Shareholders are part-owners of a corporation. They need to know how the company did to decide whether to continue to hold, sell or buy more shares. Every quarterly earnings report is accompanied by a company press release in which the management summarizes the result and puts the best spin on the situation. The accompanying financial statements provide the numbers shareholders need to verify the story. Short of outright fraud, the numbers are pretty accurate. because they are certified by an independent auditor, the report is filed with the Securities and Exchange Commission and the CEO must sign off on the accuracy of the reporting.
Financial Statement Components
A financial statement consists of a balance sheet and a profit-and-loss (P&L) statement. Both provide useful information to investors.
The P&L shows how much the company took in in sales, how much it paid out in expenses and what the result was: profit or loss. Shareholders need to know how much a company made on a per-share basis (earnings per share) and how that compares with previous quarters--whether a company's earnings are growing, and how fast. The faster the earnings growth, the greater the potential stock price appreciation.
The balance sheet shows how sound a company is financially and how well the management is handling the finances. Shareholders typically look at several items, such as cash and equivalents, accounts receivable, inventories and long-term debt. A company with a lot of cash and no, or little, debt is in a very strong financial position as it has the resources to weather a potential downturn. On the other hand, growing long-term debt indicates potential problems: The company is borrowing more money for current operations, and it will have to continue to make interest payments even in an economic downturn, which will put it in a precarious financial position if it does not generate enough cash from operations.
Shareholders may put more or less weight on different items depending on the company or economic or market conditions. For example, they may scrutinize the research and development expenses of a technology company to determine whether it is spending enough money to develop new products or fret over the growing accounts receivable and inventories of a manufacturing company in an economic downturn because those items indicate the products are not selling and the company is having a hard time collecting the money it is owed.
To help investors analyze company financials, analysts have come up with a multitude of financial ratios, such as price-to-earnings, price-to-sales, dividend payout, debt coverage and quick ratio, which are derived from reported financial data. Many investment websites, such as Reuters, list those ratios so investors do not have to create them from scratch each quarter.