Fundamental Analysis Flashcards
To understand The Tools of Fundamental Analysis
The Balance Sheet
The balance sheet represents a record of a companies assets, liabilities and equity at a particular point in time. The balance sheet is name by the fact that a business’ financial structure balances in the following manner: Assets = Liabilities + Shareholders Equity It tells you how much a company owns, its assets, and how much it owes, its liabilities. The difference between what it owns and what it owes is its equity, also commonly called Net Equity or Shareholders Equity.
Balance Sheet Cont.
Assets - represent the resources that the business owns or controls at a given point in time. Examples of this are cash, investory, machinery, and building. The other side of the equation represents the total value of the financing the company has used to acquire those assets. Financing comes as a result of liabilities or equity. Liabilities represent debt Equity represents the total value of money that the owners have contributed to the business. Example of this is retained earnings, which is profit made in the previous years.
The Income Statement
Balance sheet = snapshot approach, more high level Income statement measures a companies performance over a specified amount of time. The income statement presents information about revenues, expenses and profit that was generated as a result of the business’ operations for that period
Statement of cash flows
Represents a record of a business’ cash inflow and outflows over a period of time. Cash flow focuses on the following cash-related activities: Operating Cash Flow (OCF) Cash generated from day-to-day business expenses Cash from investing (CFI) Cash used for investing in assets, as well as the proceeds from the sales of other businesses, equipment or long-term assets Cash from financing (CFF) Cash paid or received from the issuing and borrowing of funds Cashflow statements is viewed as a more conservative measure of a company’s performance
Footnotes of Financial Statements
Serves to tie up any loose ends and complete the financial picture. The footnotes list important information that could not be included in the actual ledgers. Ex., relevant things like outstanding leases, maturity dates of outstanding debt and details on compensations plan like stock options etc.
What are the expenses?
Two most common are Cost of goods sold (COGS) is the expenses most directly involved in creating revenue. It represents the costs of producing or purcahsing the goods and services sold by the company. Ex., ABC pays a supplier $4 for teh box of sopa, and sells it for $5. When it is sold, ABC’s COGS for the box of soap would be $4 Selling, general and administrative (SG&A) includes marketing, salaries, utility bills, technology and other general costs associated with running a business, also included depreciation and amortization. Companies must include the cost of replacing worn out assets. Cutting out research and development (R&D) might look good on a financial statement but it is essential for growth and should not be cut. Lastly, taxes and interest payments are to be considered
Profits = Revenue - Expenses
Profit - is revenue - your total expenses. However there are several profit subcategories that tell investors how the company is performing. Gross Profit- calculated as revenue - Cost of sales. At ABC the gross profit from the sale of the soap would have been $1, sold for $5 - $4 for COGS = $1 Gross profit.
Assets
There are two types of assets Current assets - are likely to be used up or converted into cash within one business cycle, usually treated as twelve months. Three very important current assets found on the balance sheet are: Cash, Inventories, and Accounts Receivable. Non current assets - are anything not a current asset. This includes fixed assets like property, plant and equipment (PP&E). Unless the company is in financial distress, investors don’t need to pay attention to fixed assets.
Liabilites
Current - Obligations the firm must pay within a year, ex., owing money to a supplier. Non-current - Obligations the company owes in a year or more, ex., bank and bondholder debt
Quick Ratio
Current assets - liabilities / current liabilites
Equity
What shareholders own, it is often called shareholder equity. Total assets - Total liabilites = Equity Two important equity items are paid in capital and retained earnings. Paid- in capital - The amount of money shareholders paid for their shares when the stock was first offered to the public. Represents how much money the firm received when it sold its shares. Retained earnings - A tally of the money the company has chosen to reinvest in the business rather than pay to shareholders. Investors should look at how closely a company puts retained capital to use and how a company generates a return on it.
Cash Flow State vs . Income Statement
The cash flow statement shows how much cash comes in and goes out of the company over the quarter or the year. At first glance, that sounds a lot like the income statement in that it records financial performance over a specified period. But there is a big difference between the two. What distinguishes the two is accrual accounting, which is found on the income statement. Accrual accounting requires companies to record revenues and expenses when transactions occur, not when cash is exchanged. At the same time, the income statement, on the other hand, often includes non-cash revenues or expenses, which the statement of cash flows does not include. Just because the income statement shows net income of $10 does not means that cash on the balance sheet will increase by $10. Whereas when the bottom of the cash flow statement reads $10 net cash inflow, that’s exactly what it means. The company has $10 more in cash than at the end of the last financial period. You may want to think of net cash from operations as the company’s “true” cash profit. Because it shows how much actual cash a company has generated, the statement of cash flows is critical to understanding a company’s fundamentals. It shows how the company is able to pay for its operations and future growth. Indeed, one of the most important features you should look for in a potential investment is the company’s ability to produce cash. Just because a company shows a profit on the income statement doesn’t mean it cannot get into trouble later because of insufficient cash flows. A close examination of the cash flow statement can give investors a better sense of how the company will fare.
Operating Cash Flow (OCF)
The section shows how much cash comes from sales of the company’s good and services - the amount of cash needed to make and sell those goods and services. Investors tend to prefer companies that produce a net positive cash flow from operating activities. High growth companies ten d to show negative cash flow from operations in their formative years.
Cash Flow from Investing (CFI)
This section largely reflects the amount of cash the company has spent on capital expenditures, needed to keep the business going i.e., new equipment. It also included acquisitions of other businesses and monetary investments such i.e., Money Market Funds
Cash From Financin (CFF)
This sections describes the cash associated with outside financing activities. Typical sources of cash from financing examples would be cash raised by selling stock and bonds, or bank borrowings. NOTE: Paying back a bank loan would show up as a use of cash flow as would dividend payments and repurchasing common stock.
