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Analyzing the Company Financial Reports

By Parmelee Eastman

"Public companies" are the companies that sell shares of ownership (called "stock) in a public "stock market" like the New York Stock Exchange (NYSE) and NASDAQ in the USA, or the Montreal Exchange or Canadian Securities Exchange in Canada.

In the USA, these public companies are required by the U.S. Securities and Exchange Commission to publish quarterly and annual financial reports. Those statements include the income statement, segment and/or geographic breakdown, balance sheet, cash flow, and notes on accounting practices.

[Related: Researching Private Companies and Nonprofit entities.]

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What Can You Learn?

Analyzing the recent financial picture helps you understand why the firm might hire you and what the goals and environment of the firm might be. While the past financial performance does not guarantee the future, the insight does help predict it.

Why Are They Hiring?

Is the job you want a replacement person for an essential job? A revenue-generating sales position (which might be very pressured)? How likely is the company to be able to provide you with advancement possibilities and pay raises, or even stay in business? The company's profitability picture can give you insight into what may be happening and why.

What's the Trend?

Let's look at the company's annual report, audited financial information required of all U.S. "C" corporations by the SEC, often available on company websites or at libraries.

The income statement shows the revenue received by the company for the most recent year, the prior one to four years, and the previous eight (or more) quarters. What is the trend in revenue? Essentially flat, steadily rising, erratic, or down? And what does the Management Discussion reveal about the reasons for changes in revenue?

While the firm is barred from projecting the future in its financial reports, you can gain a sense of the stability of revenue from the five year trend.

Larger entities separate revenue and profit by business segment and possibly by geography (generally too high level to be useful). You can see how important your area of interest is to the firm overall.

Choosing Your Part of the Company

Hewlett Packard's 2014 (year ended Oct 31, 2014) annual report showed the results for its six segments. Which divisions would you like to join? And which would you avoid?

   Revenue Earnings
from Operations
Earnings as a %
of Revenue
Personal Systems $34,303m $1,270m 3.7%
Printing 22,814 4,185 18.2%
Enterprise Group 27,814 4,008 14.4%
Enterprise Services 22,398 803 3.6%
Software 3,933 872 22.2%
HPFS 3,498 389 11.1%

 

On Oct 6, 2014, HP announced that the company is splitting into two Fortune 50 businesses. Hewlett-Packard Inc. which includes the Personal Systems and Printing segments, and Hewlett-Packard Enterprises will have the Enterprise Group, Enterprise Services, Software, and HPFS.

HP Inc. is being positioned as a mature business -- indeed the PC industry has seen sales shrink recently. By the way, HP has laid off 36,000 employees and has targeted 10,000 more jobs in order to re-direct funds into sales and R&D.

Which business would you prefer to join?

Is the Company Profitable?

Profits or net income for the company are what's left after taxes and special charges are deducted from total or gross income. Are profits non-existent, flat, steadily rising, erratic, or down? Why? If the company has a poor record of profitability, why is it hiring?

Special or one-time charges or additions for plant closings, increases or decreases from reserves, or revenue from the sale of divisions can distort the trends. However, ask yourself if the charges are unlikely to re-occur or are they symptoms of executive failings.

Assets, Liabilities, and Cash (a.k.a. "Salary Continuation")

The company balance sheet contains the company's assets, liabilities and debts, and equity ("equity" is the value of the stock in the public stock market).

  • How much cash and assets such as accounts receivable that will turn into cash quickly does it hold in comparison to its short-term liabilities? (This number is called "liquidity.")
  • What are amounts of debt and equity or shareholder value? If the debt is high or the equity low, how stable is this firm? In general, short-term (less than one year) assets should match short-term liabilities and long-term assets should match long-term liabilities. If the company built a manufacturing facility with short-term loans from a bank, watch out!

Cash flow statements show the sources of cash such as profits, loans, equity investments, and how the cash is spent on items including inventory increases, debt reductions, or stock re-purchases. Accounting rules require that revenue be recognized or included when the products or services are delivered. For example, a company cannot include both years of a two-year contract when the contract is first awarded. Each year must be reported separately. And financing such as loans are not included in the income statement, but the interest paid is included as a negative.

Cash flow statements focus on cash in and cash out regardless of the reporting under accounting rules. Look at the cash flow statement to see how the organization obtains enough money to pay its obligations. Negative cash flows do not always indicate a problem. For instance, fast-growing entities often consume more cash than they generate internally, and use outside financing to pay their bills.

Financial analysts use ratios to compare companies in the same industry.

  • The "current ratio" shows the amount of liquid assets to short-term debt.
  • "Debt to equity" ratio indicates how risky the company's financing structure is.

Calculating the firm's ratios and comparing them to industry averages can indicate variations that should be investigated. Again, differences do not necessarily indicate a problem. The firm's financial strategy or history may have resulted in non-standard ratios. Reading the notes to the financial statements can clarify some of the rules and reasons for classifications of items.

A Word of Caution

No single financial figure or ratio stands alone. Insight into the financial health of the company comes from analyzing the pieces together to discover the true standing of the company. And the financials fit into a larger picture of the company and its future direction.


About the author...

Parmelee Eastman is president of EastSight Consulting which helps provide more effective utilization of external information in internal decision-making processes. EastSight Consulting clients range from start-ups to Fortune 500 companies. Prior to founding EastSight, Parmelee was the vice president of the global technology and communications practice at Fuld & Company and employed for 16 years at Digital Equipment Corporation. Parmelee holds a B.A. from Wellesley College and an M.B.A. from the Harvard Business School. She can be reached at peastman@eastsightconsulting.com.


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