Why analyze financial statements? As an organization, how do financial statement

Question

Why analyze financial statements? As an organization, how do financial statements contribute to the decision making process? As an individual investor, how are financial statements helpful when making investment decisions? If you wanted to invest $1,000 in a soft drink company, and you narrowed your choice down between Coke and Pepsi, where would you look to find each company's respective financial statements?  Based on the most current company information, which company would you choose and why?

Explanation / Answer

Prospective Investors need Financial Statements to assess the viability of investing in a company. Investors may predict future dividends based on the profits disclosed in the Financial Statements. Furthermore, risks associated with the investment may be gauged from the Financial Statements. For instance, fluctuating profits indicate higher risk. Therefore, Financial Statements provide a basis for the investment decisions of potential investors.

Some investors consider the balance sheet the best statement to get a good overall view of a company's financial position. The balance sheet follows the basic accounting equation assets equal liabilities plus owners' equity. The difference between what a company has and what it owes equals equity, or net worth. A high net worth may indicate that a company is relatively debt free, particularly if its owners' equity is higher, expressed as a percentage of assets, than other companies in its industry.

The income statement shows how much profit a company has earned during a given period. The format includes a gross profit calculation, followed by an operating income section. This produces operating income. Non-operating income or losses, including one-time or special sources of revenue or expense, are then added to derive net income. Gross profit is based on revenue minus the cost of producing the goods or services that a company sells, called the cost of goods sold. This shows how efficiently the company generates income from its production. Operating income considers many other costs along with the cost of goods sold, including overhead and depreciation on equipment. This is important in determining the company's basic profitability, especially when compared to prior periods or to other companies in its field. Growing operating income is a good sign. Special items may positively or negatively affect a period's net income, but they are less likely to affect long-term concerns.

The statement of cash flows also reveals useful information when making investment decisions. It shows the net change in the company's cash position during a given period. In general, stable or growing cash flow means the company can cover its short-term debt payments and expenses, while also keeping up with any long-term debt obligations. You can also look over the structure of the cash flow to see how much cash is generated from operating activities versus financing and investing. It is a good sign when a company's cash from operating income routinely exceeds its net income. This shows income is turning into cash. Typically, an effective cash position is favorable in an investment because it shows less risk of loan defaults or bankruptcy.

The statement of owners' equity isolates the equity section of the balance sheet. Its primary purpose is to show the trend in retained earnings for the company. Retained earnings are accumulated profits not paid out in dividends. This is useful in investment decisions because higher retained earnings relative to dividends means you get less dividend income. However, this often means the company is looking to grow and is holding onto income for reinvestment versus paying it out in the near term.

Coke vs Pepsi

Real advantage that Pepsi has over Coke is its product diversification, which really showed in the report. The PepsiCo Americas Foods division saw strong 6% organic revenue growth, with its North American and Latin American divisions both contributing to rising sales. Frito-Lay's U.S. market share also climbed despite increasingly strong competition.

Moreover, Pepsi's emerging-market performance underscored how important the international markets are for the company. Adjusting for the impact of corporate structural changes, revenue in its fast-growing Asia, Middle East, and Africa segment rose 15%, with strength on both the snack side and the beverage side of the business. Even struggling Europe posted some impressive gains in sales and profits.

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