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October 31, 2012

Balance Sheets and Income Statements :: What do they really mean?

Filed under: Food for thought for friends — Alec @ 3:35 pm

It has been 25 years, but I have read and reviewed hundreds of Balance Sheets and Income Statements since I sat through those “Stock Analysis Finance” classes. You can break For Profit Businesses into 4 simple categories:

Cash Cows :: Making lots of money, have market share, does not require a lot of capital [for example Orthopedic Hip & Knee Industry].

Dogs :: Losing market share and not making money [for example Kodak].

Star ::  Making money, has a good market share, growing and long range potential [for example Apple]

Oil Wells or Questions :: Not making money or not making much, requires lots of capital,  but huge long term potential [for example facebook].

All these companies must make money and maintain positive cash flow or have investors with deep pockets. If they don’t they will either go out of business, be sold, merge, etc. When they have to make changes like those I just mentioned, investors, employees and retirees are at risk of losing their stake. It doesn’t take long for big changes to happen, it can be only a matter of a few years.

The Balance Sheet tells us cash flow, long and short-term assets and debts, and usually inventory is in the asset column. The Income Statement tells us profit, but it can also include adjustments for inventory. The Income Statement is Sales (Revenue) minus Expenses. When a company makes money it is used to pay dividends, invest in new capital, invest in growth etc.
When they make more money than the market expects, their stock goes up. When they don’t, their stock generally goes down. And when a company loses money on a continuous long run, or unpredictably, their stock goes down.

The Chairman and his team’s objective is to grow Revenue and Profit percentage every quarter and every year, with the goal of it being higher than the previous. When it doesn’t happen this way, the stock market and stock price reflects poorly. When a company doesn’t make as much
money as the stock market expects, crazy things happen like drastic moves South or worse, to Asia. Sometimes the new location will offer a company huge tax incentives, pay for new capital, and maybe long term income and property tax credits. I am not advocating this approach. It frequently happens in our world today, even if the domestic plant currently is profitable. If the profit isn’t what the stock market wishes, the company may struggle. Raising taxes on local plants can drive a profitable company into a situation where the incentives to move outweigh the reasons to stay.

So what happens to us?! Your 401k, your IRA, your pension fund… is all in these stocks. When companies don’t make money, your financial future is at risk.

It’s scary to think that a company can make a 10 to 20% profit and go out of business. Cash flow and suppliers can put a company out of business. Pitfalls are everywhere : the tendency to over borrow, if a customer doesn’t pay on time or at all, if they over invest in new capital or expansion, or if the bank stops lending to them, the company can end up with lots of assets but no cash. A good example of this happened at International Harvester in the 1980’s. They overbuilt tractors and combines. Many more than they could sell and more than they had the demand for. Profit looked great due to generation, but they went bankrupt.

Business is not as simple as just being profitable this quarter. Being a success in business can be complicated. So what do YOU do? Let US help you be a star of the business world!

1 Comment

  1. Cash is King, Queen and Jack!

    Comment by Fred Pieplow — October 31, 2012 @ 7:47 pm

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