How to read a company financial statement
Spring is here. The Easter bunny is on his or her way as Easter approaches. Get those kites decorated!
Meanwhile, millions of publicly traded companies (those operating on a calendar year) across the globe are in the process or reporting their full year generally, independently audited 2018 financial results to their shareholders and the general public.
These reports are absolutely necessary for transparency and good corporate governance, but also legally required, in various formats, by most countries’ investment securities laws.
The US Securities and Exchange states that “it is mandatory for publicly traded companies to make SEC filings as the information (verified by the SEC) helps investors to make informed decisions when planning to sell, buy, or hold a company’s securities”.
Bermuda has 11 main board and two small cap publicly traded domestic companies as listed issuers on our own internationally recognised Bermuda Stock Exchange. Each company hosts a page of detailed financial information, just for your perusal: its unique security identifier, ISIN (international securities identification number), trading history, pricing and number of shares issued. For instance, Argus Group Holdings Ltd cites 21 million-plus shares, its dividend history and significant financial information including quarterly interim and annual financial reports.
Reviewing any extensive financial statement can be both frustratingly tedious, sometimes virtually incomprehensible, and boring, particularly when we are all caught up in the urgent rush of everyday life.
Who has time for so many numbers, given that an annual financial statement for even a small company can run over 100 pages?
Moneywise will feature a review of couple of our companies over the next month or so — as a prelude to the New Bermuda Investment Primer (part of the Bermuda Fundamental Financial Planning Primer Series of e-Books) launch.
Eventually, you will have a few main indicative points (in a checklist format) that will illuminate company operations. Then, it is up to you to review further detail.
These check points focus on what to look for; what do the numbers mean; why should you care; can they be used to make investment decisions?
Is there any applicability to daily economic life, such as my pension investments?
The question you, as readers, may ask is why should you care — whether you own Bermuda company shares or not — about this stuff? Because these companies, after all, are our local businesses. We know the people; many employees are friends or relatives. We see them; we use their products or services, we rely on them to be there: banking, insurance, pensions, investments, communications, media, utilities, services, etc.
So, we start. Let’s use the example of the sample balance sheet enclosed. Every company operating today generates a balance sheet, a statement of financial position for some point in time that resembles this format of simple numbers.
Analysts derive financial substance from these numbers with ratios, comparisons to prior years, tracking against other firms, industries, consumer and competitive trends, stock market directions, interest rates and future projections, along with many other, thought to be thousands, of analytical models!
Much verbiage is used, many with formulaic backing. You’ve heard the acronyms that financial commentators use: Ebitda, capex, book value, loss ratios, ROE, EPS, QE, GDP, Libor, NAV, TTM, ROA, PE, capex, and on and on. They know what they are talking about, it can often seen like pure Greek to you.
It is almost all about the numbers. An audited company financial statement (always a snapshot in time) consists of three main sections and a narrative called Notes to the Financial Statements:
1. A balance sheet, or statement of financial position.
2. An income statement, or statement of profit and loss.
3. The statement of cash flows.
First. The company balance sheet in our chart, is so called because the total assets number $770,000 (owned by the company in the top half of the picture), must equal the liabilities $481,000 (the debt owed by the company) plus the stockholders’ equity $289,000 remaining. In other words, the company’s debt and equity indicate how the assets are acquired. We’ll ignore the fact for now that this balance sheet is probably millions, not thousands!
The Stockholder’s Equity section is also called the book value of the company — arrived at by subtracting total debt liabilities from total assets. Remember the balance sheet must balance. How that SE is arrived at, is discussed in future section.
The book value is the recorded historical cost of the company. However, the company stock value in the open investment market may be trading at a completely different price as it will reflect investor perceived projections of future demand.
Market sentiment, though not always based upon numeric fundamentals, is an expression to describe pricing, receptiveness to increases in value and stock movements of a company shares, along with the markets as a whole.
There is almost always a difference between these two important numbers — a substantial argument for having clear, verifiable financial information that investors and shareholders can rely on. Whether book value is higher than market share value or the reverse is a common investor valuation ratio tool.
Numerous other investment analyses ratios can be determined simply by calculating various ratios from the balance sheet numbers.
The book-to-market ratio is used to find a company’s value by comparing its book value to its market value. A company’s book value is calculated by looking at the company’s historical cost, or accounting value.
A firm’s market value is determined from its share price in the stock market and the number of shares it has outstanding, which is its market capitalisation.
Question, readers. What is the book value of this company? Do you think that market share value is the same? Why would there be a difference?
Part two: my personal company financial statement indicators, and how do ratios help us with investment decisions, along with the profit and loss statement.
Accounting Coach, LLC. This is a terrific website, if you want to informally increase your bookkeeping skills, accounting verbiage or investment knowledge to just better understand the financial statements issued by public companies.
The Motley Fool
Company financials and annual reports by Karen Blakeman, RBA Information Services, http://www.rba.co.uk/sources/finars.htm
• Martha Harris Myron CPA CFP JSM: Masters of Law — international tax and financial services. Dual citizen: Bermudian/US. Pondstraddler Life, financial perspectives for Bermuda islanders and their globally mobile connections on the Great Atlantic Pond. Finance columnist to The Royal Gazette. All proceeds earned from this column go to The Reading Clinic. Contact: email@example.com