What should investors focus on in financial statements?

ByMatt Krantz, USA TODAY
January 13, 2012, 12:10 AM

— -- Q: What kind of information should investors pay attention to when reading companies' financial reports? Please use General Motors gm as an example.

A: Public companies provide piles of financial information to investors. But if you don't know how to read these documents or don't know what to look for, you can quickly get buried.

Companies release all sorts of documents to investors, ranging from quarterly reports, annual reports and press releases. Digging into these statements and discussing all the elements worth examining is covered by many full-length books.

If you're interested in more detail, there are also past Ask Matt columns on the topic you might want to read.

The reason there is so much information on financial statements is because these documents are the most critical pieces of information investors will get from individual companies. Reading these documents closely is one of the best ways for investors to get a better grip on what's going on with the company to which they've entrusted their money. Ignoring these reports is akin to driving down the freeway blindfolded.

But for this column, I'll cover a few of the main highlights investors should watch for. This is by no means an all-inclusive or exhaustive list of all parts of financial reports investors should consider. Think of this as more of a basic checklist to get started.

Investors can always get free access to all public financial documents from the Securities and Exchange Commission's website. It's important to familiarize yourself with how to download and view companies' financial reports.

As you start examining statements, a few things to take a close look at include:

•Earnings and revenue growth. If you invest in a company, the most important thing is the bottom line. You want to know how much the company earns and whether it's boosting its sales. This can tell you whether a company is on a growth trajectory or in decline, key factors that determine how much the company is worth. A company's earnings and revenue can be compared with its stock price to tell you if a stock is expensive or reasonably priced.

You can get these data from the company's earnings press releases, quarterly reports (10-Q), or annual reports (10-K). These reports contain critical financial statements called the balance sheet, income statement and statement of cash flow. These three statements will be discussed in more detail below.

Regarding General Motors, the financial statements tell a story of recovery. The company reported revenue of $149.2 billion during the 12 months ended Sept. 30, 2011, according to S&P Capital IQ. That's up 10% from 2010 and up 43% from 2009. There's still room for recovery, though, as revenue is down 17% from 2007.

On the bottom line, GM reported net income of $9.9 billion during the 12 months ended Sept. 30, 2011. That's up 59% from 2010. More encouraging is the fact the company is back in the black following massive losses of $38.4 billion and $30.9 billion in 2007 and 2008.

Getting these numbers takes some work. You need to add up the data in each of the past four quarters, as well as the same quarters in the previous period, to calculate the change.

•Cash flow trends. There's a big difference between what a company says it earned, using accounting standards, and how much cash a company hauls in. Cash is money in hand, not the result of accounting measurements and judgment calls, as is the case with earnings and net income. When a company's net income is much higher than cash flow, investors want to be aware and find out why.

Going back to the income statements, GM reported net income of $9.9 billion in the 12 months ended Sept. 30, 2011. Flipping to another financial statement, the statement of cash flow, we find GM reported cash from operations of $5.2 billion during the 12 months ended Sept. 30, 2011, according to S&P Capital IQ. Much of the difference is due to large contributions made as pension contributions. GM's cash-flow situation is even more strained if you consider that it made $5.7 billion in capital expenditures during the period.

•Debt load. Just as many consumers got into hot water by borrowing too much, sometimes companies go overboard with debt, too. Debt isn't necessarily toxic for companies, as long as the companies generate ample cash flow to service the debt payments.

It's critical for investors to understand how much debt companies have and how that debt compares with a company's ability to pay. This requires examining a company's balance sheet and income statement.

Start with the balance sheet, which shows how much debt a company has. GM, thanks largely to its bankruptcy protection proceedings, has greatly reduced its debt load. As of Sept. 30, 2011, GM was carrying $2.7 billion in long-term debt, which is down 91% from 2007. Meanwhile, the company's cash and short-term investments has more than doubled from 2008, to nearly $32 billion as of Sept. 30, 2011.

Thanks to the company's bankruptcy restructuring, the company's interest expense during the 12 months ended Sept. 30 was $653 million. That's incredibly manageable based on the company's current financial performance. The company's earnings before interest, taxes and non-cash expenses was $11.9 billion during the 12 months ended Sept. 30, which is 18 times the company's interest expense.

If investors would take the time to consider the three things described above, they would have gone a long way toward understanding the status of a company they're betting on. The whole exercise would take less than an hour, much less for those with experience reading financial documents. It's time well spent, as it could help investors find potential problems before they cause a major downdraft in the shares.

It's also important to note that when GM provides its annual report later this year, investors will have an easier time. All the 12-month statistics will be available on a single report, eliminating the need to add up all four quarters for each 12-month period.

Furthermore, there are some online resources that make finding some of these data easier. USATODAY.com provides some of the data described above on GM's stock quote page. Additionally, Nasdaq.com provides some summary 12-month data on its website, as well.

Matt Krantz is a financial markets reporter at USA TODAY and author of Investing Online for Dummies and Fundamental Analysis for Dummies. He answers a different reader question every weekday in his Ask Matt column at money.usatoday.com. To submit a question, e-mail Matt at mkrantz@usatoday.com. Follow Matt on Twitter at: twitter.com/mattkrantz

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