A publicly listed company in the UK will report its financial results to the market at least twice a year. These results will often move a share price in a positive or negative direction depending on whether they exceed, equal or fall short of what investors were expecting.
The statements themselves can be lengthy and include a significant amount of industry jargon and seemingly unnecessary detail, making them difficult to understand.
This article will help you comprehend the figures and be able to spot the real news which is often buried in the numbers.
It is important to look beyond the headline figures to get the full picture on how a business is performing. Although results from firms in different sectors can vary significantly there is some crucial information which will feature in every company's financial statements.
Balance sheet
A balance sheet is a snapshot of the financial position of the company at the end of the period covered by the results.
It is made up of assets and liabilities (what the company owns and what it owes).
If a group's liabilities exceed its assets then this might raise concerns about its ability to continue operating.
Assets come in two varieties, non-current and current. Typically non-current assets include things like property, land, trademarks and money devoted to research. Current assets include stock and cash in the bank.
Liabilities are also split into the current and non-current categories. Current liabilities are those debts which are due within a year while non-current are anything with a longer time frame and could include a company's pension obligations.
By subtracting total liabilities from total assets we can come up with an intrinsic measure of the firm's value also known as net assets or net asset value (NAV). Most commonly this is expressed as a function of the share price.
The share price will often be higher than the NAV per share because the market is factoring in expected profit alongside the NAV when valuing a company.
Income statement
The income statement presents similar information to that found in the balance sheet but rather than being a snapshot it is a summary of the company's finances over a period of time, such as six or 12 months.
The first number you see on the income statement is revenue which is the total amount of money received by the company for goods sold or services provided during a certain period.
Once the cost of achieving these revenues is taken away you are left with the operating profit.
On its own this might not mean much but by comparing it with the previous year's number (typically displayed alongside it) you can see if profit is rising or falling.
The pre-tax profit figure takes into account financing activities (which includes interest earned or paid and one-off charges). It is one of the most widely used measures when looking at a company's performance.
Alongside the income statement you can usually find information on earnings per share (EPS). This measure can be used to help understand how a company is valued by the market relative to its peers.
By dividing the share price by the historic earnings per share number we can come up with a ratio - the price/earnings (PE) ratio - which can then be compared against a company's peer group.
Often included in this section is information on the dividend - the dividend per share (DPS) allows us to work out an historic yield for the company. This yardstick is expressed as a percentage and is determined by dividing the DPS by the current share price and then multiplying it by 100.
Cash flow statement
The cash flow statement tells us how much money is running in and out of a company.
Cash is the fuel which keeps a business ticking over and, unlike earnings measures such as EPS and pre-tax profit, which can be manipulated through clever accounting, it is difficult to obscure cash flow.
For most companies, the pre-tax profit and EPS numbers are still valid indicators of how a business is performing as management teams recognise that inflating returns will only work in the short-term.
However, it is worth checking if sales and profit are backed by cash flow because if they are not, then it should be cause for concern.
The statement will run through three stages. First it reflects the amount of money coming in from operating activities.
Next the company will add or subtract cash flows from investing activities. This includes things like money received for the sale of property, investment in joint ventures and cash spent on new equipment.
Finally, cash flows from financing are taken into account. These will include things like cash raised from the sale of shares and money brought in as a result of loans as well as interest paid on existing debts and dividend payments to shareholders. You will then end up with your net increase or decrease in cash.
Notes to the accounts
If you have the time it is worthwhile looking at the notes to the accounts.
The little numbers you will see next to items in the accounts are references to the specific note that explains that item.
If something does not make sense at first glance in the balance sheet, income or cash flow statement, the notes may help.
PUTTING IT INTO PRACTICE
The best way of illustrating the pointers outlined above is to apply them to a real-life example. In this case results for the year to 31 July 2017 from industrial conglomerate Smiths Group (SMIN).
Announced on 22 September 2017, the shares fell in response to the numbers as the market focused on relatively disappointing underlying performance.
| Smiths Group condensed 2017 results | ||
| Balance sheet | ||
| As at 31 July 2017 | As at 31 July 2016 | |
| Non-current assets | £3.13bn | £2.72bn |
| Current assets | £2.03bn | £1.73bn |
| Current liabilities | £867 million | £991 million |
| Non-current liabilities | £2.18bn | £1.82bn |
| Total net assets | £2.1bn | £1.66bn |
| Income statement | ||
| 12 months to 31 July 2017 | 12 months to 31 July 2016 | |
| Revenue | £3.28bn | £2.95bn |
| Operating profit | £674m | £387m |
| Headline operating profit | £589m | £510m |
| Pre-tax profit | £601m | £316m |
| Earnings per share | 142.1p | 65.6p |
| Dividend per share | 43.25p | 42p |
| Cash flow statement | ||
| 12 months to 31 July 2017 | 12 months to 31 July 2016 | |
| Net cash inflow from operating activities | £479m | £358m |
| Net cash outflow from investing activities | £234m | £124m |
| Net cash gained from/(used) in financing activities | £116m | (£332m) |
| Net increase/(decrease) in cash and cash equivalents | £361m | (£98m) |
| Opening cash and cash equivalents | £430m | £495m |
| Closing cash and cash equivalents | £781m | £430m |
| Net debt at start of year | £978m | £818m |
| Net debt at end of year | £967m | £978m |
| Source: Smiths Group 22 September 2017 | ||
Quick-fire analysis
Smiths' operating profit for the July 2017 financial year was inflated by the £175m booked from the disposal of businesses. This helps explain the disparity between headline and statutory operating profit.
Historic price/earnings ratio (PE) = current share price (£15.89 as of close on 3 October 2017) divided by earnings per share (142.1p) = 11.2
Historic dividend yield = dividend per share (43.25p) divided by current share price (£15.89 as of close on 3 October 2017) expressed as percentage = 2.7%
The amount of net debt decreased due to the disposal of businesses through the course of the year
