How to Read Financial Results

Overview

A company's annual report is the most vital way for potential investors to understand the financial state of a company.

A company annual report is also a marketing tool designed to attract investors, and a company will try to present themselves in the best light possible without violating any legal regulations. Unfortunately, while many investors read annual reports, they fail to read them successfully.

In other words, while annual reports do not deceive or reflect false information about the business, investors should always read them with a sense of doubt. Learn how to read between the lines and make out the actual condition of the company.

This module will assist you as an investor to learn how to make the most sense out of a company’s financial results.

Before Reading the Financial Statements

The more you read financial statements/integrated reports, the more comfortable you will become with the presentation, and the better able you will be to interpret what the statements are telling you. Most of the numbers in the financial statements don’t stand alone.

Each financial statement will have several footnotes that strengthen the numbers – make sure you read these carefully. It’s also important to remember that to get a good feel for the company, you should look at it within a much larger context.

Some of the things you need to consider before reading the financial statements or integrated report include:

Perspective: Put the company into a context that includes its industry, the economy, interest rates, the business cycle, etc. For example, the financial statements and ratios of a basic material company such as Sasol are hugely different from that of a retailer such as Pick n Pay.

Trends: Look at the company’s own trends or how it has performed over the past three, five or 10 years. You might find that this year’s performance is much better, or worse, than the performance over the past few years. If so, look for reasons – it may be that a company that supplies animal feed suffered a downturn during the drought.

As you are reading the financial statements of a company, remember that public companies produce two types of numbers: unaudited and audited.

Unaudited: Unaudited numbers are sometimes called management figures. They are produced for executives and managers for specific purposes, such as inventory control and cash flow projections.

Audited*: This is where an independent auditing firm (e.g. Ernst & Young) has reviewed the numbers to provide assurance that certain procedures have been followed so that the numbers follow accounting principles i.e. so that the numbers you are reading correctly show the state of the company.

The three financial statements that you will come across are the income statement, the balance sheet and the cash flow statement. We will now consider what you need to look for in each of these.

*Please note that not all numbers that are released to the public by companies have been reviewed by outside auditors.

Income Statement

The income statement shows what the company makes in profits or losses during the reporting period, such as a quarter or a year.

The key information for you to look for in the income statement include the likes of:

Revenue
Headline Earnings
Cost of Goods Sold
Gross Profit
Operating Expenses
Other Revenues or Expenses
Income Taxes
Net Income
Earnings Per Share (EPS)

These topics go beyond the scope of this module and you would need to do your own research to understand them better.

Balance Sheet

This is a snapshot of the company’s assets, liabilities and shareholders’ equity on the last day of the reporting period.

The left side of the balance sheet lists the assets (i.e what the company owns). The right side lists the liabilities (i.e. what the company owes), and the shareholders’ equity (i.e. the funds invested in the company and retained earnings). The two sides must balance, so the balance sheet format is assets equal liabilities plus shareholders’ equity (A = L + E).

The balance sheet displays data from the two most recent years, which lets you calculate changes from one year to another. Major changes in any account must be examined and could be worth following up.

These are the items to look for on a balance sheet: