Reading Financial Reports For Dummies

Lita Epstein, MBA is a financial writer who focuses on career growth and business topics. She earned her MBA from Emory University and her BA from Rutgers University. Lita has written more than 40 books, including the previous editions of Reading Financial Reports For Dummies.

• Introduction 1About This Book 2Conventions Used in This Book 2What You’re Not to Read 2Foolish Assumptions 3Icons Used in This Book 3Beyond the Book 4Where to Go from Here 4Part 1: Getting Started with Financial Reports 5Chapter 1: Opening the Cornucopia of Reports 7Figuring Out Financial Reporting 8Preparing the reports 8Seeing why financial reporting counts (and who’s counting) 9Checking Out Types of Reporting 11Keeping everyone informed 11Following the rules: Government requirements 12Going global 13Staying within the walls of the company: Internal reporting 14Dissecting the Annual Report to Shareholders 15Breaking down the parts 15Getting to the meat of the matter 16Keeping the number crunchers in line 17Chapter 2: Recognizing Business Types and Their Tax Rules 19Flying Solo: Sole Proprietorships 20Keeping taxes personal 20Reviewing requirements for reporting 21Joining Forces: Partnerships 21Partnering up on taxes 22Meeting reporting requirements 22Seeking Protection with Limited Liability Companies 22Taking stock of taxes 23Reviewing reporting requirements 23Shielding Your Assets: S and C Corporations 23Paying taxes the corporate way 24Getting familiar with reporting requirements 25Chapter 3: Public or Private: How Company Structure Affects the Books 27Investigating Private Companies 28Checking out the benefits 29Defining disadvantages 30Figuring out reporting 31Understanding Public Companies 32Examining the perks 33Looking at the negative side 34Filing and More Filing: Government and Shareholder Reports 35Quarterly reports 35Yearly report 35The rules of the Sarbanes-Oxley Act 36Dodd-Frank’s impact on financial industry regulation 39Entering a Whole New World: How a Company Goes fromPrivate to Public 41Teaming up with an investment banker 41Making a public offering 42Chapter 4: Digging into Accounting Basics 45Making Sense of Accounting Methods 45Cash-basis accounting 46Accrual accounting 46Why method matters 46Understanding Debits and Credits 48Double-entry accounting 49Profit and loss statements 50The effect of debits and credits on sales 50Depreciation and amortization 51Checking Out the Chart of Accounts 52Asset accounts 54Liability accounts 56Equity accounts 57Revenue accounts 58Expense accounts 59Differentiating Profit Types 60Gross profit 60Operating profit 60Net profit 61Part 2: The Big Show: Annual Reports 63Chapter 5: Exploring the Anatomy of an Annual Report 65Everything but the Numbers 66Debunking the letter to shareholders 66Making sense of the corporate message 67Meeting the people in charge 68Finding basic shareholder information 68Getting the skinny from management 68Getting guarantees from management 72Bringing the auditors’ answers to light 73Presenting the Financial Picture 76Summarizing the Financial Data 77Finding the highlights 77Reading the notes 78Chapter 6: Balancing Assets against Liabilities and Equity 79Understanding the Balance Equation 80Introducing the Balance Sheet 80Digging into dates 80Nailing down the numbers 81Figuring out format 82Ogling Assets 84Current assets 84Long-term assets 88Accumulated depreciation 90Looking at Liabilities 91Current liabilities 91Long-term liabilities 92Navigating the Equity Maze 93Stock 93Retained earnings 94Capital 94Drawing 94Chapter 7: Using the Income Statement 95Introducing the Income Statement 96Digging into dates 97Figuring out format 97Delving into the Tricky Business of Revenues 100Defining revenue 100Adjusting sales 101Considering cost of goods sold 103Gauging gross profit 104Acknowledging Expenses 105Sorting Out the Profit and Loss Types 107EBITDA 107Nonoperating income or expense 108Net profit or loss 109Calculating Earnings per Share 109Chapter 8: The Statement of Cash Flows 111Digging into the Statement of Cash Flows 112The parts 112The formats 113Checking Out Operating Activities 115Depreciation 116Inventory 116Accounts receivable 116Accounts payable 117The cash flow from activities section, summed up 117Investigating Investing Activities 118Understanding Financing Activities 119Issuing stock 119Buying back stock 119Paying dividends 120Incurring new debt 120Paying off debt 121Recognizing the Special Line Items 121Discontinued operations 121Foreign currency exchange 122Adding It All Up 122Chapter 9: Scouring the Notes to the Financial Statements 123Deciphering the Small Print 124Accounting Policies Note: Laying out the Rules of the Road 125Depreciation 126Revenue 126Expenses 127Figuring out Financial Borrowings and Other Commitments 128Long-term obligations 128Short-term debt 129Lease obligations 130Mergers and Acquisitions: Finding Noteworthy Information 131Pondering Pension and Retirement Benefits 132Breaking Down Business Breakdowns 134Reviewing Significant Events 135Finding the Red Flags 137Finding out about valuing assets and liabilities 138Considering changes in accounting policies 138Decoding obligations to retirees and future retirees 139Chapter 10: Considering Consolidated Financial Statements 141Getting a Grip on Consolidation 141Looking at Methods of Buying Up Companies 147Reading Consolidated Financial Statements 148Looking to the Notes 150Mergers and acquisitions 152Goodwill 152Liquidations or discontinued operations 152Part 3: Analyzing the Numbers 155Chapter 11: Testing the Profits and Market Value 157The Price/Earnings Ratio 158Figuring out earnings per share 158Calculating the P/E ratio 159Practicing the P/E ratio calculation 160Using the P/E ratio to judge company market value (stock price) 162Understanding variation among ratios 163The Dividend Payout Ratio 164Determining dividend payout 165Digging into companies’ profits with dividends 165Return on Sales 167Figuring out ROS 167Reaching the truth about profits with ROS 168Return on Assets 168Doing some dividing to get ROA 169Ranking companies with the help of ROA 169Return on Equity 169Calculating ROE 170Testing companies using ROE 170The Big Three: Margins 171Dissecting gross margin 171Investigating operating margin 172Catching the leftover money: Net profit margin 173Chapter 12: Looking at Liquidity 175Finding the Current Ratio 177Calculating the current ratio 177What do the numbers mean? 178Determining the Quick Ratio 178Calculating the quick ratio 178What do the numbers mean? 179Investigating the Interest Coverage Ratio 180Calculating the interest coverage ratio 180What do the numbers mean? 181Comparing Debt to Shareholders’ Equity 182Calculating debt to shareholders’ equity 182What do the numbers mean? 183Determining Debt-to-Capital Ratio 184Calculating the debt-to-capital ratio 184What do the numbers mean? 186Chapter 13: Making Sure the Company Has Cash to Carry On 187Measuring Income Success 188Calculating free cash flow 188Figuring out cash return on sales ratio 190Checking Out Debt 191Determining current cash debt coverage ratio 192Computing cash debt coverage ratio 194Calculating Cash Flow Coverage 196Finding out the cash flow coverage ratio 196Mattel 197Hasbro 198What do the numbers mean? 198Part 4: How Companies Optimize Operations 199Chapter 14: Turning Up Clues in Turnover and Assets 201Exploring Inventory Valuation Methods 201Applying Three Inventory Valuation Methods 204Average costing 205FIFO 206LIFO 206How to compare inventory methods and financial statements 207Determining Inventory Turnover 208Calculating inventory turnover 208What do the numbers mean? 210Investigating Fixed Assets Turnover 210Calculating fixed assets turnover 210What do the numbers mean? 211Tracking Total Asset Turnover 211Calculating total asset turnover 212What do the numbers mean? 212Chapter 15: Examining Cash Inflow and Outflow 213Assessing Accounts Receivable Turnover 213Calculating accounts receivable turnover 214What do the numbers mean? 216Taking a Close Look at Customer Accounts 217Finding the Accounts Payable Ratio 218Calculating the ratio 218What do the numbers mean? 219Determining the Number of Days in Accounts Payable 219Calculating the ratio 220What do the numbers mean? 220Deciding Whether Discount Offers Make Good Financial Sense 221Calculating the annual interest rate 221What do the numbers mean? 222Chapter 16: How Companies Keep the Cash Flowing 223Slowing Bill Payments 223Speeding Up Collecting Accounts Receivables 224Borrowing on Receivables 226Reducing Inventory 227Getting Cash More Quickly 228Part 5: The Many Ways Companies Answer to Others 231Chapter 17: How Companies Find Errors: The Auditing Process 233Inspecting Audits and Auditors 234Looking for mistakes 234Meeting Mr or Ms Auditor 234Examining Records: The Role of the Auditor 235Preliminary review 236Fieldwork 236Audit report 238Filling the GAAP 238Accounting standards: Four important qualities 239Changing principles: More work for the FASB 240Getting more involved internationally 241Chapter 18: Government Regulations and Reporting Requirements 243Checking Out the 10-Q 244Financial information 244Other critical matters 245Introducing the 10-K 246Business operations 246Financial data 246Information about directors and executives 247The extras 248Investigating Internal Controls 248Uncovering the Ways Companies Keep in Compliance 250Digging into Board Operations 252Understanding the nominating process 253Contacting board members 254Finding Out about Insider Ownership 254Chapter 19: Creating a Global Financial Reporting Standard 255Why Develop a Worldwide Financial Standard? 256Key Moves to Reshape Global Financial Reporting 256Who Benefits from a Global Standard and How? 258Investors 258Capital Markets 258Companies 258Key Differences between GAAP and IFRS 259Accounting framework 259Financial statements 260Revenue recognition 262Assets 262Inventory 262Related-party transactions disclosures 263Discontinued operations 263Impairment charges 264Chapter 20: Understanding the Analyst–Corporation Connection 265Typecasting the Analysts 266Buy-side analysts 266Sell-side analysts 267Independent analysts 270Bond analysts 270Regarding Bond-Rating Agencies 271Delving into Stock Rating 273Taking a Look at How Companies Talk to Analysts 274Analyst calls 274Press releases 275Mobile apps 276Road shows 276Chapter 21: How Companies Communicate with Shareholders 277Making the Most of Meetings 278Checking Out How the Board Runs the Company 279Watching the directors 279Speaking out at meetings 281Moving away from duking it out 282Sorting through Reports 282Catching Up on Corporate Actions 283Culling Information from Analyst Calls 285Listening between the lines 286Knowing when to expect analyst calls 289Staying Up-to-Date Using Company Websites 289Regarding Reinvestment Plans 290Dividend reinvestment plans 290Direct stock purchase plans 290Chapter 22: Keeping Score When Companies Play Games with Numbers 291Getting to the Bottom of Creative Accounting 292Defining the scope of the problem 292Seeing through cooked books 293Unearthing the Games Played with Earnings 295Reading between the revenue lines 296Detecting creative revenue accounting 300Exploring Exploitations of Expenses 302Advertising expenses 303Research and development costs 303Patents and licenses 304Asset impairment 304Restructuring charges 305Finding Funny Business in Assets and Liabilities 306Recognizing overstated assets 306Looking for undervalued liabilities 309Playing Detective with Cash Flow 311Discontinued operations 311Income taxes paid 312Part 6: The Part of Tens 315Chapter 23: Ten Financial Scandals That Rocked the World 317Enron 318Madoff 319Citigroup 319Adelphia 320WorldCom/MCI 320Tyco 321Waste Management 322Bristol-Myers Squibb 323Halliburton 324Arthur Andersen 325Chapter 24: Ten Signs That a Company’s in Trouble 327Lower Liquidity 327Low Cash Flow 328Disappearing Profit Margins 328Revenue Game Playing 329Too Much Debt 330Unrealistic Values for Assets and Liabilities 330A Change in Accounting Methods 330Questionable Mergers and Acquisitions 331Slow Inventory Turnover 332Slow-Paying Customers 332Glossary 333Index 341