Put it all together and what does it spell? $$$

So, now that you know all about how to read financial statements (see here and here, if you missed them), let's see how they all fit together.

Let's use Coach, Inc. (COH) for our example. Although the company recently saw a decline in profits, it's still financially solid. Let's have a look:

Balance Sheet:
For simplicity's sake, we'll look at annual data. Financial information comes out quarterly (and the date of "quarter end" depends on the company), but it's better to get the big picture view and not freak out if there is a small earnings drop in one quarter.

You'll see that total assets, especially cash, has steadily increased (Great sign!), and although total liabilities have also increased, they are proportional to assets. Coach hasn't taken out an exorbitant amount of debt that it will never be able to pay back. Actually, Coach's long term debt has DECREASED, which is great.















Income Statement:
I've cut the screen shot off here at net income. There's a whole mess of lines that come after that, but we're going to focus on revenues, expenses, and the Bottom Line.

Notice that Coach's annual revenues have, again, steadily increased. That's why it's important to look at the big picture -- there may be dips some quarters, but annual revenues should grow consistently, as should gross profit. Expect expenses to increase; it's totally okay AS LONG AS THEY ARE PROPORTIONAL TO REVENUES. Fractions should stay intact!

Coach is a great example of a company that has been around forever, but still manages to grow wildly, evidenced in the large leaps in net income. While competitors such as Michael Kors and Tori Burch are starting to eat into the market, Coach is still a strong player, taking advantage of growth opportunities around in the world, not just in the US.



Cash Flow Statement:
Cash flow statements are generally the shortest of the financial statements, so, no, your eyes are not playing tricks on you.

You'll see that, in recent years, Coach has pulled in more cash than it has paid out (negative numbers are payouts, positive numbers are inflows), which has pluses and minuses for investors. Plus: The company has cash to pay its bills, so it's not going under any time soon. Minus: The company has cash that it has not given to you, and it is just sitting there.

Notice that the amount paid out as dividends is getting increasingly negative -- that's a good thing: the dividend to investors has increased. Buuuuut, by the end of fiscal year 2012, Coach pulled in an extra $217 million in cash. An investor has to ask herself what the company plans to do with all that, if the dividend is not going to increase. Luckily, Coach has some changes in its retail offerings in store, so we'll soon witness them put that cash to work.















And that's that! Not so bad, huh? Surprisingly simple? Of course this can get infinitely more complicated, and it does, but I won't take you through all that. (If you'd like to know all there is to know, I recommend your local top-25 ranked MBA program.)

Now, you're armed. You know the basics of individual stock selection, you can spot a good stock investment when you see one, when to buy it, when to...sell it?

We'll touch on the delicate topic of ending a stock relationship when we return after these brief messages from our sponsor!

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!