💲𝑭𝒊𝒏𝒂𝒏𝒄𝒊𝒂𝒍 𝑺𝒕𝒂𝒕𝒆𝒎𝒆𝒏𝒕𝒔 𝑨𝑩𝑪💲
As always in December and January, the busy season for accountants hit me full force, which is why nothing came from me here on GQ for quite some time. A time when Accountants and public Accountants (Wirtschaftsprüfer) face each other as gladiators in the Zaubermanage. In the end, only one comes out of the duel unscathed...and you know who that is...the master of the 4 elements HGB, OR, IFRS and Swiss GAAP FER. So here I am and I want to give you some more basics to get you started in the world of elementary magic.
𝘈𝘤𝘤𝘰𝘶𝘯𝘵𝘢𝘯𝘵: "𝘚𝘰𝘮𝘦𝘰𝘯𝘦 𝘸𝘩𝘰 𝘥𝘰𝘦𝘴 𝘱𝘳𝘦𝘤𝘪𝘴𝘪𝘰𝘯 𝘨𝘶𝘦𝘴𝘴𝘸𝘰𝘳𝘬 𝘣𝘢𝘴𝘦𝘥 𝘰𝘯 𝘶𝘯𝘳𝘦𝘭𝘪𝘢𝘣𝘭𝘦 𝘥𝘢𝘵𝘢 𝘱𝘳𝘰𝘷𝘪𝘥𝘦𝘥 𝘣𝘺 𝘵𝘩𝘰𝘴𝘦 𝘰𝘧 𝘲𝘶𝘦𝘴𝘵𝘪𝘰𝘯𝘢𝘣𝘭𝘦 𝘬𝘯𝘰𝘸𝘭𝘦𝘥𝘨𝘦. 𝘚𝘦𝘦 𝘢𝘭𝘴𝘰 𝘮𝘢𝘨𝘪𝘤𝘪𝘢𝘯, 𝘸𝘪𝘻𝘢𝘳𝘥"
So, in order to analyze companies it needs a basic knowledge of how to read and interpret annual reports. Therefore, in this post I would like to briefly explain to you how the individual sections are structured and what information they give us. I am referring exclusively to the financial report. Because in the annual report, in addition to the financial report, there are other helpful sections for your due diligence that give you insights into the strategy, challenges, management or risks of the company. These require less explanation, but are no less relevant!
Finally, I give you a small learning task and link you to the annual report of Novo Nordisk (pharmaceutical company from Denmark - no investment advice, I am invested myself!) as well as individual questions about it. So you can check for yourselves if my contribution has helped you and implement the learnings directly. The corresponding solutions are of course available in the comment function.
𝐈𝐧𝐡𝐚𝐥𝐭𝐬𝐯𝐞𝐫𝐳𝐞𝐢𝐜𝐡𝐧𝐢𝐬:
I. Income Statement
II. balance sheet
III. cash flow statement:
IV. Learning Task
V. Conclusion
So how do I properly read and interpret corporate financial reports?
The financial report is divided into three main sections (income statement, balance sheet, cash flow statement). But what questions are answered in these statements on the income statement, balance sheet and cash flow statement, and what exactly do you do with the answers? I would now like to explain all this to you in more detail. The ABC of Financial Statements awaits you :)
𝐈. 𝐄𝐫𝐟𝐨𝐥𝐠𝐬𝐫𝐞𝐜𝐡𝐧𝐮𝐧𝐠/𝐈𝐧𝐜𝐨𝐦𝐞 𝐒𝐭𝐚𝐭𝐞𝐦𝐞𝐧𝐭
Basic question answered: Is the company profitable?
-->Disclosure of the profit situation!
𝘋𝘪𝘦 𝘌𝘳𝘧𝘰𝘭𝘨𝘴𝘳𝘦𝘤𝘩𝘯𝘶𝘯𝘨 𝘴𝘢𝘨𝘵 𝘢𝘶𝘴:
-How efficient is the company?
-How profitable is the company?
-Where and how could the company make better decisions?
-What are the costs and how can they be controlled?
Basic structure:
Sales - Expenses = Profit
-Turnover = The turnover of a company is composed of all the revenues that a company generates through the sale of goods or its services. [1]
Subtracting the expenses incurred from the revenue generated yields the profit. [1]
-Expenses = Periodized expenses of a business for goods, services, and government charges consumed during an accounting period, which are compared to revenues in the income statement (other: Costs). [2]
Expenses can be broken down into:
-Cost of goods sold: what it costs the company to produce the product to generate revenue. Sales less cost of goods sold = Gross Profit.
Gross margin = gross profit / sales
-Overhead Expenses: Costs that are required to keep the business running but cannot be directly attributed to the revenue or product/service produced. These can be broken down into fixed costs (no matter how much is produced and sold, the fixed costs never change - e.g. rent) and variable costs (which vary according to activity/productivity - e.g. electricity).
Net margin = net profit / sales
Net profit = profit minus all expenses
Net margin and gross margin and the costs included in them thus provide information on whether the company has a sensible and efficient cost allocation. Maybe the company has too high costs for administrative things or even interest for loans, even compared to the competition. It is also possible that the production costs are too high, which affects the margins.
The profit and loss statement can be prepared according to the total cost method (TCO) or the cost of sales method (COS). This results in different classification structures. However, the content or the informative value is the same.
𝐈𝐈. 𝐁𝐢𝐥𝐚𝐧𝐳/𝐁𝐚𝐥𝐚𝐧𝐜𝐞 𝐒𝐡𝐞𝐞𝐭
Basic question answered: Is the company healthy?
-->Presentation of the financial position!
𝘋𝘪𝘦 𝘉𝘪𝘭𝘢𝘯𝘻 𝘴𝘢𝘨𝘵 𝘢𝘶𝘴:
-How much cash does the company have on hand?
-Can the company pay its bills?
-How much are the liabilities?
-Do the assets cover the liabilities?
-What is the ratio of debt/liabilities to equity/equity (the lower the better)?
-How high is the equity ratio (equity/assets)?
The balance sheet is composed of:
A. Assets/Assets:
→Everything you own!
-Cash,
-Inventories,
-trade receivables,
-machinery,
-buildings,
etc.
B. Liabilities
→Everything that is owed to someone in some form!
-Trade payables,
-Tax liabilities,
-bank loans,
etc.
C. Equity
→Says what one is "worth!"
If you sell all your assets and pay liabilities, equity is the value that remains.
Composition of Equity:
-share capital
-Annual surplus/profit of the current year (comes from the income statement/income statement).
-Profit carried forward/Retained earnings (accumulated profits of previous periods - These come from the income statement and are in principle the net profits of the previous years)
-Profits withdrawn from the company in the form of dividends.
-Own shares/Treasury shares
-Capital reserves
Equity is the basis of the relative valuation ratio KBV (market capitalization / equity).
DE: Equity = Assets - Liabilities
ENG: Equity = Total Assets - Total Liabilities
In contrast to the income statement, the balance sheet contains stock figures. In principle, this means nothing other than that my balance sheet continues over the following years. In the income statement we start at 01.01. of a year (if the FY lasts from 01.01. to 31.12.) always again at 0, similar to your tax return. Your income, which you have to pay tax on, you also have to pay tax on only in the year of accrual (inflow principle) and not cumulatively on the following years. In the same way, sales and expenses are only shown once in the reporting period. The balance sheet, on the other hand, shows all inventory figures (machines, inventories, cash, etc.), which can reappear in the following year.
𝐈𝐈𝐈. 𝐆𝐞𝐥𝐝𝐟𝐥𝐮𝐬𝐬𝐫𝐞𝐜𝐡𝐧𝐮𝐧𝐠/𝐂𝐚𝐬𝐡𝐟𝐥𝐨𝐰 𝐒𝐭𝐚𝐭𝐞𝐦𝐞𝐧𝐭:
Fundamental question answered: Can the company survive?
𝘋𝘪𝘦 𝘎𝘦𝘭𝘥𝘧𝘭𝘶𝘴𝘴𝘳𝘦𝘤𝘩𝘯𝘶𝘯𝘨 𝘴𝘢𝘨𝘵 𝘢𝘶𝘴:
-How much cash did the company receive and how is/was it used during the fiscal year?
A distinction is made between whether the cash came from:
-Operating activities (cash flow from operating activities)
-investing activities (cash flow from investing activities)
-financing activities (cash flow from financing activities)
originates from.
A. Cash flow from operating activities
-Cash outflow from rental payments
-Cash from sales of products/services (as soon as customer pays)
-Cash outflow from tax payments
-Cash outflow from payment of wages and salaries
B. Cash flow from investments (cash flow from investing activities)
-Purchase and/or sale of assets/assets
-Purchase and/or sale of machinery
C. Cash flow from financing activities (Cash flow from financing activities)
-Cash from capital increases
-Cash outflow from dividend payments
-Cash outflow from share buybacks
-Cash outflow from borrowings
-Cash outflow from loan repayments
Cash at the beginning of the period (01.01.xx) +/- changes during the period (from A,B and C) = Cash at the end of the period (31.12.xx)
Cash at the end of the period (31.12.xx) = Cash on the balance sheet (asset)
Target:
postive cash flow!
Free cash flow (FCF) = Cash flow from operating activities - Cash flow from investments
The FCF indicates how much cash flow is still available to the company in order to pay dividends or repay loans at the end. It is freely available to the company. [3] Therefore, this key figure is very important in balance sheet analysis and for shareholders! It can also provide information on the extent to which the company acts in a shareholder-friendly manner or is more concerned with repaying debts first.
The cash flow statement can be prepared using the direct or indirect method. However, the end result is always the same.
𝐈𝐕. 𝐋𝐞𝐫𝐧𝐚𝐮𝐟𝐠𝐚𝐛𝐞
Go to Novo Nordisk's homepage and open the Annual Report 2021 in the "Investors" section (homepage: https://www.novonordisk.com/). If you want to skip this learning effect use the following link which will open the Annual Report as PDF directly:
Go there to the relevant section and answer the following questions:
Income statement:
1) For fiscal year 2021, what are the following (in DKK million)?
a. Sales or net revenue
b. Cost of goods sold
c. Gross profit
d. Gross margin
e. Net margin
f. EBT*
*EBT = Earnings before taxes
Balance sheet:
2) For the fiscal year 2021, what are the following (in DKK million)?
a. Total assets
b. Total Liabilities
c. Equity
d. Equity ratio
Cash flow statement:
3) What is the free cash flow (FCF) for fiscal year 2021 (in DKK million)?
4) How many dividends were paid in fiscal year 2021 (in DKK million)?
5) How many shares were repurchased by the company in fiscal year 2021 (in DKK million)?
𝐕. 𝐒𝐜𝐡𝐥𝐮𝐬𝐬𝐰𝐨𝐫𝐭
I hope you were able to take away a lot of useful information from my explanations and assignments. With this post I wanted to give you the basics of income statement, balance sheet and cash flow statement. If you have internalized these, feel free to read my more advanced posts (link follows). Because now you have the tools to understand them even better. In the same way you will be able to interpret my stock analyses better. As a small support I add a nice chart of Damodaran (I already introduced him as "Valuation Guru"), also visible in his blog:
https://aswathdamodaran.blogspot.com/
To quote Damodaran here:
"Much of the raw data that you use in corporate finance and valuation comes from accounting statements, and if you do not understand the difference between operating and net income, you are fatally handicapped. If your accounting basics are strong, you can move right along..."
So I hope you understand that the accounting basics are indispensable to be able to perform deeper company valuations.
Building contributions:
-Value Investing - Buffett
https://app.getquin.com/activity/XcuRrJwmyP
-The little guide of valuation
https://app.getquin.com/activity/laOUVhfFDI?lang=de&utm_source=sharing
Sources:
[1]
https://www.bwl-lexikon.de/wiki/umsatz/
[2]
https://wirtschaftslexikon.gabler.de/definition/aufwendungen-30077
[3]
https://www.bwl-lexikon.de/wiki/free-cash-flow/
Additional sources:
Annual Report Novo Nordisk; https://www.novonordisk.com/content/dam/nncorp/global/en/investors/irmaterial/annual_report/2022/novo-nordisk-annual-report-2021.pdf
https://www.novonordisk.com/investors/annual-report.html
Image:
https://www.merchantmaverick.com/quick-guide-accounting-terms-concepts/
