Let’s take this a step further and really dig into the finances of each company you choose. We all know that owning a piece of a company can be exciting especially when we are familiar with their products, which has been around for many decades. In Investor 101, we learn to remove our emotions and put our business hat on.
You would be surprised that not every big company operates efficiently as it should so they have to be scrutinized just as much as the new guys on the block. Good thing for us(the public), we have access to information that really tells the true story of each organization.
As a shareholder, you have to know what you are getting yourself into and the best way to do this is to learn how to read 3 important company documents such as income statements, balance sheets, and cash flow statements. By understanding these 3 documents, you will know whether the company stock you love is a good buy or not.
Income Statement: presents the revenues and expenses for a specific period of time. Both revenue and expenses result in net income or net loss for the company. Net loss occurs when expenses exceed revenue. Net income occurs when revenue exceeds expenses.
Equation: Revenue – Expenses = Operating Income
Balance Sheet: reports the assets, liabilities, and owner’s equity at a specific date. This tells you how much the company owns(assets) and what the company owes(liabilities).
Equation: Assets = Liabilities + Shareholder’s Equity
Statement of Cash Flows: summarizes information about the cash inflows(receipts) and cash outflows(payments) for a specific period of time. This is the main document that really ties in the income statement and the balance sheet together by telling you whether the company has any money leftover.
Key Things To Look For When Analyzing An Income Statement
(Income Statement example from Investing.com)
1. Revenue should always exceed Expenses on this statement. It’s a red flag if the expenses is bigger than the revenues shown meaning that the company is having problems.
2. Non Recurring Charges should not appear frequently in this statement. These are one-time charges that are not part of regular operations. Examples: Closing a plant or selling a division. In a healthy company, this line will be blank majority of the time.
3. Look at the Selling, General, and Administrative line to see if the overhead expenses is rising fast in this area. If this line item is drastically increasing even though revenue(sales) remains the same then this company is not very a cost-effective firm.