Figures That Tell A Company’s Story

Foreword from ShareInvestor

This article “Figures That Tell A Company’s Story” by Chen HuiFen was first published in The Business Times on 12 Nov 2007 and is reproduced in this blog in its entirety.

But not necessarily the whole story. CHEN HUIFEN explains what the financial data in an annual report tells about a company’s health

ANNUAL reports are among some of the tools investors use to research listed companies. However, such documents issued by the companies themselves should always be viewed with caution.

Annual reports don’t always tell the whole story. By the time they are printed, new developments may have taken place. Also, being a marketing channel, it is not unusual for companies to use annual reports to present information in such a way that they are perceived in the best light possible. Still, they are one of the many research tools that are readily available and easily kept. Many companies post soft copies of their annual reports on their official websites. And there are also copies available on the Singapore Exchange (SGX) website.

For the newbies out there, we explored the value in ploughing through the prose in annual reports last week. This includes the chairman’s statement, which usually gives an overview of the company’s performance, information on the quality of the management, the auditors’ report, and the remuneration of directors. In this instalment, we look at the financial data in the annual report. Just what should one look out for when perusing those numbers?

P & L

Read the notes/footnotes with certain items in a P&L statement as these tend to explain in detail how those numbers were arrived at.

One of the first numerical tables you see is the consolidated profit-and-loss account. This provides the financial performance of the company in terms of revenue, expenses and earnings for a 12-month period. The same set of financial data is usually compared with that in a previous fiscal year. This will give the reader a raw idea of whether the firm has done better or worse, against the year-ago duration.

There are usually notes or footnotes accompanying certain items in a P&L statement. Read them, as these tend to explain in detail how those numbers were arrived at. The notes section is also where one may find information about such matters as discontinued operations, employee stock options and subsidiaries owned by the company.

Analysts use the P&L statement to calculate a number of ratios that may be useful in their assessment of a company. Take, for example, net profit margin. The net profit margin gives an idea of how much a company makes for each dollar of sales generated. Just take the net profit figure, divide it by the total sales. The resulting number is usually expressed as a percentage. The higher the net profit margin, the stronger the business.

Balance Sheet

A company’s balance sheet provides an idea of what it owns and owes at a particular point in time. This explains why the date attached to a balance sheet is often expressed in the manner “as at DATE, YEAR”. A company’s balance sheet indicates if it will have the resources to fund its growth. If what it owns is more valuable than what it owes, then the difference would be its worth – at least on paper.

Assets and liabilities are among the key items in the balance sheet. They are further broken down into current assets and liabilities, which respectively refer to assets that can be converted into cash within a year, and debts that are due within a year.

The share capital refers to the total funds raised from a company’s issue of shares. Over the years, the share capital typically increases, as retained profits grow. However, when there is a significant jump, it could indicate an issue of new shares. This should prompt the reader to question if it also means a dilution of shareholders’ value – since new shares placed out to new buyers means that the same company is being divided into more slices, owned by more players. There is no dilution if the new shares are placed out to existing shareholders or when the jump in share capital arises from a rights issue.

Cash Flow Statement

The cash flow statement shows a company’s incoming and outgoing funds for a certain period of time. It illustrates the short-term viability of the firm, whether it is able to finance the payment of goods and services required to fuel its growth.

Cash flow may be grouped into three types: cash flow from operations (derived by selling of goods and services offered by the company); from investing (sale or purchase of long-term assets such as plants and equipment); and from financing (issuing of dividends, shares and bonds or share buyback from shareholders).

A company has a healthy cash flow when the cash generated by its operations more than covers what it needs for investing. At the bottom of the cash flow statement, there is an entry which gives the net cash balance called “cash and cash equivalents at end of the year”. Assess the cash flow statement with the balance sheet and P&L in mind. Although a positive cash flow typically suggests financial well-being, a negative cash flow is not necessarily the opposite. Sometimes, negative cash flow is a result of an aggressive expansion strategy over a certain period of time.