Numbers to Look for on Penny Stock Financial Statements - dummies

Numbers to Look for on Penny Stock Financial Statements

By Peter Leeds

You can find out essential information about a penny stock company from the financial statements. You want to know that a company is making money, has a viable business plan, isn’t crushed beneath a mountain of debt, and will still be in business six months from now.

While you will have different expectations in financial results from one company to the next, certain questions apply to all of them:

  • Are they making money?

  • Can they pay their bills?

  • Do they have too much debt?

You can get the answers to all these questions by doing a quick financial review.

Strong numbers on the income statement

One of the most important aspects of any business is to generate revenue through the sale of products and services. Although observing the sales figures is helpful, it only tells part of the story. You also want to see how much of that income translates into profit after factoring in all corporate expenses, such as the costs to produce their wares.

Assess the strength of a company’s sales results within the following parts of the income statement:

  • Revenues: Revenues are a marker that customers find value in the products or services of the underlying company, and so when a company reports sales, it demonstrates the viability of the company’s business model. The higher the revenues, the greater the demand for its offerings.

  • Cost of revenues: This should be a fraction of the total revenues. Consider a penny stock with $100 in sales. If its cost of revenue is $40, then it made a $60 profit from producing and providing its wares. If costs were more than $100, the company is operating at a loss, and if it is at $100, it is breaking even.

  • Gross income: Companies calculate gross income by subtracting costs of sales from total sales. Gross income is how much profit a company achieves by producing and selling its wares.

  • Operating expenses: Operating expenses include costs such as rent, advertising, administrative costs, unusual one-time expenses, and more. These costs are subtracted from the gross income. You want to see that the operating expenses don’t eat up the total gross income and that there is some profit remaining after taking these costs into account.

  • Net income (earnings): Net income is what’s left after subtracting the costs of sales and operating expenses from the revenue. When a company has a net income, it means that it’s generating more money than it is spending.

Strong numbers on the balance sheet

The balance sheet reveals the company’s ability to survive and expand, while also showing which businesses are running into financial trouble. You can see the viability of a penny stock in both the short term and long term by looking at its balance sheet.

To assess any penny stock, you should look for strength in the balance sheet through the following comparisons:

  • Current assets compared to current liabilities: Make sure that the company has enough money to at least cover its current liabilities. Any company that doesn’t have more in assets than liabilities in the coming year could be on its way out or facing a cash crunch. The greater the current asset number, the better.

  • Long-term assets compared to long-term liabilities: Do long-term assets cover the long-term liabilities? Ideally, you want long-term assets to outweigh long-term liabilities, although this is less crucial than making sure that current assets cover current liabilities.

Strong numbers on the cash flow statement

The cash flow statement can be complicated because many companies have money coming in and going out in several different ways, such as financings, returns on stock market investments, and net profits or losses. The cash flow statement provides a summary of the final result of all these different events that affect a company’s cash.

Look into the following parts of the cash flow statement to assess the strength of a penny stock:

  • Operating activities: You want the penny stock you’re reviewing to show profits from its operations, or at very least be able to cover any shortfalls though other categories on its statement of cash flows. While companies reporting a loss from its operating activities can survive by generating funds in other ways, it eventually will need to start producing a profit or run the risk of going out of business.

  • Investing activities: A company that shows no investment income is no cause for concern. Likewise, when the business generates money through this aspect of the cash flow statement, that’s a positive event. However, if a company reports a loss from investing activities, you need to find out how it lost that money, if the amount will impact its operations, and if it is likely to suffer another similar loss.

  • Financing activities: Most stocks generate the cash they need to operate by issuing shares of the company. Gains from these activities are reported on the cash flow statement. Although it’s acceptable for new companies to rely on issuing shares to generate most of the money they need to operate as long as they are heading toward self-sufficiency, be wary of companies that operate this way on an ongoing basis.

  • Miscellaneous items: This category is unique to each company and each situation. When reviewing this category, look into any big amounts reported here, note whether they produce or cost money, and make sure that you understand them and whether they benefit the underlying company and its shareholders.

  • Net change in cash position: After taking every factor into account, you should hope for a net increase in cash. If the companies are losing money from their operations, they have hopefully generated all they need to keep their business going through other sources, such as financing or investing.