Balance Sheet

Definition:

 Reports a company's assets, liabilities and shareholders' equity.

 Provides a snapshot of what a company owns and owes, as well as the amount invested
by shareholders.
 Shows financial strength of a business
 Don’t provide enough info, but it’s the first thing to look into to see if its worth investing

How to determine a financially stable company?

1. Total current assets / Total current liabilities

 Number should be above 1

 Ratio above 2 is very good, above 3 means that company is not going to go out of
business
 Higher ratio of current assets vs current liabilities, safer and less risky the business
 For example, if a business shut down and their ratio is 2, it means that the business has
enough assets to pay off its liabilities over 2 times. They have more than enough assets to
pay off their liabilities.

2. Total cash and total current assets should be growing over the years

 If total current assets are going down over the years and the total current liabilities are
going up over the years, there is a problem. Company moving in wrong direction as debt
if going up and assets are going down.
 Same goes to total assets and total liability
 Even if total liability kept going up over the years, if the total assets also going up year by
year then it’s okay.

3. Stockholder’s equity

 Total asset – total liability = stockholder equity

 If stockholder equity going down it means liabilities are growing faster than assets.
 Therefore, stockholder equity should be continually increasing year over year

Retained earnings – Net income business generated after paying out all of its dividends

Total asset – total liability = total stockholder’s equity

Income Statement

Definition:

 Profit or Loss statement

 The income statement reflecting a business's performance via its revenues, expenses, and
profits
 Including noncash accounting such as depreciation

What to look into?

 Operating income should be positive number, means generating income

 Same goes to net income
 Look into the historical numbers and compare from year to year for total revenue, gross profit,
operating income and net income (Preferably 10 years back)

 For above, even though the total revenue is increasing year after year, however, the gross
profit is decreasing. Gross profit for 2016 is greater than of 2019 despite 2019 has higher
total revenue. Why 2019 has lower gross profit? From the case above, it is because of the
cost of revenue in 2019 is quite high and that’s why the gross profit in 2019 is lower. It
also tells that the gross margin in 2016 (26.86%) is higher than 2019 (22.09%).
  For net income, 2019 is greater than 2016. For this case, it is because of the income tax
expense back in 2016 was higher compared to 2019. This tells you that the tax that the
company have to pay lowered from 2016 to 2019 and since the income tax expense is
lowered, the company is generating more net income in 2019.

Gross profit margin 

 It illustrates how well a company is generating revenue from the costs involved in

producing their products and services. The higher the margin, the more effective the
company's management is in generating revenue for each dollar of cost. 
 Gross profit = Total revenue – cost of revenue (COGS)
 Gross Profit Margin= (Revenue−Cost of Goods Sold)/Revenue
 The gross margin represents the portion of each dollar of revenue that the company
retains as gross profit. For example, if a company's recent quarterly gross margin is 35%,
that means it retains $0.35 from each dollar of revenue generated.

Operating profit margin (Almost the same as gross profit margin)

 Operating profit/earnings = Gross profit – total operating expenses

 Operating profit Margin= Operating Earnings/Revenue
 Good operating margin is about 15 percent, the higher the better
 It tells you how much of the total revenue is actually profits for the business.
Cash flow Statement

Definition

 The CFS allows investors to understand how a company's operations are running, where
its money is coming from, and how money is being spent.
 Measures how well a company manages its cash position, meaning how well the
company generates cash to pay its debt obligations and fund its operating expenses. 
 CFS is distinct from the income statement and balance sheet because it does not include
the amount of future incoming and outgoing cash that has been recorded on
credit. Therefore, cash is not the same as net income, which on the income statement and
balance sheet includes cash sales and sales made on credit.
 The first section of the cash flow statement is cash flow from operations, which
includes transactions from all operational business activities. 
 Cash flow from investment is the second section of the cash flow statement, and is the
result of investment gains and losses. 
 Cash flow from financing is the final section, which provides an overview of cash used
from debt and equity.
 Income statement is not the same as the company's cash position. The cash flow
statement, though, is focused on cash accounting.
 For example, let's consider a company that sells a product and extends credit for the sale
to its customer. Even though It recognizes that sale as revenue, the company may not
receive cash until a later date. The company earns a profit on the income statement and
pays income taxes on it, but the business may bring in less cash than the sales or income
figures.
 Cash flow from operations is basically the company’s net income in a cash version.
 Another example, accounts receivable is a noncash account. If accounts receivable go up
during a period, it means sales are up, but no cash was received at the time of sale. The
cash flow statement deducts receivables from net income because it is not cash. The cash
flows from the operations section can also include accounts payable, depreciation,
amortization, and numerous prepaid items booked as revenue or expenses, but with no
associated cash flow.

Things to look into

 Net operating cash flow should be positive. If negative, means company is losing
money on their operation or actual operations is not producing a profit.
 Under cash from investing activity, if the amount of acquisitions of the company on
other business is very high means it is a red flag. This means that the company is
investing more money into acquiring other business instead of their own, which tells you
that you should consider investing your own money into that particular business as well.
  So, take note on how much the company is actually investing back to their own versus
how much companies are investing into acquiring another business. If a company is
investing in other business is more than their own means you should start asking
questions and digging a little deeper.
 Under cash from financing activity, it is not a bad thing to see a company repurchase
their own stock if they can afford to do it (company generate tons of cash flow). But if
the company’s cash flow does not support stock repurchase but they did the repurchasing,
it is a red flag, because the company is not spending their money wisely.
 Positive other financing activities (under cash from financing expenses) means the
company raised money through getting a new debt.
 Net change in cash = Operating + Investing + Financing
 Free cash flow = Cash from operating activities – Capital expenditure (Investment back
into property, plant and equipment)
 If a company is generating negative cash flow and they are repurchasing stocks and
paying dividends, it is a red flag.
 Company’s free cash flow should increase year over year.
 Net income and cash by operating activities should also increase year by year.
 Under financing activities, pay attention to how much new debt the company is taking on.
Need to find out why the company is raising so much new debt.

What is free cash flow?

 Free cash flow measures a company's ability to generate cash

 The presence of free cash flow indicates that a company has cash to expand, develop
new products, buy back stock, pay dividends, or reduce its debt.
 Relies heavily on the state of a company's cash from operations, which in turn is heavily
influenced by the company's net income.
 Thus, when the company has recorded a significant amount of non-operating earnings or
expenses that are not directly related to the company's normal core business (Ex. a one-
time gain on the sale of an asset) the analyst or investor should carefully exclude those
from the free cash flow calculation to get a better picture of the company's normal cash-
generating ability.
 Investors should also be aware that companies can influence their free cash flow by
lengthening the time they take to pay the bills (thus preserving their cash), shortening the
time it takes to collect what's owed to them (accelerating the receipt of cash), and putting
off buying inventory (again, preserving cash). It is also important to note that companies
have some leeway about what items are or are not considered capital expenditures, and
the investor should be aware of this when comparing the free cash flow of different
companies.
 FCF = Operating Cash Flow - Capital Expenditures
https://investinganswers.com/dictionary/f/free-cash-flow#:~:text=Free%20cash%20flow%20(FCF)
%20is,reducing%20debt%2C%20or%20other%20purposes.

https://www.investopedia.com/terms/c/cashflowstatement.asp

Why is depreciation added back to cash flow statement? (Same goes to stock based
compensation)

Depreciation is a non-cash expense, so when that expense is incurred it needs to be added back in
order to get a full accounting of cash flows. Accounting-wise, depreciation is treated as though it
were any other cash expense. So it’s added to total expenses and deducted from your total
income to get down to net income. But in reality, no cash is paid out. So to adjust for
accounting’s treating depreciation as though cash was paid out, we need to add it back to zero it
out. This makes cash outflows equal to what they truly are. If you don’t add back depreciation
when looking at cash flow, you will have a misleadingly low cash flow.

Positive change in working capital

Working capital = Total asset – total liability. Positive change in working capital means the
company took on a new debt or sold a fixed asset to generate more money.

What is P/E ratio?

 P/E ratio = Stock price/Earnings per share

 Companies that have no earnings or that are losing money do not have a P/E ratio.
 The P/E ratio helps investors determine the market value of a stock as compared to
the company's earnings. In short, the P/E ratio shows what the market is willing to pay
today for a stock based on its past or future earnings.
 A high P/E could mean that a stock's price is high relative to earnings and possibly
overvalued. Conversely, a low P/E might indicate that the current stock price is low
relative to earnings.