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Fundamental Analysis

source: Understanding Financial Statements by James O. Gill and Moira Chatton.

Financial statements are the principal means of reporting financial information to people within an organization – management and other employees – and to people outside an organization – banks, investors, suppliers and others.

Publicly-traded corporations must comply with strict requirements for financial statement reporting. Generally Accepted Accounting Principles (GAAP) are the “ground rules” for financial reporting. They provide the framework for what information is included in financial statements and how the information should be presented. They are designed so that financial statement information about businesses is reliable and comparable.

To have a functional understanding of finance, it is essential to thoroughly understand balance sheets, income statements and cash flow statements.

The Balance Sheet

A company's financial position or health is shown on the balance sheet. It shows the business's financial position on a particular date.

Assets = Liabilities + Net Worth

Assets are normally debit balances and are what a business owns. Assets are broken into two main categories: current assets and fixed assets. Current assets usually mean anything that can be converted into cash within one year. Fixed assets, often called long term assets, are more permanent items like buildings and major equipment.

Liabilities are normally credit balances and are what a business owes. Liabilities are divided into two main categories: current liabilities and long term debt. Current liabilities include bills for such items as included in accounts payable, inventory, rent, salaries, etc. Long term debt includes items that by agreement do not need to be paid back quickly, such as a mortgage or long term note.

The difference between assets and liabilities equals net worth, which is often called stockholder's equity for publicly traded corporations:

Equity = Assets - Liabiliies

The Income Statement

The income statement, often called the profit and loss statement, P&L or statement of operations, shows the performance of a business over a period of time be it a month, a quarter or a year. The basic formula to determining performance is

Revenues – Expenses = Income

Gross profit sometimes called gross margin. The words income, profit and earnings are often used synonymously on income statements.

The Cash Flow Statement

The balance sheet shows the health of a business as of a specific date. An income statement tells how a business performed over a period of time. The cash flow statement usually used as a planning tool.

This statement helps a business to target when cash will be needed to pay bills and helps managers to make business decisions such as when to expand a business or take on a new product line.

The cash flow statement only deals with cash activity – cash paid out and cash taken in. It allows managers to make arrangements before cash is actually needed.

Financial Ratios

Ratios are tools to help you analyze a business. Ratios measure proportions. Ratios also measure relationships. They do this because they can translate assets, such as tools and inventory, and liabilities, such as payable and loans, into common dollar figures. By doing this it is easy to see valuable relationships between two seemingly unrelated items. Ratios also allow you to make comparisons between time periods and between different businesses. Read more »

Growth Rate

Growth is an important element of fundamental analysis. Stock Analyzer compresses historical and year over year growth rates for five major financial metrics (Equity, EPS, Sales, Free Cash Flow, Cash from Operating Activity and ROIC) into one number – Growth Grade. Read more »

Value Price

Value Price (also frequently called fundamental value or intrinsic value) is ordinarily calculated by summing the future income generated by the asset, and discounting it to the present value. Read more »