Reading Financial Reports for Dummies (3 page)

Navigating the Equity Maze .......................................................................... 89

Stock ...................................................................................................... 89

Retained earnings ................................................................................ 90

Capital ................................................................................................... 90

Drawing ................................................................................................. 90

Chapter 7: Using the Income Statement. . . . . . . . . . . . . . . . . . . . . . . . . .91

Introducing the Income Statement .............................................................. 92

Digging into dates ................................................................................ 93

Figuring out format .............................................................................. 93

Delving into the Tricky Business of Revenues ........................................... 96

Defi ning revenue .................................................................................. 96

Adjusting sales ..................................................................................... 97

Considering cost of goods sold .......................................................... 99

Gauging gross profi t .......................................................................... 100

Acknowledging Expenses ........................................................................... 101

Sorting Out the Profi t and Loss Types ...................................................... 103

EBITDA ................................................................................................ 103

Nonoperating income or expense .................................................... 104

Net profi t or loss ................................................................................ 105

Calculating Earnings per Share .................................................................. 105

Chapter 8: The Statement of Cash Flows . . . . . . . . . . . . . . . . . . . . . . . .107

Digging into the Statement of Cash Flows ................................................ 107

The parts ............................................................................................. 108

The formats ........................................................................................ 109

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Checking Out Operating Activities ............................................................ 111

Depreciation ....................................................................................... 111

Inventory ............................................................................................. 112

Accounts receivable .......................................................................... 112

Accounts payable .............................................................................. 113

Summing up the cash-fl ow-from-activities section ........................ 113

Investigating Investing Activities ............................................................... 114

Understanding Financing Activities .......................................................... 115

Issuing stock ....................................................................................... 115

Buying back stock .............................................................................. 115

Paying dividends ................................................................................ 116

Incurring new debt ............................................................................ 116

Paying off debt ................................................................................... 117

Recognizing the Special Line Items ........................................................... 117

Discontinued operations................................................................... 117

Foreign currency exchange .............................................................. 118

Adding It All Up ............................................................................................ 118

Chapter 9: Scouring the Notes to the Financial Statements . . . . . . .121

Deciphering the Small Print ....................................................................... 122

Accounting Policies Note: Laying Out the Rules of the Road ................ 122

Depreciation ....................................................................................... 123

Revenue ............................................................................................... 124

Expenses ............................................................................................. 124

Figuring Out Financial Borrowings and Other Commitments ................ 126

Long-term obligations ....................................................................... 126

Short-term debt .................................................................................. 129

Lease obligations ............................................................................... 130

Mergers and Acquisitions: Noteworthy Information .............................. 131

Pondering Pension and Retirement Benefi ts ........................................... 132

Breaking Down Business Breakdowns ...................................................... 133

Reviewing Signifi cant Events ...................................................................... 135

Finding the Red Flags .................................................................................. 136

Finding out about valuing assets and liabilities ............................. 137

Considering changes in accounting policies .................................. 137

Decoding obligations to retirees and future retirees .................... 138

Chapter 10: Considering Consolidated Financial Statements . . . . . .139

Getting a Grip on Consolidation ................................................................ 139

Looking at Methods of Buying Up Companies ......................................... 144

Reading Consolidated Financial Statements ............................................ 146

Looking to the Notes ................................................................................... 148

Mergers and acquisitions ................................................................. 149

Goodwill .............................................................................................. 149

Liquidations or discontinued operations ....................................... 150

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Part III: Analyzing the Numbers ................................ 151

Chapter 11: Testing the Profi ts and Market Value . . . . . . . . . . . . . . . .153

The Price/Earnings Ratio ............................................................................ 154

Figuring out earnings per share ....................................................... 154

Calculating the P/E ratio ................................................................... 155

Practicing the P/E ratio calculation ................................................. 156

Using the P/E ratio to judge company

market value (stock price) ............................................................ 157

Understanding variation among ratios ........................................... 159

The Dividend Payout Ratio ......................................................................... 160

Determining dividend payout........................................................... 160

Digging into companies’ profi ts with dividends ............................ 161

Return on Sales ............................................................................................ 163

Figuring out ROS ................................................................................ 163

Reaching the truth about profi ts with ROS .................................... 164

Return on Assets .......................................................................................... 164

Doing some dividing to get ROA ...................................................... 165

Ranking companies with the help of ROA ...................................... 165

Return on Equity .......................................................................................... 165

Calculating ROE .................................................................................. 166

Reacting to companies with ROEs assistance ................................ 166

The Big Three: Margins ............................................................................... 167

Dissecting gross margin .................................................................... 167

Investigating operating margin ........................................................ 168

Catching the leftover money: Net profi t margin ............................ 169

Chapter 12: Looking at Liquidity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .171

Finding the Current Ratio ........................................................................... 172

Calculating the current ratio ............................................................ 172

What do the numbers mean? ........................................................... 173

Determining the Quick Ratio ...................................................................... 173

Calculating the quick ratio................................................................ 173

What do the numbers mean? ........................................................... 174

Investigating the Interest Coverage Ratio ................................................ 175

Calculating the interest coverage ratio ........................................... 175

What do the numbers mean? ........................................................... 176

Comparing Debt to Shareholders’ Equity ................................................. 176

Calculating debt to shareholders’ equity ....................................... 177

What do the numbers mean? ........................................................... 178

Determining Debt-to-Capital Ratio ............................................................ 178

Calculating the debt-to-capital ratio ................................................ 178

What do the numbers mean? ........................................................... 180

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Chapter 13: Making Sure the Company Has Cash to Carry On. . . . . .181

Measuring Income Success ........................................................................ 181

Calculating free cash fl ow ................................................................. 182

Figuring out cash return on sales ratio ........................................... 184

Checking Out Debt ....................................................................................... 185

Determining current cash debt coverage ratio .............................. 186

Computing cash debt coverage ratio .............................................. 188

Calculating Cash Flow Coverage ................................................................ 190

Finding out the cash fl ow coverage ratio........................................ 190

Hasbro ................................................................................................. 192

What do the numbers mean? ........................................................... 192

Part IV: Understanding How Companies

Optimize Operations ................................................. 193

Chapter 14: How Reports Help with Basic Budgeting. . . . . . . . . . . . .195

Peering into the Budgeting Process .......................................................... 196

Who does what ................................................................................... 196

Setting goals ....................................................................................... 197

Building Budgets .......................................................................................... 199

Providing Monthly Budget Reports ........................................................... 201

Using Internal Reports ................................................................................ 203

Chapter 15: Turning Up Clues in Turnover and Assets . . . . . . . . . . . .205

Exploring Inventory Valuation Methods ................................................... 206

Applying Three Inventory Valuation Methods ........................................ 208

Average costing .................................................................................. 209

FIFO ...................................................................................................... 210

LIFO ...................................................................................................... 210

Comparing inventory methods and fi nancial statements ............ 211

Determining Inventory Turnover .............................................................. 211

Calculating inventory turnover ........................................................ 212

What do the numbers mean? ........................................................... 213

Investigating Fixed Assets Turnover ......................................................... 214