The Statements – III
One of the most important things to check when investing are the statements companies publish. Usually, you will be able to find them in the company’s “Investor Relations” page on the company’s website. These will tell you many important pieces of information on the company’s financials and it will be the place where you can find the metrics that we have talked over the last module. This will further help you fundamentally analyse the company and help you to make buy, sell or hold decisions. Financial statements are written records that convey the business activities and the financial performance of a company. Financial statements are often audited by government agencies, accountants, firms, etc. to ensure accuracy and for tax, financing, or investing purposes. Financial statements include, of course, the Income Statement, the Balance Sheet and the Cash Flow Statement, all of which, we will be addressing today.
The Income Statement covers a specific range of time, a quarter for quarterly income statement or an year for annual income statement. It shows the reader the specific timeframe relevant revenue, the expenditure, net income and the EPS. Usually, it has the past two or three years to serve as a comparison.
The income Statement shows the profitability of the company over a specified timeframe and how it has grown year-over-year/quarter-over-quarter. Therefore, the formula of the Income Statement is to take the Revenue and subtract the Expenses to achieve a Net Income, which is how much a company has gained (profit) or loss.
Type of Revenue
There are two different types of revenue. Operation Revenue and Non-operation Revenue. Operation Revenue would be, for Apple, for example, the sales they make on their products such as the iPhone and the MacBook’s. That is their core business and therefore their Operation Revenue. The Non-Operation Revenue include anything else that is not Operation Revenue such as, interest earned on cash in the bank, rental income from a property, income from strategic partnerships like royalty payment receipts or income from an advertisement display located on the company's property.
Type of Expenses
The main purpose of an Income Statement is for the investors to see how good the company is at controlling their expenses, to help that translate into profits.
Typical expenses are the regular expenses a company has to pay, such as employers wages, sales commissions, and utilities just like electricity and transportation. Primary expenses are incurred during the process of earning revenue from the primary activity of the business. Expenses include the cost of goods sold, selling, general and administrative expenses, depreciation or amortization, and research and development. Expenses that are linked to secondary activities include interest paid on loans or debt. Losses from the sale of an asset are also recorded as expenses.
Example of an Income Statement
Below you can see the Income Statement for Apple in 2019
Unlike the Income Statement, the Balance Sheet represents a specific point in time rather than a period. It might not have been the same yesterday and might not be the same tomorrow, it only displays today’s information, so it is very important to see the date that that Balance Sheet is referent to. The balance sheet provides an overview of a company's assets, liabilities, and stockholders' equity.
The Balance Sheet formula is the sum of the total liabilities with the total Equity giving you the Assets of a Company. The balance sheet identifies how assets are funded, either with liabilities, such as debt, or stockholders' equity, such as retained earnings and additional paid-in capital. Assets are listed on the balance sheet in order of liquidity. Liabilities are listed in the order in which they will be paid. Short-term or current liabilities are expected to be paid within the year, while long-term or non-current liabilities are debts expected to be paid in over one year.
The Assets included in the Balance Sheet are the cash and cash equivalents, the Accounts receivables (the money the company is owed by their customers) and the Inventory.
The Liabilities in the Balance Sheet include the short and long-term debt, the wages the company payees their employees and the Dividends that are paid by the Company.
Shareholders' equity, in the Balance Sheet, is a company's total assets minus its total liabilities. Shareholders' equity represents the amount of money that would be returned to shareholders if all of the assets were liquidated and all of the company's debt was paid off. Retained earnings are part of shareholders' equity and are the amount of net earnings that were not paid to shareholders as dividends
Example of a Balance Sheet
Below you can see the Balance Sheet of Apple in 2019
Cash Flow Statement
The Cash Flow Statement provides the reader with the company’s ability to generate cash that will be required in order to pay off the liabilities seen in the Balance Sheet. This statement is merely a complement to the two previous ones, yet very important.
It offers the reader the information on how the company earned its money, and how well is it being spent. It is a great statement to understand how financially solid the company is. Unlike the Income Statement and the Balance Sheet, the Cash Flow Statement does not have a formula, but instead, it contains three sections that report on the cash flow for the various activities that a company has. Those three components of the Cash Flow Statement are listed below.
The Operating Activities that appear on the Cash Flow Statement include any sources and uses of cash from running the business and selling its products or services. Cash from operations includes any changes made in cash, accounts receivable, depreciation, inventory, and accounts payable. It also includes income tax payments, wages, interest payments, cash receipts from the sale of a product or service and rent.
The Investing Activities in the Cash Flow Statement include any sources and uses of cash from a company's investments into the long-term future of the company. A purchase or sale of an asset, loans made to vendors or received from customers or any payments related to a merger or acquisition is included in this category.
Also, purchases of fixed assets such as property, plant, and equipment (PPE) are included in this section. In short, changes in equipment, assets, or investments relate to cash from investing.
Cash from financing activities include the sources of cash from investors or banks, as well as the uses of cash paid to shareholders. Financing activities include debt issuance, equity issuance, stock repurchases, loans, dividends paid, and repayments of debt.
Example of a Cash Flow Statement
Below you can see the Cash Flow Statement of Apple in 2019
Financial Statement Limitations
Financial Statements provide great information that will certainly help you make investment decisions. Yet it is important to know that they too have limitations. They are very open to interpretation. Although they are numbers, and numbers are not interpretable, one investor might be fine with a certain amount of debt in a company and a different investor might be very uncomfortable with the exact same amount of debt in the exact same company.