Introduction 1

Part I: Getting Down to Financial Reporting Basics 7

Chapter 1: Opening the Cornucopia of Reports 9

Chapter 2: Recognizing Business Types and Their Tax Rules 21

Chapter 3: Public or Private: How Company Structure Affects the Books 29

Chapter 4: Digging into Accounting Basics 43

Part II: Checking Out the Big Show: Annual Reports 59

Chapter 5: Exploring the Anatomy of an Annual Report 61

Chapter 6: Balancing Assets against Liabilities and Equity 75

Chapter 7: Using the Income Statement 91

Chapter 8: The Statement of Cash Flows 107

Chapter 9: Scouring the Notes to the Financial Statements 121

Chapter 10: Considering Consolidated Financial Statements 139

Part III: Analyzing the Numbers 151

Chapter 11: Testing the Profits and Market Value 153

Chapter 12: Looking at Liquidity 171

Chapter 13: Making Sure the Company Has Cash to Carry On 181

Part IV: Understanding How Companies

Optimize Operations 193

Chapter 14: How Reports Help with Basic Budgeting 195

Chapter 15: Turning Up Clues in Turnover and Assets 205

Chapter 16: Examining Cash Inflow and Outflow 217

Chapter 17: How Companies Keep the Cash Flowing 227

Part V: The Many Ways Companies

Answer to Others 235

Chapter 18: Finding Out How Companies Find Errors: The Auditing Process 237

Chapter 19: Digging into Government Regulations 247

Chapter 20: Creating a Global Financial Reporting Standard 259

Chapter 21: Checking Out the Analyst-Corporation Connection 269

Chapter 22: How Companies Communicate with Shareholders 281

Chapter 23: Keeping Score When Companies Play Games with Numbers 295

Part VI: The Part of Tens 317

Chapter 24: Ten Financial Scandals That Rocked the World 319

Chapter 25: Ten Signs That a Company’s in Trouble 329

Glossary 335

Index 343

Table of Contents

Introduction 1

About This Book 2

Conventions Used in This Book 2

What You’re Not to Read 2

Foolish Assumptions 3

How This Book Is Organized 3

Part I: Getting Down to Financial Reporting Basics 4

Part II: Checking Out the Big Show: Annual Reports 4

Part III: Analyzing the Numbers 4

Part IV: Understanding How Companies Optimize Operations 4

Part V: The Many Ways Companies Answer to Others 5

Part VI: The Part of Tens 5

Icons Used in This Book 5

Where to Go from Here 6

Part I: Getting Down to Financial Reporting Basics 7

Chapter 1: Opening the Cornucopia of Reports 9

Figuring Out Financial Reporting 9

Preparing the reports 10

Why financial reporting counts (and who’s counting) 11

Checking Out Types of Reporting 12

Keeping everyone informed 13

Following the rules: Government requirements 14

Going global 15

Staying within the walls of the company: Internal reporting 15

Dissecting the Annual Report to Shareholders 17

Breaking down the parts 17

The meat of the matter 18

How the number crunchers are kept in line 19

Chapter 2: Recognizing Business Types and Their Tax Rules 21

Flying Solo: Sole Proprietorships 21

Keeping taxes personal 22

Reviewing requirements for reporting 22

Joining Forces: Partnerships 23

Partnering up on taxes 23

Meeting reporting requirements 24

Seeking Protection with Limited Liability Companies 24

Taking stock of taxes 24

Reviewing reporting requirements 25

Reading Financial Reports For Dummies, 2nd Edition x

Shielding Your Assets: S and C Corporations 25

Paying taxes the corporate way 26

Getting familiar with reporting requirements 27

Chapter 3: Public or Private: How Company Structure Affects the Books 29

Investigating Private Companies 29

Checking out the benefits 30

Defining disadvantages 31

Figuring out reporting 32

Understanding Public Companies 33

Examining the perks 35

Looking at the negative side 35

Filing and more filing: Government and shareholder reports 36

A Whole New World: How a Company Goes from Private to Public 39

Teaming up with an investment banker 40

Making a public offering 41

Chapter 4: Digging into Accounting Basics 43

Making Sense of Accounting Methods 43

Cash-basis accounting 43

Accrual accounting 44

Why method matters 44

Understanding Debits and Credits 46

Double-entry accounting 47

Profit and loss statements 47

The effect of debits and credits on sales 48

Digging into depreciation and amortization 49

Checking Out the Chart of Accounts 50

Asset accounts 51

Liability accounts 53

Equity accounts 54

Revenue accounts 55

Expense accounts 56

Differentiating Profit Types 57

Gross profit 57

Operating profit 58

Net profit 58

Part II: Checking Out the Big Show: Annual Reports 59

Chapter 5: Exploring the Anatomy of an Annual Report 61

Everything but the Numbers 62

Debunking the letter to shareholders 62

Making sense of the corporate message 63

Meeting the people in charge 64

Table of Contents xi

Finding basic shareholder information 64

Getting the skinny from management 64

Bringing the auditors’ answers to light 68

Presenting the Financial Picture 71

Summarizing the Financial Data 72

Finding the highlights 72

Reading the notes 73

Chapter 6: Balancing Assets against Liabilities and Equity 75

Understanding the Balance Equation 75

Introducing the Balance Sheet 76

Digging into dates 76

Nailing down the numbers 78

Figuring out format 78

Ogling Assets 80

Current assets 80

Long-term assets 83

Accumulated depreciation 86

Looking at Liabilities 87

Current liabilities 87

Long-term liabilities 88

Navigating the Equity Maze 89

Stock 89

Retained earnings 90

Capital 90

Drawing 90

Chapter 7: Using the Income Statement 91

Introducing the Income Statement 92

Digging into dates 93

Figuring out format 93

Delving into the Tricky Business of Revenues 96

Defining revenue 96

Adjusting sales 97

Considering cost of goods sold 99

Gauging gross profit 100

Acknowledging Expenses 101

Sorting Out the Profit and Loss Types 103

EBITDA 103

Nonoperating income or expense104

Net profit or loss 105

Calculating Earnings per Share 105

Chapter 8: The Statement of Cash Flows 107

Digging into the Statement of Cash Flows 107

The parts 108

The formats 109

Reading Financial Reports For Dummies, 2nd Edition xii

Checking Out Operating Activities 111

Depreciation 111

Inventory 112

Accounts receivable 112

Accounts payable 113

Summing up the cash-flow-from-activities section 113

Investigating Investing Activities 114

Understanding Financing Activities 115

Issuing stock 115

Buying back stock 115

Paying dividends 116

Incurring new debt 116

Paying off debt 117

Recognizing the Special Line Items 117

Discontinued operations 117

Foreign currency exchange 118

Adding It All Up 118

Chapter 9: Scouring the Notes to the Financial Statements 121

Deciphering the Small Print 122

Accounting Policies Note: Laying Out the Rules of the Road 122

Depreciation 123

Revenue 124

Expenses 124

Figuring Out Financial Borrowings and Other Commitments 126

Long-term obligations 126

Short-term debt 129

Lease obligations 130

Mergers and Acquisitions: Noteworthy Information 131

Pondering Pension and Retirement Benefits 132

Breaking Down Business Breakdowns 133

Reviewing Significant Events 135

Finding the Red Flags 136

Finding out about valuing assets and liabilities 137

Considering changes in accounting policies 137

Decoding obligations to retirees and future retirees 138

Chapter 10: Considering Consolidated Financial Statements 139

Getting a Grip on Consolidation 139

Looking at Methods of Buying Up Companies 144

Reading Consolidated Financial Statements 146

Looking to the Notes 148

Mergers and acquisitions 149

Goodwill 149

Liquidations or discontinued operations 150

Table of Contents xiii

Part III: Analyzing the Numbers 151

Chapter 11: Testing the Profits and Market Value 153

The Price/Earnings Ratio 154

Figuring out earnings per share 154

Calculating the P/E ratio 155

Practicing the P/E ratio calculation 156

Using the P/E ratio to judge company market value (stock price) 157

Understanding variation among ratios 159

The Dividend Payout Ratio 160

Determining dividend payout160

Digging into companies’ profits with dividends 161

Return on Sales 163

Figuring out ROS 163

Reaching the truth about profits with ROS 164

Return on Assets 164

Doing some dividing to get ROA 165

Ranking companies with the help of ROA 165

Return on Equity 165

Calculating ROE 166

Reacting to companies with ROEs assistance 166

The Big Three: Margins 167

Dissecting gross margin 167

Investigating operating margin 168

Catching the leftover money: Net profit margin 169

Chapter 12: Looking at Liquidity 171

Finding the Current Ratio 172

Calculating the current ratio 172

What do the numbers mean? 173

Determining the Quick Ratio 173

Calculating the quick ratio 173

What do the numbers mean? 174

Investigating the Interest Coverage Ratio 175

Calculating the interest coverage ratio 175

What do the numbers mean? 176

Comparing Debt to Shareholders’ Equity 176

Calculating debt to shareholders’ equity 177

What do the numbers mean? 178

Determining Debt-to-Capital Ratio 178

Calculating the debt-to-capital ratio 178

What do the numbers mean? 180

Reading Financial Reports For Dummies, 2nd Edition xiv

Chapter 13: Making Sure the Company Has Cash to Carry On 181

Measuring Income Success 181

Calculating free cash flow 182

Figuring out cash return on sales ratio 184

Checking Out Debt 185

Determining current cash debt coverage ratio 186

Computing cash debt coverage ratio 188

Calculating Cash Flow Coverage 190

Finding out the cash flow coverage ratio190

Hasbro 192

What do the numbers mean? 192

Part IV: Understanding How Companies

Optimize Operations 193

Chapter 14: How Reports Help with Basic Budgeting 195

Peering into the Budgeting Process 196

Who does what 196

Setting goals 197

Building Budgets 199

Providing Monthly Budget Reports 201

Using Internal Reports 203

Chapter 15: Turning Up Clues in Turnover and Assets 205

Exploring Inventory Valuation Methods 206

Applying Three Inventory Valuation Methods 208

Average costing 209

FIFO 210

LIFO 210

Comparing inventory methods and financial statements 211

Determining Inventory Turnover 211

Calculating inventory turnover 212

What do the numbers mean? 213

Investigating Fixed Assets Turnover 214

Calculating fi xed assets turnover 214

What do the numbers mean? 215

Tracking Total Asset Turnover 215

Calculating total asset turnover 215

What do the numbers mean? 216

Chapter 16: Examining Cash Inflow and Outflow 217

Assessing Accounts Receivable Turnover 217

Calculating accounts receivable turnover 218

What do the numbers mean? 219

Table of Contents xv

Taking a Close Look at Customer Accounts 220

Finding the Accounts Payable Ratio 222

Calculating the ratio 222

What do the numbers mean? 223

Determining the Number of Days in Accounts Payable 223

Calculating the ratio 223

What do the numbers mean? 224

Deciding Whether Discount Offers Make Good Financial Sense 225

Calculating the annual interest rate 225

What do the numbers mean? 226

Chapter 17: How Companies Keep the Cash Flowing 227

Slowing Down Bill Payments 227

Speeding Up Collecting Accounts Receivables 228

Borrowing on Receivables 230

Reducing Inventory 231

Getting Cash More Quickly 232

Part V: The Many Ways Companies

Answer to Others 235

Chapter 18: Finding Out How Companies Find Errors: The Auditing Process 237

Inspecting Audits and Auditors 237

Looking for mistakes 238

Meeting Mr. or Ms. Auditor 238

Examining Records: The Role of the Auditor 239

Preliminary review 240

Fieldwork 240

Audit report 242

Filling the GAAP 242

Accounting standards: Four important qualities 243

Changing principles: More work for the FASB 244

Chapter 19: Digging into Government Regulations 247

Checking Out the 10-Q 248

Financial information 248

Other critical matters 249

Introducing the 10-K 250

Business operations 250

Financial data 250

Information about directors and executives 252

The extras 252

Investigating Internal Controls 253

Reading Financial Reports For Dummies, 2nd Edition xvi

Uncovering the Ways Companies Keep in Compliance 254

Digging into Board Operations 256

The nominating process 256

Contacting board members 257

Finding Out about Insider Ownership 258

Chapter 20: Creating a Global Financial Reporting Standard 259

Why Develop a Worldwide Financial Standard? 259

Key Moves to Reshape Global Financial Reporting 260

Who Benefits from a Global Standard and How? 261

Investors 261

Capital Markets 262

Companies 262

Exploring Key Differences between GAAP and IFRS 262

Accounting framework 263

Financial statements 263

Revenue recognition 265

Assets 265

Inventory 266

Related-party transactions-disclosures 266

Discontinued operations 267

Impairment charges 267

Chapter 21: Checking Out the Analyst-Corporation Connection 269

Typecasting the Analysts 269

Buy-side analysts 270

Sell-side analysts 271

Independent analysts 273

Bond analysts 274

Regarding Bond Rating Agencies 274

Delving into Stock Rating 276

Taking a Look at How Companies Talk to Analysts 277

Analyst calls 277

Press releases 278

Road shows 279

Chapter 22: How Companies Communicate with Shareholders 281

Making the Most of Meetings 282

Checking Out How the Board Runs the Company 283

Watching the directors 283

Speaking out at meetings 284

Moving away from duking it out 285

Sorting through Reports 286

Catching Up on Corporate Actions 287

Culling Information from Analyst Calls 288

Listening between the lines 289

Knowing when to expect analyst calls 292

Table of Contents xvii

Staying Up to Date Using Company Web Sites 292

Regarding Reinvestment Plans 293

Dividend-reinvestment plans 293

Direct-stock-purchase plans 294

Chapter 23: Keeping Score When Companies Play Games with Numbers 295

Getting to the Bottom of Creative Accounting 296

Defining the scope of the problem 296

Recipes for cooked books 297

Unearthing the Games Played with Earnings 298

Reading between the revenue lines 299

Detecting creative revenue accounting 303

Exploring Exploitations of Expenses 305

Advertising expenses 306

Research and development costs 306

Patents and licenses 307

Asset impairment 308

Restructuring charges 309

Finding Funny Business in Assets and Liabilities 309

Recognizing overstated assets 310

Looking for undervalued liabilities 312

Playing Detective with Cash Flow 314

Discontinued operations314

Income taxes paid 315

Part VI: The Part of Tens 317

Chapter 24: Ten Financial Scandals That Rocked the World 319

Enron 320

Citigroup 321

Adelphia 321

WorldCom/MCI 322

Sunbeam 323

Tyco 323

Waste Management 324

Bristol-Meyers Squibb 325

Halliburton 325

Arthur Andersen 326

Chapter 25: Ten Signs That a Company’s in Trouble 329

Lower Liquidity 329

Low Cash Flow 330

Disappearing Profit Margins 330

Revenue Game-Playing 331

Reading Financial Reports For Dummies, 2nd Edition xvii

Too Much Debt 332

Unrealistic Values for Assets and Liabilities 332

A Change in Accounting Methods 332

Questionable Mergers and Acquisitions 333

Slow Inventory Turnover 334

Slow-Paying Customers 334

Glossary 335

Index 343