How to Determine a Company’s Worth

By Matt Krantz from Investing Online For Dummies, 7th Edition

Online investors can use a company’s worth to determine whether to invest with them. To learn more about companies you might want to invest in, you can study the income statement, the balance sheet, and the cash flow statement.

What's an income statement all about?

The income statement begins with revenue, which is a measurement of the value of the goods and services sold by the company. The company’s expenses are then subtracted from revenue to arrive at the company’s profit. Making things a bit more complicated, though, is that profit can mean one of several things:

Operating profit: Measures how much the company makes after paying day-to-day costs, such as buying raw materials that go into the product as well as paying salaries.
Net income: Shows you how much the company made after subtracting all its costs. If the company lost money, it’s said to have a net loss.
Diluted earnings per share: Measured by dividing adjusted net income by the number of shares outstanding. Monitoring dilution is important because when executives exercise stock options, they get additional shares in the company, so new shares are created. And more shares means the company’s profits are cut into more slices, making your slice worth less.
*Basic earnings per share: Arrived at by simply dividing a company’s net income by shares outstanding.
*Proforma earnings per share: A controversial way to measure earnings that was originally designed to help investors. Proforma earnings allow companies to leave out certain expenses to help investors understand how the company did excluding the effect of a big event, like a merger. Some companies, though, abused proforma earnings.

What's on a company's balance sheet?

In the balance sheet a company separates what it owns from what it owes. The following list breaks it all down for you piece by piece:

Assets are objects of value the company owns, including property, equipment, and machinery.
Liabilities are the company’s obligations. Liabilities include such things as bank loans, IOUs given to suppliers, taxes owed, or promises to deliver products to customers in the future. Liabilities are further classified as
Shareholders’ equity measures the value of the investors’ ownership of the company.

One big thing to pay attention to in the balance sheet is the company’s number of shares outstanding because it measures how many pieces the company’s profits are sliced into and how big a piece each shareholder gets.

What does a cash flow statement reveal?

Don’t make the mistake of ignoring the cash flow statement. This statement cuts through all the smoke and mirrors of accounting to show you how much cold hard cash came into or went out of a company. The statement is divided into the following three parts:

Cash from operating activities tells you how much cash the company used or generated from its normal course of business. This portion of the cash flow statement adjusts net income by adding back expenses that didn’t cost the company cash, most importantly an expense called depreciation, which accounts for the cost of wear and tear on equipment.
Cash from investing activities shows how much cash a company uses to invest in new property and equipment. The section also shows how much cash the company generates selling assets.
Cash from financing activities illustrates how much cash a company brings onto its balance sheet, mostly by selling bonds.