Six Things in an Annual Report Necessary for Fundamental Analysis
After a huge annual report arrives in the mail, you may not know where to begin. So here are six things you should always consider when you get an annual report to make sure you are picking up the key elements needed in fundamental analysis:
Compare this year’s annual report with last year’s annual report. The best way to read this year’s annual report is side-by-side with last year’s. Make sure the company achieved the goals it set for itself. If the company missed its goals, that’s a good place to start using your fundamental analysis skills to figure out why management fell short and whether it’s a reason to be concerned about the company’s future.
See how cash flow compares with net income. Accounting rules give companies a fair amount of leeway in how they report profits. Cash, however, is cash, and this line item is particularly important in fundamental analysis to assess when making investing decisions. You want to make sure that the company is bringing in roughly the same amount of cash as it reports as profit.
Consider operating and gross margins. Too many investors get overly consumed with a company’s bottom line. However, the amount of profit a company generates should be considered in comparison with its revenue. Operating and gross margins, two financial measures fundamental analysts pay close attention to, let you do this analysis.
Look for any deterioration. If you’re investing in a company because you think it has great growth prospects, make sure it’s actually growing. A basic analysis of a company’s fundamentals, including revenue and earnings, will show you how to do this pretty quickly.
*Take a look at the CEO’s paycheck. Most annual reports come packaged with a so-called proxy statement. These statements typically tell you how much the top executives are paid. Sometimes this information is found in the annual report. You want to be mindful that excessive compensation could be a sign that top management is out for itself, not you. Paying attention to executive pay is a way to look beyond financial statements to perform a complete analysis of a company.
Sleuth for potential conflicts of interest. The proxy statement also allows investors to vote on key matters. Don’t just rubber-stamp directors the company recommends for the board. Check the proxy to see if those people have any business dealings with the company. If so, you might withhold your vote for them. Voting for members of a company’s board of directors is a way to use fundamental analysis to safeguard your interest in the company.
Accounting Glossary
accounting equation
The equation Assets = Liabilities + Equity, which demonstrates the two-sided nature of accounting and is useful for explaining the concept of double-entry accounting (or double-entry bookkeeping).
Accounting Glossary
accounting period
The time period for which financial information is being tracked in a business, such as monthly, quarterly, or annually.
Accounting Glossary
accounts receivable
An account that records the amounts that customers owe to a business.
Accounting Glossary
adjusting entry
A correction made to a bookkeeping account that adjusts for accounting errors or other necessary changes at the end of the accounting period.
Accounting Glossary
cash flows
Used to describe the source or sources of cash or how cash is used.
Accounting Glossary
Chart of Accounts
A list of all the accounts used by a business, including what types of transactions go into each account.
Accounting Glossary
debit
An accounting entry that increases an asset or expense account, and decreases a liability or income account.
Accounting Glossary
dividends
A portion of a company’s profits paid by share of common stock on a quarterly or annual basis.
Accounting Glossary
FASB
Financial Accounting Standards Board. FASB is the highest-ranking authority in the private (non-government) sector of the U.S. for making pronouncements on GAAP and for keeping accounting standards up-to-date.
Accounting Glossary
Federal Unemployment Tax
In the U.S., the fund that used to be known simply as Unemployment. Employers contribute to the fund, and states also collect taxes to fill their unemployment fund reserves. (The acronym FUTA means Federal Unemployment Tax Act.)
Accounting Glossary
fidelity bonds
A type of insurance — typically carried by employers for their employees — that helps guard against theft and reduce the risk of loss.
Accounting Glossary
FIFO
First-in, first-out. A method for costs of goods sold in which a business charges out product costs to cost of goods sold expense in the chronological order in which the goods were acquired.
Accounting Glossary
fungible
Describes a product that is interchangeable and virtually indistinguishable from another product.
Accounting Glossary
General Ledger
A summary of all of a business’s accounts and transactions.
Accounting Glossary
IASB
International Accounting Standards Board. The IASB (based in London) is the main authoritative accounting standards setter outside the U.S.
Accounting Glossary
Journals
The location in which bookkeepers keep records (in chronological order) of daily company transactions.
Accounting Glossary
LIFO
Last-in, first-out. A method for costs of goods sold that selects the last item you purchased first, and then works backward until you have the total cost for the total number of units sold during the period.
Accounting Glossary
LLP
Limited liability partnership. A legal structure that state laws offer to qualified professionals in which all the partners have limited liability.
Accounting Glossary
PC
Professional corporation. A legal structure that state laws offer to qualified professionals who otherwise would have to operate as an unlimited partnership liability.
Accounting Glossary
petty cash
A cash account that businesses keep on hand for unexpected expenses.
Accounting Glossary
revenue
Monies that are collected in the process of selling a company’s goods and services.
Accounting Glossary
salvage value
The amount that an asset is worth after it has been fully depreciated.
Accounting Glossary
statement of cash flows
A financial statement that summarizes a business’s cash inflows and outflows during an accounting period.
Accounting Glossary
transactions
Economic exchanges between a business or other entity and the parties with which the entity interacts and makes deals.
Accounting Glossary
worker’s compensation insurance
A type of insurance carried by employers that covers its employees in case they are injured on the job.
