General suggestions
With any financial statement, you should first look at the changes from year to year — both in the raw numbers and in the percentage changes in the numbers. These comparisons may indicate "trends" and are very helpful in assessing a company.
It is hard to generalize about a good rate of change — it depends on the line item you are looking at and the rates of change in prior years. If a company's sales rose 15 percent in each of the past three years, and rose only 10 percent this year, it would not be good. However, if the past years' rates of increase had been only five percent, and this year's rate is 10 percent, it would be quite good.
Most large companies include data for three years, but I recommend looking at longer periods of time if possible.
The financial statements represent a good starting point in judging a company's financial strength, but they are only a starting point. To complete the picture, you must acquire more information about the company's products, people, technology, and other resources that may give it a competitive advantage in the marketplace. One of the best sources of supplemental information is the non-financial section of the annual report. This section, usually in front, often tells a lot about top management's views on the company's future and ability to compete.
On this statement, one of the figures I look at is the total operating income and its ratio to total revenue (net sales):
total operating income
total revenue
Ideally, I would like to see operating income growing, both as an absolute number and as a percentage of total revenue. That would usually mean a company is growing its operating income and becoming more efficient over time in managing its costs and operating expenses. There is no "ideal percentage" because the target percentage varies from industry to industry.
On this statement, two things I look for are the figure for total stockholders' equity and the ratio of total liabilities to total stockholders' equity:
total liabilities
total stockholders' equity
Generally, a lower ratio of liabilities to equity means a lower risk for a company's creditors and lower costs when the company borrows money. Yet, how much debt a company carries compared with stockholders' equity varies widely according to the norms for the industry and the company's financial strategy. Just because a company has a high debt ratio is not a signal of weakness, if the ratio is in the ballpark for the industry.
With the statement of financial position, it is important to remember that most companies try to shine the spotlight on assets, not on liabilities. For instance, this statement typically provides a number for total assets and total stockholders' equity but not for total liabilities (to obtain total liabilities, subtract total stockholders' equity from total assets). An anonymous writer once said, "The needs of man are few — to get food, find shelter, and keep debt off the balance sheet [statement of financial position]". Keep this in mind and train yourself to seek out liabilities reported indirectly as well as directly.
Be sure to check the notes too, for liabilities you might find there. Look into note titles such as "Debt", "Other Liabilities and Environment", "Interest on Debt", "Commitments and Contingencies", "Leases", "Pensions" and "Post-Retirement Obligations".
Financial information is useful, but not every asset and liability can be measured in accounting terms. Statements of financial position often omit assets that are hard to measure or do not result from specific past events. For example, Coca-Cola does not report the company trademark — estimated to be worth more than $50 billion — on this statement. Also, Boeing's statement of financial position does not include the value of its vast workforce of engineers and aeronautics experts. These intangible assets can make the market value of a successful company's stock much greater than the statement reports.
On this statement, I look at the figure for cash provided, or used, by operating activities (operations). Without a doubt, this number is the most critical on this statement. These activities represent the basic business of the company. If a company consistently fails to make money at its basic business, it will have a hard time surviving. In a healthy mature company, operating activities normally result in positive cash flows.
The other ways a company receives or spends cash — investing and financing — are more difficult to interpret. For example, negative investing cash flows may indicate only that the company is growing and buying assets that enable it to manufacture more products. Financing cash flows are affected by a company's borrowing and the amount paid in dividends during the year. To interpret these numbers, you need more information on the company's strategies.
|
