financial statement book.

The Interpretation of Financial Statements : The Classic 1937 Edition --- Ben Graham, Spencer Meredith, Michael Price

Many useful insights. Not so useful for GAAP, since accounting has changed since 1937.

The Analysis and Use of Financial Statements --- White, Sondhi, Fried

Very comprehensive description of financial statements.
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