Why Financial Statements Are Important
Financial Statements (why they are important and what you need to know to make investment decisions).
Portfolio managers, financial analysts or anyone that manages money as a profession will tell you that financial statements are an important part of the overall investment analysis of every company. They can warn of potential problems and, when used correctly, help determine what a business is really worth. And ultimately, thats one of the things you really want to know, after all your potentially going to invest in it.
But financial statements can be very intimidating to someone who has never been taught to understand them.
So, if you have never read a financial statement or just don’t understand them – I’m going to teach you how to carefully analyze the financial statements of a publicly traded company so you, too, can determine what the company is worth and then decide if you want to purchase it.
This financial analysis allows you to enhance the decision-making process by helping to identify companies that are overvalued, or better yet, undervalued.
Even if you have never taken a course in finance or accounting, after reading these series of articles, you should be able to read and evaluate a business’s financial statements. Then you can use that information as part of your overall investment analysis.
What information are you going to need
Let’s discuss first what information you will need. No one should think of investing in a company based merely on a supposedly hot tip, a broker’s recommendation, or even what you saw a mutual fund portfolio manager recommend on TV or the internet.
Even if the company is one you’ve discovered on your own, you shouldn’t just run out and buy shares of its stock. First, get your hands on the company’s financial information and get to know the situation thoroughly. Read!
For all of you out there that want to do it “old school” you can call the company you’re interested in directly, ask for the investor relations department, and request an investor information packet. A full packet typically contains the following, all of which you want and should ask for:
The annual report (most recent), which would include the income statement, balance sheet, and cash flow statement.
Press releases (all recent ones).
Analysts’ reports (any available up-to-date ones).
By the way, if you’re wondering what all this is going to cost you, it’s nothing: This information is free!
Nowadays, though, the Internet is the place to do the best research. You can get a substantial amount of information online. You can access all recent SEC filings, including company 10-Ks and 10-Qs, without ever leaving your keyboard. (Yahoo! Finance, Google Finance, CBS MarketWatch, and MoneyCentral, Bloomberg are good ones.) All you need to know is a company’s ticker symbol to acquire news, financial snapshots, financial statements, and estimates of future earnings. You can also go directly to the company’s Web site. Most publicly traded companies’ Web sites have investor relations sections where you can get all the information you need plus press releases.
Just what are Financial Statements?
To begin with, whether a company is privately held or publicly traded on any of the major exchanges, it has to produce financial statements. For a publicly traded company, financial statements are required by law and must include a balance sheet, an income statement, a statement of cash flows, an auditor’s report, and a relatively detailed description of the company’s operations and prospects for the upcoming year.
Financial statements are necessary sources of information. Contained in the midst of all the numbers are both the past and current direction of a company. Although there are several financial statements that a company has, these series of articles will focus only on those that are most important in making a sound investment decision. Think of yourself as the portfolio manager of your own mutual fund. You are deciding what stocks to buy for your fund. Your goal: Get the best possible return for your shareholders—in this case, the “shareholders” are you!
Why We Have Financial Statements
Before getting into the details of financial statements, it’s important to understand why they are put together in the first place. The management of any business requires a flow of information to make informed, intelligent decisions affecting the success or failure of its operations. Investors need statements to analyze investment potential. Venture capital and private equity firms, asset management firm portfolio managers, angel investors, and banks require financial statements to decide whether to invest in a company or loan money, and many companies need statements to ascertain the risk involved in doing business with their customers and suppliers.
Where You Get Financial Statements
The best and most reliable place to obtain financial statements would be directly from the company, of course. As mentioned earlier, for publicly traded companies, you can call the investor relations department and ask for the financial information of the company. You will want to get a copy of all the financial documents for the past year or two from the company you are interested in investing in. Most of them (not all) can be found at Yahoo! Finance: Type in the ticker symbol of the company you want to research and then click on the “Financials” link to bring up a copy of the latest quarterly financial statements. There are a number of other finance sites that can provide you with financial statements; I just think the Yahoo! site is easy to use.
Financial statements also appear in the company’s 10-Q and 10- K reports. The 10-K is issued once a year, along with the annual report, whereas 10-Qs are issued three times a year, at the end of the intervening quarters. The 10-Q summarizes the company’s quarterly performance. The 10-K is dedicated to a company’s financials, not its story, and thus includes information you simply won’t find in most annual reports, like insider stock holdings and brief biographies of the management team.
For private companies, the information is not available to the general public or over the Internet. Financial statements are only given—for the most part—to would-be investors (e.g., angels or private equity or venture capital investors) or debt holders. For example, a bank that the company was trying to get a loan from would require financial statements.
What You Need To Know
How you read the financial statements to conduct your fundamental analysis (I’ll discuss this later) really depends on who you are and what your interest in the company is. Management, creditors (e.g., banks), and investors (buy-side firms, venture capital, private equity, angel investors) all utilize financial statements. Each group is interested in different things. For example, on the one hand, an investor might assess profitability, growth, stability, and the rate of dividends. On the other hand, a creditor is much more interested in the amount of debt that a company currently has and whether it has the ability to make repayments.
Financial statements are customarily prepared on a quarterly, biannual, or annual basis. The date of a financial statement is of considerable importance. Most are usually drawn up on a yearly (fiscal) basis.
Next up, I’ll discuss the statements themselves.
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