Reading the accounts like an analyst: cheat sheet

The summary, key terms and the trap to avoid for every lesson, in order. Print it, or read it, cover it, and say it back.

The three statements and how they link Reading the accounts like an analyst

Income statement: profit over a period. Balance sheet: own and owe on a date. Cash flow statement: where the cash went.
Profit less dividends (and anything else charged there) moves retained earnings.
Opening cash plus the three sections (and exchange effects) gives closing cash.
Non-cash costs and working capital explain why operating cash differs from profit.
Follow the cash: ask what happened in each section before judging.

income statement: revenue less expenses for a period, ending in profit (also called the profit and loss account)
cash flow statement: the change in cash for a period, split into operating, investing and financing
accrual accounting: counting revenue when earned and expenses when incurred, not when cash moves
retained earnings: profits kept in the business over the years, part of equity
indirect method: building operating cash flow from profit by adjusting for non-cash items and working-capital changes
working capital: short-term assets such as receivables and inventory, less short-term liabilities such as payables

Watch out: Treating profit as cash, or "profit minus dividends" as the change in cash. Cash moves through all three sections of the cash flow statement; profit reaches cash only through the operating section, after non-cash items and working capital.

Common-size statements and trends Reading the accounts like an analyst

Common-size: lines as a % of revenue (or of total assets).
Trend: compare each line with earlier years, as a % change or index.
Check the base: same denominator, same length of year, no hidden one-offs.
Separate parts of revenue that move differently.
A falling percentage can hide a rising amount; look at the money too.

common-size statement: each line shown as a % of revenue (income statement) or of total assets (balance sheet)
vertical analysis: another name for common-size analysis within one year
horizontal analysis: comparing the same line across years, as a % change or index
trend index: a line's value each year ÷ its base-year value × 100
adjusted (non-GAAP) figure: a company's own measure that leaves out items it considers unusual; it must be reconciled to the reported figure

Watch out: Reading a falling percentage as a falling amount. Maple's overheads fell from 25% to 23% of revenue but rose from 200 to 230 in money. A common-size figure can move because the line changed, because the base changed, or both. Always look at the money figures too.

Profitability ratios: margins, ROA and ROE Reading the accounts like an analyst

Margins (gross, operating, net) measure what is kept from each sale.
ROA and ROE measure what is earned on assets and on the owners' money, on average balances.
Small or negative equity makes ROE huge, negative or meaningless.
Add back after-tax interest to compare companies with different debt.
When a ratio looks impossible, check its base.

gross margin: gross profit ÷ revenue
operating margin: operating profit ÷ revenue
net margin: net income ÷ revenue
return on assets (ROA): net income ÷ average total assets
return on equity (ROE): net income ÷ average shareholders' equity
shareholders' deficit: negative equity: liabilities exceed assets on the balance sheet, often after large buybacks

Watch out: Mixing a top and a bottom that don't belong together: group profit over the parent's equity when there are minority owners; net income (after interest) compared across companies with very different debt; or any ratio on an equity figure that is tiny or negative. Each ratio should compare a profit with the capital that earned it.

Efficiency ratios and the cash conversion cycle Reading the accounts like an analyst

Asset turnover: revenue ÷ average total assets.
Inventory and payable days use cost of sales; receivable days use revenue.
Cash conversion cycle = inventory days + receivable days − payable days.
Receivables growing faster than sales: check the note, the sales mix and one-offs before calling it a warning.
Give a verdict with what would change it.

asset turnover: revenue ÷ average total assets
inventory days: inventory ÷ cost of sales × 365
receivable days: receivables ÷ revenue × 365
payable days: payables ÷ cost of sales × 365
cash conversion cycle: inventory days + receivable days − payable days
wholesale: selling to other businesses (here, retailers), usually on credit

Watch out: Dividing inventory and payables by revenue instead of cost of sales, or taking the receivables line as "money customers owe" without reading the note. Companies' receivables can include supplier rebates, tax refunds, insurance claims and other non-customer amounts.

DuPont analysis: where ROE comes from Reading the accounts like an analyst

ROE = net margin × asset turnover × equity multiplier; margin × turnover = ROA.
Check that the parts multiply back to the direct ROE.
Translate each part into what happened in the business.
A higher ROE from a higher multiplier means more risk, not a better business.
Strip out one-offs and say what next year's results would change your mind.

DuPont analysis: splitting ROE into net margin × asset turnover × equity multiplier
equity multiplier: average total assets ÷ average equity; a measure of leverage
leverage: using borrowed money and other liabilities to fund assets, which magnifies returns and losses
tax burden: net income ÷ pre-tax profit
interest burden: pre-tax profit ÷ operating profit

Watch out: Treating a rising ROE as good news without asking which part rose. If the multiplier did the work (more borrowing, or buybacks shrinking equity), the business hasn't improved; it has become riskier. Always show all three parts, for at least two years.