Sunday, July 15, 2007

How to read balance sheet

Anything on a company's books considered as having a posiaaative
monetary value. Assets include all things like holdings of obvious
market value (cash, real estate), (inventory,
aging equipment), and other quantities (pre-paid expenses,goodwill)
considered an asset by accounting conventions but possibly having no
market value at all.

Book value
Per-share value of shareholders' equity excluding goodwill and
other intangible assets.

Cash flow
Cash flow is essentially the movement of money into and out of your
business; it's the cycle of cash inflows and cash outflows that
determine your business' solvency.

Cash flow analysis is the study of the cycle of your business' cash
inflows and outflows, with the purpose of maintaining an adequate
cash flow for your business, and to provide the basis for cash flow

Compound Annual Growth Rate - CAGR
The year-over-year growth rate of an investment over a specified
period of time.

The compound annual growth rate is calculated by taking the nth root
of the total

percentage growth rate, where n is the number of years in the period
being considered. This can be written as follows:

Debt-to-Equity Ratio
A company's debt divided by its equity . This ratio is used as a
relative measure of debt, but it

isn't always useful since equity is a complicated number. It's
sometimes better just to look at a

company's total debt per share, which you can either look up or
calculate since Debt per share =

eps/ roe x Debt/Equity:

Method to account for assets whose value is considered to decrease
over time.

The total amount that assets have depreciated by during a reporting
period is shown on the cash

flow statement , and also makes up part of the expenses shown on
the income statement . The

amount that assets have depreciated to by the end date of the period
is shown on the balance sheet.

Earnings Before Interest and Taxes; intended to be a measure of the
amount of cash generated
by a company's operation

Earnings Before Interest, Taxes, Depreciation, and Amortization;
intended to be a measure of the

amount of cash generated by a company's operations (but leaving out
the costs of financing and

taxes - the "I" and the "T").

The danger with EBITDA is that if the "D" and "A" represent a "using
up" of an asset that will have

to be replaced in the future, then they really are operations-
related expenses, making EBITDA too liberal a number.


Economic Value Added, a measure of the superiority of the return a
company is able to realize on

invested capital above the baseline return expected by the
investment community. The formula is

EVA = NOPAT - ( C x Kc )

where C is the amount of capital a company plans to invest in a
project, and Kc is the cost of

capital, i.e. the return rate expected by investors. Positive EVA
means the project will add value

for shareholders; negative EVA means they would be better off if
management just gave them the

money as a dividend.

EVA is analogous toearnings; but where earnings expenses debt
financing only, the C x K term


in EVA is expensing the cost of all capital, equity as well as debt.

The portion of a company's assets that the shareholders own, as
opposed to what they've

borrowed: equal to total asset minus liabilities. Also
called "owners' equity" or "shareholders' equity".

An obligation to pay. These include accounts payable, and bond and
bank debt.

Liabilities are shown on the balance sheet Note that a liability is
not necessarily an evil thing for a

company. Technically it's just an asset that they have temporary
control over but don't own. If it's

a useful asset and if the cost of "borrowing" it is cheap, then a
liability can be a positive thing.

One example: if a retailer sells a gift certificate, they have to
show a liability for the value of the

merchandise they will be obligated to hand over when the giftee
shows up to redeem it; but in the

meantime they already have the cash the gifter paid, and they can
use it any way they want -- this

liability is really an interest-free loan

Operating Expenses
Expenses associated with running a business but not considered
directly applicable to the current

line of goods and services being sold. These include Sales and
Marketing, R & D, and General

and Administrative costs (including the salaries of people working
in these areas).

Operating Income
Operating Income is the pre-tax, pre-interest profit from the
company's operation

Operating profit margin
Ratio of operating income to sales revenue

P/E Ratio
The ratio of a stock price to its company's annual earning per share

Return on Assets
Earning divided by total assets

This number tells you "what the company can do with what it's got",
ie how many dollars of profits

they can achieve for each dollar of assets they control. It's a
useful number for comparing

competing companies in the same industry. The number will vary
widely across different

industries. Capital-intensive industries (like railroads and nuclear
power plants) will yield a low

return on assets, since they have to own such expensive assets to do
business. (And if they have

to pay a lot to maintain these assets, that will cut into the ROA
even more, since the maintenance

costs will decrease their earnings). Shoestring operations (software
companies, job placement

firms) will have a high ROA: their required assets are minimal.

Return on Equity
Earning divided by equity

The idea is that this tells you the number of dollars of profits the
company can earn for each dollar

of shareholders' equity; but return on asset is probably a better
number to look at. (After all, their

profitability is a function of all assets they control, not just of
the equity portion of assets. Note that

ROE is bigger than ROA, since equity is a subset of assets).

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