Wednesday, 15 May 2019

(Post 89/Year 2 week 26)Learning investing/trading together part 16:How to read financial statements(Profit/loss statement and Balance Sheet)

This week on learning investing/trading together, we will be learning how to read the financial statement, this is important as it allows us to judge whether we should invest in the company or not. (I know it sounds boring, but stick with me ok😄?)

I have written on reading some part of the financial statement, a year back here. As it does not cover the financial statements thoroughly, this post will be a good pre-read before we delve into the "deeper" stuff.

Some of this post material is from the book: How I become a profitable trader after losing $30,000(by Koh Ming Shao), you can either buy the book online or borrow the book from the library(remember my tip on borrowing books from the library?)

So let's get straight to the point!

A typical company financial statement is made up of 3 component
  1. Profit And Loss Statement
  2. Balance Sheet
  3. Cash Flow Statement
I will be using Singpost financial statement from yahoo finance as an example.Do note that i will be not be going through the terms,only those term that will be use in my upcoming post on financial ratios will be used(I will explain more about it in the future post).

Profit and Loss Statement
  • The Profit and Loss Statement shows the company's revenues and expenses over a particular period, usually a year
  • To summarize, the Profit and Loss statement show how profitable the company is
  • Below is an example of a Profit and Loss Statement/Income statement of Singpost (stock code: S08), refer to this link for the Profit and Loss statement from Singpost
  • **refer to important

Revenue

Total Revenue
  • Revenue is the amount of money a company earns through its business.
  • A good company should see its revenue increase year by year
Cost of revenue
  • It included those directly linked to product production, such as labor costs, materials, and overhead production. 
  • For example, for singpost, the sales cost refers to the electricity bill requiring the operation of the machinery, fuel for the transportation of workers, etc.(A little unsure about it myself also, as there are many factors affecting the costs of goods)
Gross profit
  • The difference between revenue and cost of revenue. The number gives an indication of the company financial health
  • Higher gross profit also indicates that the company can fend off competitors from the same industry
  • With high gross profit, the company can pay for its operating costs and other expenses
  • Hence, the more the better!
  • Gross Profit=Revenue-Cost Of revenue
Net Profit
  • This is the difference between the revenue and all of the expenses incurred for the cost of doing business(overhead)plus interest and depreciation.
  • It represents the profitability of the company. Higher net profit may also mean that the company is able to price their product higher than their competitor
  • However, if the company is constantly cutting its cost to drive up revenue, it is not a solid company as its revenue growth may have become stagnant


Operating expenses

Research development
  • Expenses spend on researching product and, service.
  • The intention to develop a product or service that will provide income over the coming years, E.g. singpost researching on a new mail sorting machine
  • Research development 2018: Nil
Selling general and administrative
  • Sum of all direct and indirect selling expenses and all general and administrative expenses (G&A) of a company
  • E.g corporate and sales or marketing salaries, commissions, advertising and any promotional materials
  • Selling general and administrative 2018:$147,624,000
Non-recurring 
  • Unusual charge, expense, or loss that is unlikely to occur again(one time off payment) 
  • This include lawsuit payments and moving expenses
Total operating expense
·   An operating expense is an expanse a business incurs through its normal business operation.
·   Operating expenses include rent, equipment, inventory cost, marketing, payroll, insurance and funds allocated for research and development

Operating income or loss
·   Operating income is an accounting figure that measures the amount of profit realized frombusiness’s operations, after deducting operation expenses such as wages, depreciation, and cost of goods sold
·   Total other income/Expenses net

Net income
·    Income minus cost of goods sold, expenses and taxes for an accounting period

Income from continuing expenses

Interest expense
·   It represents interest payable on any borrowing, bonds, loans, convertible debt or line of credit

Earnings before interest and taxes

·   An indicator of a company’s profitability.
·   Revenue minus expenses excluding tax and interest.
·   Also known as operating earnings, operating profit and profit before interest and taxes

Income before tax
·   This refers to the profit a company made before paying its income tax bill

Income tax expenses
  • The tax that the company have to pay to the government
Minority interest
  • Minority interest refer to the minority stockholders(retail investor like you and me) shares holding
Net income from continuing ops
  • The net income that the company earn after deducting the tax
Balance sheet
  • The balance sheet provides you with a snapshot of the company's financial strength at the end of the accounting year. A balance sheet tells you what a company owns (Assets) and what the companies owe(Liabilities). It is divided into 5 component as follows
  1. Non-Current Assets
  2. Current Assets
  3. Current Liabilities
  4. Non-Current Liabilities
  5. Shareholder's Equity
  • Below is an example of a balance sheet



Non-Current Asset
  • Non-current assets are assets a company does not expect to convert into cash within the current year or may take longer than one year to sell
  • Some examples of non-current assets are property, plant equipment, and vehicles. These assets are used to run the business, and can not be sold
Current Asset
  • Current assets are assets that the company is expected to convert into cash, such as cash and short-term deposits (sometimes referred to as cash and cash equivalents or cash and bank balances), inventories, trading receivables, and money that the company is expected to collect as part of a project's progressive payment (applicable to a project-based firm).
  • Under current assets, a few important components you should know are:
  • Cash & Cash Equivalents is the amount of money the company has in the bank. Remember, Cash is KING! 
  • If the company has more cash, it either means the company may not have to borrow or just borrow a little to run the business. 
  • Investors love investing in a company with little or no debt.
  • With little or no borrowing, if the business is not profitable or growing, the companies will be spared from high interest expenses or the possibility of running debt repayment problems. . 
  • However, if the company sits on a pile of cash but does not return the cash to shareholders as a dividend or expand the business, the management does not make good use of the money and generate better returns for shareholders.
  • Trade and other receivables also relate to commercial debtors.It is the monies that are own to the company by their customers. 
  • Like most businesses, their customers would be given credit terms as a gesture for an ongoing business relationship. 
  • Credit terms are given to their loyal customers such as 30 days, 60 days or even 90 days. Investors would like to see a reduction in trade and other receivables
  • Rising trade receivables would mean that the company has trouble collecting creditors ' payments and would have a severe impact on the cash flow of the company. 
  • However, due to the nature of their business, some companies always have trade that is admissible on the high side. You will need to compare companies in the same sector to determine the trend
  • Inventory refers to raw material, work-in-progress good and finished product that the company has yet to be sold off or delivered.  Investors love to see the inventory moving quickly. 
  • The faster the stock is sold, the more income the company can generate.

Current Liabilities 
  • Current Liabilities are what the company owes and must be repaid with the current accounting year.
  • These include trade and other payables (also known as commercial creditors), loans and borrowing, amounts due to clients for contracts and ongoing contract work (only applicable to a project-based company), and other financial obligations
Non-Current Liabilities
  • Non-current liabilities are what the company owes and will only be repaid after one year or more
Shareholders' equity
  • Shareholder equity refers to the company's value or net worth. 
  • It basically means the money that is left if a company sold all of its assets and paid off all of its liabilities. 
  • This leftover money belongs to the shareholders, or the owners, of the company
  • Equity= Assets -Liabilities
  • The most important section of equity is retained earning also known as retained profits or accumulated profits. 
  • As the word suggests,, the company will retain retained earning for investment purposes, distribute them as a dividend or pay off its debt,.If the company is making losses, it will be called retained losses.
Will continue the post at the next part, thanks for reading!

1 comment:

  1. I remember studying profit/loss statement, balance sheet during my college days when we had accounting classes. Your post has brought back those memories again. Thanks for sharing this info.

    ReplyDelete