Inflows, Outflows, Cashflows

If a balance sheet goes a company's financial state in this moment, the income statement tells you a little bit about how it got there. This statement might be ever so slightly more important than the others because it shows profitability.

The income statement shows a record of how much money the company took in as revenue and owes in expenses. The bottom line is net income, or profit. (And yes, the phrase "the bottom line" came from this. That's how important it is.)

When you look at an income statement, revenues should be increasing -- you want the company to sell more stuff to make more money. Expenses should generally be decreasing or staying the same; this is more about proportion, though. Expenses should grow proportionally with revenues, though this can be thrown off if the materials to make the company's products get more expensive beyond anyone's control.

Certain things on an income statement will be company-specific, so don't be surprised if not all ISs look the same way. For example, one company's interest expense might be higher than anothers because it pays a higher interest rate.

Ultimately, the income statement is about the profit sitting at the bottom. Net income should always be increasing, of course! But be mindful that the number fluctuates based on a variety of things, like the economy and the cost of materials.

Now, when I talk about "profit," I'm not necessarily talking about "cash." That's where the cash flow statement comes in.

If the balance sheet shows the company's financial state and the income statement shows profitability, then the cash flow statement shows where the money went in the midst of all that: where it went out the door, where it came in from, and how much of it remains.

Know that companies don't usually buy materials or property with cash, but with some type of debt, be it short-term or long-term. But they have to pay the debt, so they keep cash for that and for everyday expenses, like salaries.

Cash-rich companies have much more flexibility than debt-ridden ones, though. Apple, with all its cash, created devices that changed the world forever. Kodak, on the other hand, no longer has a prayer.

Keep an eye out for companies with lots of cash because, if they're not busy creating the Next Big Thing, they likely pay high dividends, which is essentially a tip to you for investing in their company. It's generally best to re-invest dividends in the company's stock because it increases your investment return over time. It's basically like investing with free money -- I can't think of anything that sounds better!

Next time, I'll bring all three statements together to show you how they work in action for Coach, Inc. You'll be back, I know! ;)
 

Strive for a Good Balance

In my last post, I talked about what makes a good buy based on the numbers you find on a company’s stock information page on Google or Yahoo finance. All of this information is helpful and necessary, but you should know where they came from.

Much of the information originated from the companies’ finance statements, 3 of which are the most talked-about: the balance sheet, income statement, and cash flow statement. These can be found under the heading "Financials," or "Financial Statements" on Google or Yahoo. Today, we'll talk balance.

A balance sheet is a “snapshot” of the company’s current financial health. It tells you how much the firm has in cash and other assets, liabilities, and equity at this moment in time.

For the sake of simplicity, we’ll call assets “what we have” or “what we’re owed.” Assets include cash (like, checking account balances), property, and accounts receivable (the amount other people owe the company). Same as with a person’s finances, companies generally want to maximize assets; who wants to be in debt?!

Speaking of debt, companies have liabilities, which are also found on the balance sheet. Liabilities include anything owed to others: accounts payable and long- and short-term debt. Again, like individuals, companies generally try to minimize their liabilities, but debt is not all bad. Companies get a special tax break for having debt, so some will take out debt just for that purpose. So don’t count a company as irresponsible for not being debt-free like LULU.

Finally on the balance sheet, you’ll find “equity.” This can be most closely related to a house: down payments and any increase in value adds to the house’s “equity.” For a company, equity is in terms of the stock it has issued and profits it has accumulated over time. This cannot be spent, but still counts as value.

If you look at a balance sheet, you’ll see that the total amount of assets will equal the total amount of liabilities plus the total amount of equity. This will ALWAYS happen. Sort of a law of nature. Assets = liabilities + equity. So, if the company has a lot of liabilities, it has to make up for it in assets and/or decrease its equity.

Why is this important to you as an investor?

It is the best way to determine the company’s financial health. It’s important to know what the company is doing with its money, but even more important to know if it has any money to begin with. If liabilities are more than 2 times the amount of cash the company has, then you should question how it plans to pay the debt down.

Look at the amounts over time. Is cash growing? If it is going down, is debt also going down? (That would mean the company is paying down excess debt.) Is debt growing? If so, is property growing? (Sometimes, you have to take out debt to buy property, of course.)

Always ask questions. The financial statements are a puzzle that all fit together; one affects the others just as well it affects other parts of itself.

Next up, income statement = profitability. Stay with me!

So now I'm back, from outer space!

Dear Readers,

I’ve fallen off the radar for quite a few months due to my wedding in spring, a summer internship that kept me quite busy, and the school year beginning in fall. I’ve also been a bit emotionally occupied with the sudden passing of a close friend of mine, who died just days after attending my wedding. That said, I’m feeling much better about life, though taking things one day at a time. Furthermore, I’d like to use this blog as a way to remind myself of the things I love in life: investing my money and time, namely in the people I love.

My next post will pick up where I left off and be posted within a day. Stay tuned, and thanks for your patience!