Fundamentals and Financial Statements
17 articles · 19 glossary terms
The three statements a company files, line by line, and how to read what they say about the business behind the ticker.
Foundations
Start here if the subject is new.The Income Statement, Line by Line
The income statement records performance over a period. It runs from revenue at the top to net income at the bottom, and each subtraction along the way answers a different question.
The Balance Sheet, Line by Line
A snapshot on one date of what a company owns, what it owes and what belongs to shareholders. It has to balance, which is a constraint that makes several things checkable.
From Revenue to Net Income
The walk down the income statement, and what each stage is capable of telling you about the business that the stage above it cannot.
Earnings Per Share
Profit divided by shares. Both halves move, and the denominator moving is what makes the diluted figure the one that matters.
Intermediate
Assumes the foundations above.The Cash Flow Statement
The statement that reconciles reported profit to cash that actually moved. It is the hardest of the three to dress up, which is why experienced readers start here.
EBITDA, and the Argument About It
Earnings before interest, taxes, depreciation and amortization is the most used and most criticized measure in finance. Both the use and the criticism are reasonable.
Free Cash Flow
The cash a business produces after the spending required to keep producing it. It is what funds dividends, buybacks, debt repayment and acquisitions.
GAAP and Non-GAAP
Filed statements follow standardized rules. The headline numbers a company puts in its press release frequently do not, and the reconciliation between the two is where the reading happens.
Debt, Leverage and Coverage
Borrowing magnifies returns in both directions. The ratios that matter are how much is owed relative to earnings, and how comfortably the interest is covered.
Leases
Lease obligations were once disclosed in a footnote and are now on the balance sheet. The change made a large existing liability visible without altering any economics.
Inventory Accounting
Which costs are assigned to goods sold is a policy choice. In a period of changing prices it changes reported profit, taxes and the balance sheet.
Advanced
Detail, edge cases and methodology.Working Capital and the Cash Conversion Cycle
The gap between paying for inputs and collecting for outputs has to be funded by somebody. Which side funds it says a lot about a company's position with its customers and suppliers.
Segment Reporting
Consolidated results average together businesses that may be moving in opposite directions. The segment note is where that averaging is undone.
Quality of Earnings
Two companies can report the same profit and one of the numbers is more likely to persist. Quality is about persistence and about how much of the profit is cash.
Revenue Recognition
When a sale becomes revenue is a judgment governed by a five-step framework. The judgment is where a substantial share of accounting problems have originated.
Pension Obligations
A defined benefit plan is a long-dated liability whose measured size depends on a discount rate. Small changes in assumptions move it substantially.
Accounting Red Flags
A checklist assembled from what has actually preceded accounting failures. None of the items is proof of anything, and several together are a pattern.
Terms Defined in This Subject
Open one for its definition, and the article that explains it in full.
Frequently Asked Questions
What are the three financial statements?
The income statement, the balance sheet and the cash flow statement. The income statement reports revenue and profit over a period, the balance sheet lists what the company owns and owes on one date, and the cash flow statement shows the cash that actually came in and went out, which is where accounting choices are hardest to hide.
Read the full article: The Income Statement, Line by LineWhat is free cash flow?
Free cash flow is the cash a business generates from operations after paying for the capital spending needed to keep and grow it. It is commonly computed as operating cash flow minus capital expenditure, and it is the cash actually available to repay debt, pay dividends or buy back shares.
Read the full article: Free Cash FlowWhat is the difference between GAAP and non-GAAP earnings?
GAAP earnings follow the accounting standards every US public company must report under. Non-GAAP figures are the company's own adjusted versions, usually excluding items such as stock-based compensation or restructuring costs. Companies must reconcile the two in their filings, and the reconciliation shows exactly what was left out.
Read the full article: GAAP and Non-GAAP