The Daily Breakdown looks at some of the most important terms and financial metrics when it comes to fundamental analysis. Let’s dive in.
For those interested in other parts of the Fundamental Analysis Boot Camp, consider the following links:
- Boot Camp Day 1: Fundamental Analysis
- Boot Camp Day 3: Key Ratios to Know
- Boot Camp Day 4: Fundamental Investment “Vibes”
- Boot Camp Day 5: Value Investing vs. Growth Investing
Quick TLDR
- 3 most important financial statements
- Making sense of key lingo
What’s Happening?
In fundamental analysis, these are the three most important financial reports: The balance sheet, income statement, and cash flow statement. Let’s break them down. (To cut right to the chase, check out the “cheat sheet” at the bottom. Tomorrow, we’ll go over the key ratios that evaluate these metrics).
Balance Sheet
The balance sheet provides a snapshot of a company’s financial position and helps investors assess liquidity, solvency, and capital structure.
It follows the equation: Assets = Liabilities + Shareholders’ Equity.
Assets include what the company owns (cash, bonds, inventory and property), while liabilities cover what it owes (loans and accounts payable, for instance). Equity represents shareholders’ residual interest after liabilities are subtracted from assets.
Income Statement
The income statement shows a company’s financial performance and outlines key metrics, like revenue, expenses, and profits or losses.
It starts with revenue at the top and subtracts costs — like COGS, operating expenses, interest, and taxes — to arrive at a “net” figure of either profit or loss. This statement reveals how effectively a company is generating profit from its operations. Key line items include gross profit, operating income (EBIT), and earnings per share (EPS).
The income statement is essential for evaluating profitability, cost control, and revenue growth, and it’s widely used in valuation models and investment decisions. Lastly, investors can use the income statement to compute the company’s margins.
Cash Flow Statement
The cash flow statement details the actual cash generated by the business. It’s divided into three sections: operating, investing, and financing activities.
Operating cash flow reflects cash generated by core business operations. Investing activities include cash generated by buying or selling assets. Financing covers raising or repaying capital (like issuing debt or dividends).
Positive operating cash flow is a strong indicator of a company’s health. It’s key for assessing whether a firm can sustain operations and growth.
Key Terms
Revenue. Also called sales or top line, revenue is the total amount of money a company earns from its normal business operations, before any costs or expenses are deducted.
Earnings. Also known as the bottom line, earnings are the profit a company has left over after all expenses — including operating costs, interest, taxes, and depreciation — have been deducted from revenue.
Gross Margin. Gross margin is a profitability ratio that shows the percentage of revenue remaining after deducting cost of goods sold (COGS). A higher gross margin means a company retains more per dollar of revenue to cover other costs and profit.
It’s calculated as: (Revenue – COGS) / Revenue (and then multiplied by 100 to express as a percentage).
Operating Margin. This measures how much profit a company makes from its operations before interest and taxes. It’s calculated as: Operating Margin = Operating Income / Revenue
Current Assets. Examples include cash, accounts receivable, inventory, and short-term investments. These assets are important because they indicate a company’s short-term financial health and liquidity — essentially, its ability to pay off short-term obligations.
Current Liabilities. These are obligations due within one year, such as accounts payable, short-term debt, and accrued expenses. Comparing current liabilities to current assets helps gauge a company’s ability to meet short-term obligations.
Free Cash Flow (FCF). FCF is the cash a company generates after capital expenditures (like buying equipment). It represents money available to repay debt, reinvest, or return to shareholders, and is a key indicator of financial flexibility and long-term sustainability.
It’s calculated as: FCF = Operating Cash Flow – Capital Expenditures
Disclaimer:
Please note that due to market volatility, some of the prices may have already been reached and scenarios played out.