Understanding Financial Accounts
Analysing the Financial Results of a Public Company
How to analyse and interpret the financial statements of a public company, including the Profit & Loss and Balance Sheet.
It’s no secret that a successful company must deliver steady, profitable growth. Here’s how to assess that.
Locate the latest financial accounts on the Regulatory News Service. It may be the Interim or Final Results. This is a standard measure of the company’s trading performance, cashflow and balance sheet, as required by the stock exchange rules. Published accounts often affect the share price on the day of release because they contain key data about the success and health of the business.
The report will begin with a short summary, for instance:
- Revenues up by 16% at £24.4m (2006: £21.1m)
- Gross profits up by 29% at £5.11m (2006: £3.96m)
- Profits before tax up 45% at £1.83m (2006: £1.25m)
- Earnings per share up by 37% at 5.2p (2006:3.8p)
- Interim dividend up by 33% at 0.8p (2006: 0.6p)
- Net cash of £5.2m (2006: £1.5m)
These are all key figures, so it is important to note that there are improvements across the board.
Consolidated Income Statement
The ideal growth stock investment will have demonstrated three years of growth in revenues and pre-tax profits. These figures can be traced back in the top set of numbers, labelled the Consolidated Income Statement.
After paying all costs and tax on profits, the accountants divide this final figure by the number of shares in issue. This gives an Earnings Per Share (EPS) figure, which will be handy for calculating a valuation for a stock.
If revenues (also referred to as turnover or sales) grow, but overall profitability declines, then the business has incurred much higher costs. Find out in the accompanying statement as to why this has happened. It could limit profitability again next year.
Sometimes a company will quote adjusted profits, which excludes the impact of one-off expenses (also called exceptional or non-recurring costs) such as listing fees or acquisition costs. It is safe to go with the adjusted figure, as this represents the underlying growth of the business.
Balance Sheet
Citing a net cash figure is positive; it usually means the company is cash generative (or it received a new inflow of funds some other way) and does not have any long-term debt. Debt can be a real drag; it is expensive to maintain, and ultimately has to be paid off by money that could otherwise have been re-invested in the business.
Some businesses need to take on a lot of debt to acquire assets. This is fine, providing the business model is set to generate an overall return on investment. For instance, a gold mine requires serious infrastructure in place, which is initially funded by bank debt. But once the company starts producing and selling gold, the venture will become highly profitable and the debt will be rapidly paid off.
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