How to Read a Financial Statement

National Press Foundation April 2011

Why This Matters

S&L Crisis = FIRREA Enron, WorldCom = SOX 2007-2009 Financial Crisis = TARP

Understanding Financial Statements Allows You to Ask Smarter Questions, Engage Management in Higher Level Dialogue and Write More Powerful Stories

Rules of the Game

Generally Accepted Accounting Principles Financial Accounting Standards Board (FASB), Norwalk, Conn. est. 1973 sets U.S. GAAP 1934 Securities Exchange Act requires publicly traded companies to file audited financial reports. Enforced and regulated by the Securities and Exchange Commission (SEC)

Why it really is a Game

Disclosure in a competitive environment Pressure to manipulate financial statements Keeping up with high growth industries/markets Investor Pressure Short-term, quarterly focus on gains Dependence on share price for financing Management greed/compensation

Tools for journalists where to find information

Annual Report to Shareholders 10-K annual reports 10-Q quarterly reports 8-K material event filing Proxy statements Earnings calls Analyst reports Form 144 - Insider transactions Annual meeting

10-K Annual Report

Income Statement Balance Sheet Management Discussion and Analysis Structure of Industry and Competition Footnotes Auditors statement Statement of Cash Flows Liquidity Position Contingencies

10-Q Quarterly Report

Quarterly earnings statement Due within 45 days Unaudited Compare to the press release Focus on income from continuing operations before transactions: What EPS would have been

8-K Filing material events

Notifies investors of material events Hire, fire, departure of top officers Acquisition or sale Change in control Plant shutdowns, layoffs Subsidiary sales, acquisitions Triggering events (loan obligations) Bonds, stock sales, financing Lawsuits, bankruptcies etc.

Proxy statements
Relates to the election of boards of directors at annual meeting Allows shareholders to vote by proxy, i.e.; mail, on issue facing the company Includes #s on management compensations, stock options. Auditor changes Insights into CEO incentives and board relationships

Income Statement (Profit and Loss, P&L, or the Bottom Line)

Gross Revenue - Cost of sales, administration - Depreciation, amortization = Operating profit + Other revenues other expenses = Taxable income - Income taxes = Net income - Dividends = profits reinvested

Balance Sheet
Assets - Liabilities = Equity Liabilities + Equity = Assets?

Equity / # shares outstanding = book value per share

Compare to stock price; What is market saying?

Cash Flow real money vs. accrual

Income from operations (adjust for) +/- non-cash expenses/revenue +/- changes in working capital = Net cash from operations +/- Cash from investing activity +/- Cash from financing = Net Cash flow Change in cash = beginning - ending cash

Getting Past the Snapshot Effect

Financial reports reflect financial condition on four days a year. Balance sheets expand or contract during the time in between reporting periods. Revenue recognition varies Use spreadsheet to stack historic data for long-term perspective Look for economic/macro trends Access management strategy vs context

Ratio Analysis/Monetary Measures

ROE = Return on Equity, income/equity ROA = Return on Assets, income/assets EPS = Earnings Per Share, $$s/# shares Debt Ratio = Debt/Assets COGS = Cost Goods Sold, Cost Sales EBITDA = Earnings before interest, taxes, depreciation and amortization Compare to other competitors and industry averages to benchmark performance

How to Put it All Together

What is the companys business, mission? How much cash does it really make? What are its resources? Where is it getting financing from? Where is it investing in its business? Is it profitable vs industry peers? What do the accounting footnotes say? What are the key ratios? What does management say?

How to Read a Financial Statement

National Press Foundation April 2011