Investment due diligence: Tips for understanding financial reports before buying stock

buying stockIf you’re thinking about buying stock in a company, you’ll probably want to read up on their financials first. Having a full understanding of how the business is performing is an essential part of making an investment decision, but it can be a little daunting for those with less experience.

With this in mind, we’ve put together a guide for everything you need to know about understanding a company’s financial statements, and exactly what these mean to you as a potential investor – whether you’re looking at a Malaysia food company or a paper company in South Africa.

Before You Start: How Well Do You Know the Company?

Before you start looking at the numbers, it’s important to develop a clear understanding of what the business does, and the market it’s in. This will make things much easier when it comes to analysing figures; you’ll have a clearer picture of what they mean and also the potential reasons for why they’re at the level they are. A reputable B2B business intelligence provider can be an extremely useful asset for this purpose.

What Financial Statements to Use

The key financial statements for considering a stock investment are the income statement, the balance sheet and the cash flow statement. This should include a breakdown of the company’s shareholders’ equity and retained earnings. While the cash flow statement may be somewhat overlooked by investors, it’s an important asset and should definitely be included in your analysis in order to give you the fullest picture possible.

Where to Find Financial Records

Where you can access the financial reports for a company will depend largely on which country they’re based in. For US companies, there’s the Securities and Exchange Commission (SEC), for Canada there’s SEDAR (System for Electronic Document Analysis and Retrieval) and for the UK there’s Companies House, or some of the information might be contained in the company’s annual report.

An easier alternative is to make use of the comprehensive company insights provided by Global Database. Not only does the B2B directory offer direct contact information for millions of companies, it also provides detailed financial insights including balance sheets, cash flow, profit and loss accounts and more.

It also has the added benefit of providing other comprehensive company details such as number of employees, location, industry, business scope, and technologies used, so as well as looking at the financials you can gain a complete overview of what the company does and how they measure up.

Making Sense of Financial Jargon

In order to understand exactly what the financial statement is telling you, there is unfortunately some industry terminology you’ll need to have a good grasp over. Using a financial dictionary or glossary will be important here. It’s also worth remembering that there’s little standardisation or one size fits all approach to financial statements; different types of companies will have different types of reporting, so you may have to become accustomed to analysing various types of data presentation.

Financial Ratios

Financial ratios are basically the key purpose behind looking at a company’s financial records; they let you know how well the business is performing and flag up any potential issues. The numbers themselves offer very little use unless you can analyse them effectively and work out the relationships between them to establish what they’re saying about the company’s financial state.

Look at the Notes

In order to get a solid picture of a company’s finances, it’s a very good idea to look at the notes from the auditor offered in the company’s statements. This will provide you with an independent opinion on their financial health, and is also an added protection against any potential fraudulent activity. If the qualifying notes aren’t positive it could be a good idea to pass on the investment.

Analyse Profit Performance

In order to determine how the company is actually performing, you need to look at sales revenue. When doing so, aim to answer questions such as whether their sales are increasing or decreasing, whether they’re profit margin is growing, and the relationship between top line (sales revenue) and bottom line (net income).

You want to establish that the company is not only stable but growing, and is also managing its finances effectively so that profits are increasing regardless of the current economic climate.

Recognise Red Flags

Keep a close eye out for any potential signs of financial distress when you’re going over a company’s financial statement. Even if a business has attractive profit margins and good sales figures, if they’re not paying bills on time or have built up a lot of debt it could signify a lack of solid financial management.

Looking at a company’s credit score can also come in very useful here. These will take into account things like whether or not they’re paying creditors back in time, and also if they’ve made a lot of credit applications in a short space of time, which could signify they’re in trouble.

Consolidated Financial Statements

If you come across a financial statement that is consolidated, it means that it contains the financial data for all of the subsidiaries belonging to a parent company. The individual business will still act as different legal entities and therefore continue to provide their own financial statements, but the consolidated statement provides an overview of the parent company’s activities as a whole.

Look Out For Possible Fraud

If a company has issued a new version of its original financial document this can be a bad sign. Why? Because the restatement won’t include any potential losses for investors. The reason behind companies wanting to restate their financial reports is often to avoid being caught out for dodgy accounting, so make sure you’re protecting yourself before making an investment by carrying out thorough due diligence.

Learning how to read company financial statements is an important skill when it comes to investing in companies, but it can take a little time to master. One important thing to remember is that the numbers alone aren’t usually enough to provide a solid overview of a company’s current state; more detailed insights are usually needed.

To gain comprehensive financial information and other insights on any company visit us at www.GlobalDatabase.com


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