Questions answered by the four statements

A company's financial statements are not just a report card of its revenue. They show how money was earned, where it was spent, and who it is owed to. Consolidated financial statements cover the entire corporate group, including subsidiaries. Mixing them with figures from the parent company alone leads to inaccurate comparisons.

Tracing from revenue to net income

Gross profit is calculated by subtracting the cost of goods sold from revenue. From there, operating expenses such as R&D and SG&A are deducted to arrive at operating profit, and after accounting for interest, other income/expenses, and taxes, you reach net income. If there is a non-controlling interest, the company's total net income is distinguished from the profit attributable to the parent company's shareholders.

If a virtual company has revenue of 100,, cost of goods sold of 40,, and other operating expenses of 30, the gross profit is 60, and the operating profit is 30. On a screen that shows total operating costs and expenses grouped as 70, calculate it as 100−70=30. Do not subtract the already included cost 40 again. Do not just look at the translated name "operating expenses"; verify if it is "Total costs and expenses" in the original text.

Assets = Liabilities + Equity

If a hypothetical company has 300, in assets and 100 in liabilities, its equity is 200. Assets include not only cash but also accounts receivable, inventory, buildings, and intangible assets. Liabilities include not only borrowings but also accounts payable and accrued expenses.

Equity is the shareholders' portion recorded on the books. It is not the same as the company's market capitalization or the money you would receive if it were liquidated now. You must read the notes to see if inventory is selling at its proper value, if there is a possibility of goodwill impairment, or if the cash is restricted in use. The classification of current items is usually related to 1 year or the normal operating cycle.

You can be profitable but still have an empty bank account

If you sell 10 on credit and generate a profit but have not yet received the payment, accounts receivable increases. A cash expenditure of 20 to purchase equipment is not necessarily equal to the expense of 20 for that year, as it can be depreciated over several years.

When you borrow money and 30 enters your account, cash increases, but it is not revenue. Therefore, compare net income with operating cash flow, and read through investment expenditures, borrowings, capital increases, and dividends. Do not directly compare cumulative cash flow from the beginning of the year with a single quarter's profit or loss.

A realistic order for reading disclosures

For U.S. companies, review both the IR performance materials and the SEC's 10-K and 10-Q filings. Foreign issuers may use other reports such as 20-F and 6-K. Also, distinguish between audit opinions in annual reports, review scopes in quarterly data, and whether there were any restatements. The reasons behind the numbers can be found in the MD&A (Management's Discussion and Analysis) and the footnotes.

1. 1

   Indicate the currency, units, closing date, and whether it is quarterly, annual, or cumulative.

2. 2

   Identify business segments where revenue and operating profit have changed.

3. 3

   Check the difference between net income and operating cash flow.

4. 4

   Connect changes in cash, debt maturity, and the number of shares.

5. 5

   Read about one-time gains and losses, changes in accounting policies, and risk factors.

Check what you have read.

• Are the consolidated standards and units consistent?
• Did you deduct the costs twice?
• Did you distinguish between cumulative cash flow and a single quarter?
• Have you checked the footnotes and amended filings?

Apply what you read to the actual screen

Try it on WAPE

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