Analysis and Use of a Financial Statement
- Locating the objective and risks of an organization in the annual report is important to assess the purpose of the company and what may harm the potential growth of the stock. The company lists both in the first few pages. An investor can find the annual report on most company's websites or on the website of the U.S. Securities and Exchange Commission. The objective is relevant because what type of company it is and what it provides to consumers.
- There are four primary types of financial statements an investor reviews: the balance sheet, the statement of income, the cash flow statement and the statement of retained earnings. The balance sheet is a snapshot picture of the company at a given point in time. The statement of income gives profit and loss production over a period of time. The statement of cash flows simply shows the movement of cash. The statement of retained earnings gives a picture of what the company did not distribute to investors.
- A ratio analysis is the study of the relationships between different variables within the financial statements. A few important analysis to look for include: the current ratio, which is assets divided by liabilities; earnings per share, which is net profit after taxes divided by the number of common stock shares outstanding; and price/earnings ratio, which is the market price of a share of common stock divided by earnings per share. The higher each of these is, the better.
- As an investor, a person seeks to produce income from the purchase of a stock through both capital gains and dividends. If a company is growth oriented or new, it may pay less in dividends for several years. The investor makes up a lack in dividends with increases in capital gains. Since this is more risky, the potential for gains is greater; however, so is the potential for loss. If an investor wants a safer purchase, he can focus on dividend-paying stocks.
