Understanding company financial statements
Understanding company financial statements can appear complicated to start with. Getting to grips with financial statements is important when investing in shares. Find some of the more important aspects of a financial statement explained below.
Turnover
Turnover is the total amount of money received by the company during its financial year. Rising turnover, together with rising profits can represent a buy signal.
Profit
The rise or fall in profits of a company is the best indicator to measure how well a company is doing. Profit is worked out by;
sales – cost of sales
Earnings per share (EPS)
Generally speaking this measures how much money a company is making for its shareholders. EPS is;
profit derivable to shareholders / number of shares in issue during the year.
The higher the EPS of a company, the better for stock market traders.
Consistent EPS growth is also important to traders as it shows the company is growing and therefore its share price is likely to grow, resulting in capital gains for traders!
Price/Earnings ratio (P/E ratio)
The price earnings ratio values a company against its per share earnings. The ratio is worked out by;
current share price / earnings per share
The P/E ratio helps a trader measure a stock against its competitors or the sector as a whole. If a company’s P/E ratio is higher than other companies, or it’s sector, then the market rates it highly. If it is lower than its competitors then it is best to leave the stock alone if you are thinking of buying.
Current ratio
The current ratio measures a company’s liquidity. It determines the companies ability to pay its short term debts with its short term assets.
The formula to work out the current ratio is;
current assets / current liabilities
If assets cover liabilities then the current ration will be greater than 1.
When buying a stock for a lengthy period of time it is important to look for companies whose current ratios lie around 1.3 – 2.5. Any lower than and the company may have trouble paying of its short term debts. Any higher might indicate that the company is not using its capital in the most efficient way. Figures outside this ratio means the company will struggle to grow and therefore their share price will struggle to grow.
Note: Companies key financial information is nearly always listed on sites that offer free fantasy trading accounts. Looking at who turns over the most money and who generates the most profits makes interesting reading! For a good graphical view of company financials use ADVFN.com.
I need an even simpler explanation for the P/E ratio. For example is it better for the P/E to be 30.10 or 10.30 (higher number before the point or after)?
Hi Janet – Thanks for your question. The P/E ratio is the ratio of the share price (per share) divided by the annual earnings per share. So, in the conventional sense of how much value you are getting out of a share, a lower number would be considered more attractive. For example – if the share price is 10 dollars, and the company earns 1 dollar per share annually, the P/E ratio would be 10. In contrast, if they earned only 50 cents/share annually, the P/E ratio would be 20. So, for the same share price, a higher P/E means you have less earnings. However, this is only one measure and you need to consider all things. For example, let’s say you are comparing two companies and Company A has a P/E of 20 while Company B has a P/E of 10. So you might think Company B is more attractive – but maybe Company A is growing at a very fast rate and next year their earnings might be double what they are today. Whereas, perhaps Company B is rapidly shrinking and next year their earnings might be half of what they are today. Investors almost always look at growth rate above all else – so remember that the P/E ratio is only one bit of data but has to be considered in a broader perspective of what is going on with a give a company. I hope this info helps you to better understand.