Wednesday, May 21, 2008

Basics of Investing – Part VI


Earlier on we discussed about Annual Audited Financial Statements. Aside from the Management Accounts (available to Management only), the most reliable information available to small time investors like us would be the Annual Audited Financial Statements. Let's have an overview of what audited financial statements are.

So what does audited mean? This merely means that there has been an independent examination of the underlying records that is used to compile the information in the financial statements. The auditors have performed some reasonableness test and checking to ensure the figures are reliable.

Are the figures 100% correct?
NO! Although an independent review has been carried out, this only gives us reasonable assurance. The more prestigious the audit firm, usually one of Big Four audit firms, the more reliable the figures. The Big Four audit firms are currently, PricewaterhouseCoopers, Ernst & Young, KPMG and Deloitte Touche Tohmatsu.

Are the figures materially correct?
YES, most of the time. Unfortunately there are exceptions, the most notable one being Enron that led to the collapse of one of the most prestigious global auditing firm – Arthur Andersen.

What about UNAUDITED quarterly and annual reports?
These means the financial statements have not been audited. Consequently, the profit announced in the quarterly reports could be different, sometimes materially different from the audited financial statements.

Income Statement
The Income Statement is also more commonly referred to as the Profit & Loss Account. This section tracks the results achieved by the company for the financial year (or quarter). It shows the Sales, Gross Profit and Profit before Taxation, Taxation Expense and Profit After Taxation, of the Company. Generally, it provides information on the financial results of the company’s efforts for the year. We can use this assess the past performance of the company and as a guide for future performance.

Balance Sheet
The Balance Sheet shows the position of the company as at the end of the financial year (or as at end of the financial quarter). The Balance Sheet contains full details of the all assets and liabilities of the company including its' Intangible Assets, Property, Plant and Equipment, Long Term and Current Assets, Long Term and Current Liabilities and the Shareholders’ Equity. This is noteworthy as it gives us an indicator as to the value or worth of a company.

Statement of Changes in Equity

As a shareholder, you should be concerned with your equity or your stake in the company. The value of your stake in the company will consist of the share capital, retained earnings and other reserves. This statement will show the movement in your equity for the financial year.

Cash Flow Statements
What is the life blood of a business? Cash!
The Cash Flow Statement shows the movement in cash flows from the beginning of the year to end of the year. This is crucial in the evaluation of how well a company is doing. Even if the company is making fantastic profits, if its’ operating cash flow position is negative; this is an indication that something is not quite right with the company!

Auditors Report
Auditors will usually give an unqualified opinion, which means that in their opinion, the audited financial statements are reasonable. If they give anything other than unqualified opinion, it means something is not right with the audited financial statements. You will need to be circumspect when relying on audited statements, if the auditors’ in their audited report gives anything, other than a qualified opinion.

Notes to the Financial Statements

This contains inter-alia, the Accounting Policies of the Company, additional details of the figures stated in the Income Statement and Balance Sheet, and non-financial information including Contingent Liabilities and Segmental Information. This allows you to gain further insight into the Company.

To truly evaluate the value or worth of shares in a company, it must be based on fundamentals. You must analyze the audited financial statements to assess the overall worth of a company. I suggest you download the audited financial statements of companies such as Nestle from the Bursa Malaysia and read it to get a feel of how they look like.


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