Financial statements: a complete overview of what to look out for and what you need to know as an investor

Studying financial statements is an essential part of fundamental analysis, without which long-term investing through stock selection cannot be done. In this review, I will focus on the most important financial data of companies.

I will focus on the financial statements for the entire year, i.e. the Annual Reports. The reports are filed on the so-called Form 10-K, under which the annual report can also be found in the case of an American company. Annual reports are the most comprehensive and, I think, the most important in fundamental analysis. Annual reports are commonly found on company websites in the Investor Relations section. But an even easier way is to use sites that collect data from annual reports and make your job much easier. I'm going to use the Yahoo Finance site for now, but it's up to you to decide which one suits you. More tips on sites I and others and investors have provided here: 4 super useful sites that will make navigating financial statements easier.

1. Income Statement

The 2021 annual report of LyondellBasell, which I wrote about a few days back, will serve as an example Will chemical giant LyondellBasell, with a dividend yield of more than 5%, become a representative of my portfolio.

The data we need to analyze can be found in the Financials section, now we are interested in the Income Statement.

Source.

On Yahoo Finance we can see the TTM box, short for trailing twelve months, next to the numbers for each year. It represents the company's results for the last 12 consecutive months. It is the simple sum of the results of a given metric for the last 4 quarters. That is, the result for Q2 2022 + Q1 2022 + Q4 2021 + Q3 2021.

Total Revenue - this is the amount of money a company earns, receives for its products or services sold. It is the amount from which costs are not deducted. Especially for a start-up company, it is essential that this value increases over the years.

Cost of Revenue - the amount of money it takes to generate revenue. This covers the costs involved in producing the product, marketing, distributing the product. Simply any cost that is directly related to the production and distribution of products or services. You can't say in general whether an increasing or decreasing trend of this metric is better. It depends on sales. A good sign is increasing sales and stagnant or decreasing cost of sales. After that, gross profit is increasing.

Gross Profit - This is nothing more than simply subtracting sales from cost of sales. It may also be referred to as gross income, or sales profit. Here, clearly, the higher the gross profit, the better. In analysis, the termgross margin is also often used, which is the ratio of gross profit to sales, multiplied by 100 to get a percentage. Later on, the term net profit or net income will also appear. The latter does not only take into account the cost of the product sold.

Operating Expenses - the costs that a company spends in some normal business activity. These can be advertising, rent, salaries and bonuses, insurance, or research and development. It may also be abbreviated as OPEX. In this case, if the numbers aren't very high and don't exceed, say, sales, that could be a problem.

Operating Income (earnings before interest and taxes) - calculated by subtracting gross profit and operating expenses. Sometimes referred to as income from operations. It is the gross income of the company, plus taxes, minus various interest charges. We want the company to grow this figure on a regular basis. As with gross profit, we have anoperating margin, which is the ratio of earnings before interest and taxes/markets, this is multiplied by 100.

Net Income (net profit/loss) - the figure that is the final result of a company's performance. Sometimes referred to as net earnings. It measures whether a company is making a profit or a loss. The more positive the result, the better. We can then see by how much total revenues exceed costs. In the case of a negative result, we speak of a loss for the company, which is usually indicated in the Annual Report in brackets. On Yahoo Finance, this figure is in the negative.

Basic EPS (earnings per share) - a popular metric that is nothing more than the ratio of net income to total shares. We definitely want EPS to grow. This can be achieved in 2 ways. Either net profit grows or the number of shares decreases. The ideal situation is when both happen at the same time.

2. Balance Sheet

Basically, the Balance Sheet is divided into Assets and Liabilities.

Assets - a resource, an asset that a company owns with the expectation that it brings, or will bring in the future, a benefit or some appreciation when sold. An asset may generate cash flow, reduce costs, or improve earnings. It may be a production facility, a patent, or perhaps a licence. Subsequently, they are divided into short-term and long-term. The opposite is liabilities.

Current Assets - a company's assets that can be sold (monetized) within one year. These assets include cash, accounts receivable, securities. They may also be referred to as Current Accounts. It is important because it shows the short-term liquidity of the company and its ability to pay off short-term liabilities.

Cash and Cash Equivalents - This shows the firm's cash directly or equivalents that can be immediately converted to cash. Cash equivalents include bank accounts and securities such as short-term government bonds. Equivalents should have a maturity of three months or less.

Receivables - money that is owed to a company. Receivables are commonly created when a company allows a buyer to purchase its product or services on credit.

Inventory - raw materials used to produce goods as well as goods that are available for sale. Inventory is further divided into raw materials, work in progress and finished goods. Inventories are valued using the FIFO, LIFO or weighted average method.

Non-current Assets - Investments in a company that will benefit the company for many years. They can be monetized in more than one year. Non-current assets include fixed assets such as the company's property, plant and equipment, but also intangible assets that cannot be physically touched, such as long-term investments or the company's trademark. Changes in fixed assets can be an indication of capital investment or liquidation.

Property, Land and Equipment (the value of all buildings, land, or furniture) - referred to as net PPE in Yahoo Finance. Fixed assets that are critical to the business operations and long-term financial health of the company. PPE purchases are a signal that management is confident in the long-term outlook and profitability of their company.

Goodwill - an intangible asset that represents the excess of another company's purchase price. Or put another way, it is the value of a given company at what it values itself. Calculated by taking the purchase price of the company and subtracting the difference between the fair market value of the assets and liabilities.

Liabilities - something that the company owes, usually some amount of money. This can include loans, accounts payable, mortgages, or maybe bonds. Like assets, they are divided into current and non-current.

Current Liabilities - This is debt owed by a company that must be repaid within one year. Usually paid from current assets, which are assets that are consumed within one year. This includes accounts payable, short-term debt, dividends and notes payable, as well as income taxes payable.

Accounts Payable (Accounts Receivable/Accounts Payable ) - Sometimes also referred to as Accounts Payable (AP), these are amounts due to vendors or suppliers for goods or services received that have not yet been paid. Management may choose to pay its outstanding accounts as close to their due date as possible to improve cash flow.

Non-current Liabilities - also known as long-term liabilities. Liabilities that are not due for more than one year. Examples of non-current liabilities are long-term loans and lease obligations, notes payable and deferred revenue.

Long Term Debt - liabilities mainly to banks

Stockholder's Equity (total, shareholders' equity) - assets of shareholders. It is obtained by subtracting assets from liabilities.

3. Cash Flow - summary of cash flows

Here we learn how the company handles its cash. Basically, the summary is divided into operating, investing and financial assets.

Operating Cash Flow - the sum of all items in the operating assets

Depreciation & Amortization - the process of depreciating the value of a loan or intangible asset. Negative amortization can occur when loan payments are less than the accumulated interest, causing the borrower to owe more money instead of less.

Stock-based compensation - The way companies use stock or stock options to reward employees instead of cash.

Change in Recoverables - an increase or decrease in the amount of money customers owe a company.

Investing Cash Flow - the sum of all cash generated from investing activities.

Capital Expenditure - the cost to a business of acquiring new and renewing old physical assets such as plant, property, industrial and technical equipment. Spending important for maintaining existing property and equipment and for investing in new technology and other assets for growth.

Financing Cash Flow - Cash flows that are used to finance a company and its capital. Financing activities include transactions involving the issuance of debt, equity and the payment of dividends.

Cash Dividends Paid - paid to shareholders

Repurchase of Capital Stock - the amount spent by a company to repurchase shares

Free Cash Flow - the money a company has left after paying operating expenses and capital expenditures. The more free cash a company has, the more it can devote to dividends, debt repayment, and growth opportunities.

Summary

I'm sure there are a ton of other concepts that could be discussed, but this should suffice as a foundation. For an even better understanding of a company's business, I recommend looking up the revenue of each segment in the Annual Report, or the composition of revenue by geography. You'll find this in the Financial Statements section right in the Form 10-K, which you already know how to find. We can also find the risk factors of the company's business in the report, which is also definitely worth reading. If you're interested, we can look at the rest of the stuff in the report, outside of Financials, sometime in the future.

Anything not clear or anything you would like to add? I'd be happy for any feedback. 😄

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Cost of Revenue - the amount of money it takes to generate revenue. This covers the costs involved in producing the product, marketing, distributing the product. Simply any cost that is directly related to the production and distribution of products or services. You can't say in general whether an increasing or decreasing trend of this metric is better. It depends on sales. A good sign is increasing sales and stagnant or decreasing cost of sales. After that, gross profit is increasing.

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