STOCK MARKET TERMINOLOGY

FOR BEGINNERS

A Complete Guide to Learning

the Stock Market Lingo

Christopher Hamilton
Copyright 2021 by HamFam - All rights reserved.

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 TABLE OF CONTENTS
Book Description
Introduction
PART 1: ON THE SURFACE
Stock price
Ticker symbol
Stocks
Common stocks
Preferred stocks
Basis point
Percent
Types of charts
Time frame
Range
Watchlist
Bid and ask
Volume
Previous close
Today’s open
Market cap
1-year target estimat
Average volume
Dividend yield
Earnings date
Percentage change
52 weeks high and low
Shares outstanding
Analyst ratings
ETFS

PART 2: UNDER THE SURFACE

Enterprise value (EV)
EBITDA
Trailing and forward p/e
 Peg ratio
Price to sales
Price to book (P/B ratio)
50-day and 200-day moving average
Held by insiders
Held by institutions
Payout ratio
Ex-dividend date
Fiscal year-end
Fiscal year
Profit margin
Operating margin
Return on assets (ROA)
Return on equity

PART 3: BEHIND THE SCENES

INCOME STATEMENT (statement of operations)
Revenue
Cost and expenses
Depreciation and amortization
Total cost
Income (loss) from continuing operations
Net income (loss) from continuing operations
Net Loss
Net income attributable to
Earnings (loss) per share attributable to and diluted EPS

BALANCE SHEET
Assets
Current assets
Cash and cash equivalents
Receivables
Inventories
Other current assets
Intangible assets
Total assets
Liability
Current liabilities
 Accounts payable
Other long-term liabilities
Equity
Retained earnings
Total equity

CASH FLOW
Cash provided by operations
Cash used in investing activities
Borrowing base
Dividends
Reduction of borrowings
Repurchases of common stock
Cash provided by (used in) financing activities
Cash equivalents
Restricted cash

CONCLUSION
 Book Description
re you thinking of trading stocks? Do you have the interest and

A enthusiasm to trade stocks but lack basic knowledge and understanding

of basic stock terminologies?
Well, you have come to the right place!
Even though stock investing does not require a lot of money and time, you must
be willing to equip yourself with basic tools and the necessary training to help
you make the right decisions. Think about it – what is the most well-known
metric for measuring a country’s economy? The strength of its currency, right?
However, this can be greatly influenced by speculators and liquidity. Before you
can start investing in the stock market, you must familiarize yourself with basic
stock terminologies. Think of it as learning to speak a new language. If you ask
any seasoned stock investor, they will tell you they started by learning the
investing terms.
There’s really no need to panic because it will not take long. Once you are done
reading this book, you will start speaking the stock investing language in no
time. Here, we will break down some of the essential stock terms every investor
must know to start investing their money wisely!
So, what are you still waiting for?
Take a deep breath, relax, and learn!
 Introduction
ook around you – you will realize that most people turn to the country’s

L stock market performance as an indicator of how well the economy is

doing. The truth is, stock markets cover all industries in all sectors of the
economy. This simply means the stock market is a barometer that tells you
which cycle of the economy we are in and the hopes and fears of the population
generating wealth and growth.
This book is for anyone who wants to learn the terms within the stock market.
These terms are not terms that just make you sound cool but are terms that are
relevant in the stock market and will help you know what to look for. There is a
lot of fluff or stock market lingo out there that isn’t really needed to understand
what a good stock is. Therefore, I have created this book to give you the terms
that matter and save you a bunch of time from trying and figuring out these
terms on your own.
Learning stocks can seem overwhelmingly difficult, to say the least, but in this
book, I will give the terms and define them for you so that you can have a guide
you can always refer to. Research the terms, come back to this book, share with
your friends, whatever you may do, at least you know you’re searching for terms
that matter as a beginner.
Before we delve deeper into the key terminologies used in the stock market let’s
first understand the meaning of stock market and how it works.
The stock market is a collection of markets and exchanges where buying, selling,
and issuance of publicly-held company shares happen. These activities happen
through institutionalized formal exchanges or over-the-counter marketplaces
operating under a set of regulations.
Perhaps you are thinking, “is there a difference between the stock market and
stock exchanges?”
Yes, there is a difference!
While most people use these terms interchangeably, stock exchange is a subset
of the stock market. If you say you trade in the stock market, it simply means
you buy and sell shares or equities on one or more of the stock exchanges, which
are part of the overall stock market. In the US, some of the leading stock
exchanges are Nasdaq, New York Stock Exchange (NYSE), and Chicago Board
Options Exchange (CBOE). All these stock exchanges make up the US’s stock
market.
Think about it – people drive to the city's outskirts and farmlands to buy a
Christmas tree. If you want wood for home furniture or renovations, you will
likely drive to the timber market. If you need groceries, you will likely go to the
stores like Walmart to get them.
In short, there are dedicated markets where buyers and sellers come to interact
and transact. The best part is, you are assured of fair prices because the number
of market participants is large. For instance, if you only have one seller of
Christmas trees in the entire city, he has the freedom to charge whatever prices
he wants because the buyers don’t have anywhere else to go. However, if the
number of Christmas tree sellers is large in the same marketplace, they will have
to compete to attract buyers.
The same thing happens when shopping online – you will compare prices
offered by different sellers on the same or across different shopping portals to
get the best deals. This forces online sellers to offer competitive prices.
In the stock market, you have the same designated market for trading various
stocks in a controlled, secure and well-managed environment. The stock market
brings together many market participants who want to buy or sell shares, which
ensures fair pricing and transaction transparency. In the past, stock markets used
to deal in paper-based physical share certificates. Today, the stock market deals
in computer-aided stock markets operating electronically.
Stock markets offer the best option for you to invest your money. In other words,
setting aside money while you are busy with life and then have that money work
for you so that you can fully reap the fruits of your labor. I like to think of
investing as a means to a happy future. According to Warren Buffet, investing
simply means “…laying out money now to receive more money in the future.”
Think about it – if you have $1000 to set aside, you are ready to invest in the
stock market. When you invest in this way, you earmark money for the future
with the hope that it will grow over time. Stock trading offers you – especially
beginners – the opportunity to gain an investment experience.
Before you commit your money to stock investment, you must ask yourself,
“what kind of investor am I?”
Think about your investment goals and how much risk you are willing to take
on. While there are investors who wish to take an active hand in managing the
growth of their money, there are those who choose to set it aside and forget it.
The good news is that the stock market offers you a secure and regulated
environment where you can transact in shares and other eligible financial
instruments with high degree of confidence.
The most important thing to note is that the stock market acts both as a;
Primary market
Secondary market
Primary market – simply means that the stock market allows companies to issue
and sell their shares to the public for the first time by issuing initial public
offerings (IPO) at a set price – like $20/share. To facilitate this process, the
company will need a marketplace where they can sell, and this is provided by the
stock market. During the capital raising process, the stock exchange serves as a
facilitator and gets a fee for its services from the company and its financial
partners.
Secondary market – Following the first-time issuance of IPO – also referred to
as the listing process – the stock exchange acts as a trading platform for regular
trading – buying and selling. This is referred to as secondary market activity
taking place in a secondary market. It is where the stock exchange bears the
responsibility of maintaining price discovery, liquidity, price transparency, and
fair-trading activities.
The stock exchange also offers new additional shares through such offerings as
follow-on offers, rights issue, or even buybacks and facilitates such transactions.
It also creates and maintains a wide range of market-level and sector-specific
indicators that help you track the movements in the overall market. Additionally,
the stock exchanges maintain company announcements, news, and financial
reporting accessible through their official websites.
 PART 1:
ON THE SURFACE
Stock price
his refers to the current price a stock share is trading for in the stock

T market. When the shares of a publicly traded company are issued, they
are assigned value that ideally reflects the company’s value. The stock
prices may go up or down depending on different factors like changes within the
industry, environmental changes, war, changes in the economy, or political
events.
One mistake people make is assuming that when the stock price is low, it means
they are cheap, and when the stock price is high, it means they are expensive.
The truth is, stock prices tell very little about the stock’s value. Most
importantly, it does not predict whether the value is headed higher or lower. Your
main goal as a stock investor is to identify stocks that are currently undervalued
by the market.
Let’s consider an example – one company has created a game-changing
technology while another is laying off staff to cut down on cost. What stocks
would you want to buy?
When buying stocks, it helps to dig deeper instead of “judging a book by the
cover.” You might be surprised that the company that has just created a game-
changing technology does not have a plan to build its initial success. On the
other hand, the company that is cutting down on costs may already be
streamlining its operations to achieve success.
The stock prices only tell you the current value of a company or its market value.
If there are more buyers than sellers, the chances are that the stock prices will
rise, and vice versa. Your role is to investigate the company to determine its true
value.
Ticker symbol
This is a unique string of letters assigned to security for the purposes of trading.
For instance, stocks listed on the NYSE might have four letters or less. On the
other hand, those listed on the Nasdaq may be up to five letters. For example, if
you wanted to search for Amazon, you would simply type in AMZN, or for
Nike, it would be NKE. These symbols are just a shorthand way of describing
stocks by different companies.
When a company issues their securities to the public marketplace, they select
symbols for their shares – often related to the name of the company. The
investors and traders will then use these symbols to place trade orders. There is
no significant difference between those with three letters and those with four or
five. Any additional letters simply mean the stocks have more features like
trading restrictions or share class, which ranges between A and Z.
But what happens if the company has more than one class of shares trading the
market?
In that case, it adds a class to its suffix. For instance, preferred stocks called
Jeff’s Tequila Corporate preferred A shares would use the symbol JTC.PR.A.
If a company is in a bankruptcy proceeding, it will have a Q letter after its
symbol. On the other hand, if the company is non-US but is trading in the US
financial markets, it will have a Y letter following its ticker symbol.
Stocks
Think about it – when you purchase a company’s stocks, you are purchasing a
small portion of that company, which is called a share. Therefore, stocks are
defined as securities that represent your ownership share in a company. As an
investor, if you think that a company’s stocks will grow in value, you can
purchase a slice of that company and sell your shares later for profit. They are
ways for you to grow your money and outpace inflation.
There are two types of stocks namely: common stocks and preferred stocks.
Common stocks
Are you new to stocks investing? Are you looking to buy few shares?
If yes, then you might want to invest in common stocks. As the name suggests,
common stocks refer to the most common type of stock in the market. When you
own common stocks, it simply means you own a slice of the company’s profits
and the right to vote. You may also earn dividends, which is a payment made to
you – the stock owner – regularly. However, these dividends are typically
variable and not a guarantee you will receive them.
Pros
They offer you potential for higher long-term returns
You have voting rights
Cons
The dividends – if available – are variable, lower, and not guaranteed
Their prices are highly volatile
In case the company goes bankrupt, you risk losing your investment
Preferred stocks
This is a type of stock in which you are entitled to a fixed dividend whose
payment is a priority over ordinary share dividends. They have a higher claim on
distribution compared to common stocks.
Pros
The dividends are higher, fixed, and guaranteed
Their prices are less volatile
In the event of a liquidation, you are likely to recover at least part of your
investment
Cons
In most cases, you have limited or no voting rights in corporate
governance
You have a lower long-term potential for growth
Basis point
This refers to a unit of measure used in finance to describe the % change in the
rate or value of a financial instrument. It is also denoted as bps or “bips.” 1 bps =
0.01%. In the bond market, bps is used to describe the yield a bond pays to an
investor.
Bips are commonly used by investors to describe the incremental interest rate
change for securities and interest rate reporting. Additionally, they are used to
prevent ambiguity or confusion when talking about absolute and relative interest
rates – especially in cases where the rate difference is less than a percent, but the
amount has a material significance.
Percent
This refers to the number of points divided into the value of the stock, which
produces a percentage change.
Let us consider an example;
If you say that a company’s stocks are up 5 points from $100/share, it simply
means it's up to $5, which translates to a 5% gain. In short, the percent value is
always calculated from the starting value, which makes the comparison
understandable.
Types of charts
As an investor, the first thing you must understand is that technical analysis is all
about timing. While a stock may be doing very well, if you trade at the wrong
price, you risk incurring heavy losses. This explains why traders use a wide
range of tools to make informed decisions in the stock market. The biggest tool
is the stock chart.
When performing technical analysis, there are three major principles you must
bear in mind;
Stock prices reflect all the relevant information about the market
The stock prices move with market trends
History has a way of repeating itself
If the stock prices move in patterns, the trick is to study the patterns to help you
make informed trading decisions, hence the reason you must learn to use stock
charts – graphical representations of stock volume and price movements over a
certain duration. Typically, the X axis represents the time – which varies from
intra-day to months or more – while the Y axis represents the movement in price.
There are various types of charts;
Line chart
This is the most common type of chart that tracks the closing prices of the stock
over a specific duration. Every closing price is represented by a dot, and all the
dots are connected by lines, which give a graphical representation. While most
people think of the line chart as simplistic, traders can use it to spot trends in
price movements.
Bar chart
This is quite similar to the line chart, except it offers more information. Instead
of a dot, every plot point is represented by a vertical line with two horizontal
lines from both sides. The top part of the vertical line is the highest price at
which a stock is traded during the day. On the other hand, the lower part is the
lowest traded price. The extension on the left represents the price at which the
stock opened, while on the right represents the closing price for the day.
The bar chart also offers insight into volatility. For instance, if the line is longer,
it simply means greater volatility in trading the stocks.
Candlestick charts
These charts are popular among technical analysts because they offer a lot of
information in a precise way. As the name suggests, the movement in stock price
is represented in candlestick shape. Just like the bar chart, it has 4 data points –
high, low, open, and close. However, this chart gives volatility information for a
longer period, and the price movements are represented in different colors. A
falling stick is black or red, while a rising candlestick is white or clear.

That said, as you trade in the stock market, you must read the chart and
understand the information it represents to help you identify patterns in price
movements and use that to make informed trading decisions.
Time frame
This is the amount of time a trend lasts in the stock market and can be identified
and used by traders. These trends can be classified as primary, intermediate, or
short-term. The truth is, markets can exist in several time frames at the same
time. In that case, there can be conflicting trends within a stock depending on the
time frame considered. It is not unusual to find stocks that are on a primary
uptrend while still being mired in the short-term or intermediate downtrends.
A general rule of thumb is that when the time frame is longer, the signals are
more reliable. The more you drill down in the time frames, the more the charts
become polluted with noises and false moves. Ideally, you should use a longer
time frame to define primary trends of whatever stocks you are trading.
Range
This displays how many periods you wish to display, which is a key depending
on the information you want. By just looking at the stock charts, you can tell
where prices have been for a particular duration without much description. Once
you set the range, you can tell the stock movement for that time. There are
various default settings – like 1,5 or 10 days; 1,3 or 6 months; 1,3,5,or 10 years.
Watchlist
These are set of securities monitored for their potential in trading or as
investment opportunities. Just as the name suggests, it is a list of stocks an
investor watches with the aim of leveraging price falls to create interesting
undervalued situations. With several instruments, you can create a watchlist that
will help you make informed and timely investment decisions. You can also use
a watchlist to keep track of companies and keep up with financial events and
news that could impact these instruments.
Bid and ask
Bid and ask are also referred to as bid and offer. They refer to two-way price
quotations indicating the best potential price a security can be bought and sold at
a certain time. The bid price is the maximum price a buyer is willing to pay for a
share of stock or securities. On the other hand, the asking price is the minimum
price a seller is willing to take for that specific security. For a transaction to
happen, a buyer must be willing to pay the best offer available or sell at the
highest bid.
The difference between bid and ask is termed as spread, which gives information
on liquidity. In other words, the smaller the spread, the greater the liquidity of
that security.
For instance, if the current price for a stock of ABC is $12.50 / $12.55, if you are
looking to buy A at the current market price, you will pay $12.55, while another
investor who wishes to sell ABC shares at the current market price will receive
$12.50.
Volume
This refers to the amount of assets or securities changing hands over a given
period, in most cases over the course of the day. For example, stock trading
volume would be the number of shares of security traded between daily open
and close. Generally, stocks with more daily volume are considered more liquid
than those without because they are more active.
In technical analysis, volume is a key indicator used to measure the relative
significance of a market move. If the volume is higher during a price move, the
move is considered more significant. However, if the volume is lower during a
price move, then the move is considered less significant.
In short, volume tells you more about the market activity and liquidity. If you
feel hesitant about the direction of the stock market, the chances are that future
trading volume will likely increase, causing options and futures ion-specific
stocks to trade actively. Overall, volumes tend to be higher near the market’s
opening and closing times; and on Mondays and Fridays. Additionally, they are
lower during lunchtimes and before holiday seasons.
Previous close
This is a security’s – including stock, commodity, bond, futures or options
contract, or market index – closing price of the preceding time of the one being
referenced. Almost always, it refers to the prior day’s final price of a security
when the market officially closed for the day.
In financial information, it is an important daily metric used for reporting
purposes. It marks the daily measuring point against which updated returns are
calculated and for which new information is collected to inform new decisions
and strategies. It is one of two key components in a candlestick day chart.
Today’s open
This is the starting period of trading on a security exchange or organized over
the counter market. In most cases, an order is considered open until it is
cancelled by the client, it is executed or it expires. Depending on the exchange,
today’s open can be the first executed trade price for that specific day. However,
there is a good chance that the open price may not be the same as the previous
day’s closing price.
You must note that different exchanges have different opening times. For
instance, NYSE may open at 9:30 am EST, while CME may open at 7:20 am
CST. That said, the main reason an order may remain open is because it carries
such conditions as stop levels or price limits. The other reason may be a lack of
liquidity for that specific security. In other words, if there are no established bids
and offers by market makers, it means no trading will happen.
Market cap
This is also referred to as market capitalization. It is the total dollar market value
of a company’s outstanding shares of stock. To calculate the market cap, you
simply multiply the total number of company’s outstanding shares by the current
market share price.
Let us consider an example; A company X has 10 million shares selling for
$100/share with a market cap of $1 billion. In that case, investors will use this
figure to tell the company size instead of using total asset figures or sales. In an
acquisition, the market cap will determine whether a takeover candidate is a
good value or not to the party acquiring it. The initial market cap of a company
is established through an IPO. Before that, the company that wishes to go public
must enlist an investment bank to employ valuation techniques to help derive a
company’s value and determine how many shares will be offered to the public
and at what price.
Once the company goes public and begins trading on the exchange, the share
price is determined based on supply and demand in the market. If the demand is
high due to favorable factors, the price will likely increase. However, if the
company’s future growth potential is in doubt, the sellers will likely drive the
price down. In that case, the market cap becomes a real-time estimate of the
company’s value.
Market cap = share price x # shares outstanding
1-year target estimate
This refers to the predicted price of stocks a year from the current date. In most
cases, the price levels reflect the collective opinion given by different analysts on
where they think the stocks will be trading a year from now. For an analyst to
give an estimate, they must predict what a company’s business will be like in a
year by focusing on the revenue and other key factors. Additionally, they must
consider the investor’s willingness to pay a given price. That said, the results of
such predictions are usually not extremely successful.
Average volume
This refers to the average number of shares you trade within a day in a given
stock. While daily volume is the number of shares you trade each day, averaging
this over a number of days gives you the average daily volume. The average
volume is a key metric because high or low trading volumes attract different
types of traders and investors.
Most traders and investors prefer high trading volumes compared to lower
volumes. This is mainly because high volumes are easier to get into and out of
position. On the contrary, lower volumes have fewer buyers and sellers, making
it harder to enter or exist at the most desired price.
Higher volumes indicate that the securities you are trading are highly
competitive, have narrower spreads, and are less volatile. Does this mean they
will not have large price moves? Definitely not! On any day, any stock can have
a very large price move even on higher than average volume.
You can use the average volume as a metric for analyzing the price action of
liquid assets. In other words, if the price of an asset is rangebound and a
breakout happens, an increase in volume is likely to confirm the breakout.
However, a lack of volume indicates that a breakout is likely to fail.
Dividend yield
This refers to a financial ratio of dividends/price showing how much a company
pays out in dividends annually relative to its stock price. This value is expressed
as a percentage. Dividend yield is likely to be paid by mature companies, while
those with higher dividend yields are likely to be in the utility and consumer
staple industries.
Even though companies in the REITs, BDCs, and MLPs are thought to pay
higher than average dividends, they are taxed heavily. This is why investors must
bear in mind that higher dividend yields don’t always mean an attractive
investment opportunity because the dividends of a stock might be increased
because of a decline in stock price.
Earnings date
This is the date of the next release of a company’s financial report. This is when
the company’s profitability for a particular duration is officially announced. In
most cases, companies in the private sector are required to give quarterly
financial reports to stock exchanges across the world so that investors know the
company's state.
Percentage change
This is a mathematical concept representing the extent of change happening over
time. In finance, this is important in telling the price change of a security. This
value can be applied to any quantity you measure over time. For instance, if you
are tracking the quoted price of a security, an increase in price is calculated using
the following formula;
[(New Price - Old Price)/Old Price] x 100.
If the answer you get is a negative value, it simply means the percentage
change is a decrease.
Alternatively, a decrease in price is calculated using the following formula;
[(Old Price - New Price)/Old Price] x 100.
If the answer you get is a negative value, it simply means the percentage
change is an increase.
52 weeks high and low
This refers to a data point in data feeds obtained from financial information
sources online, which includes the lowest and highest price at which a stock has
traded over a period of 52 weeks. Most investors use this kind of information to
tell how much fluctuation or risk they have to endure over a year if they choose
to invest in a particular stock.
The 52-week range can be obtained from stock’s quote summary given by
brokers or financial information websites. You can also see the visual
representation on a price chart displaying one year’s worth of price data.
Considering that price movement is not always balanced or symmetrical,
investors must know the most recent number – the high or the low. In most
cases, the number closest to the current price is assumed to be the most recent.
However, this is not always the case. That said, not having the correct
information risks making costly investment decisions.
Shares outstanding
These are the amount of stocks present in an open market and are currently held
by its shareholders, institutional investors, company officers, and insiders. On a
balance sheet, they are termed as Capital stock. Shares outstanding is used in
calculating key metrics like market cap, earning per share, and cash flow per
share. This number is not static and is likely to fluctuate wildly over time.
Analyst ratings
This refers to a measure of expected performance of a stock over a given
duration. In most cases, analysts and brokerage firms use these ratings when
issuing stock recommendations to traders. The analysts arrive at these ratings
after conducting comprehensive research into the public financial statements of
different companies, talking to customers and executives, or attending
conferences.
These ratings are issued at least four times annually – once every quarter. These
analyst ratings are accompanied by target prices to help traders gain deeper
insight on stock’s fair prices compared to the current market value. There are
different types of ratings;
Buy rating is a recommendation to buy specific stocks. It implies that an analyst
expects the stock price to rise in the short- or mid-term.
Sell rating is a recommendation to sell specific stocks. It implies that the analyst
expects the stock prices to decline below the current level in the short- and mid-
term. This means the analyst has identified key challenges in the company.
Hold rating implies that an analyst expects that the stock will perform in line
with the market and at the same pace as similar stock. It tells brokers not to sell
their stock nor buy more. Often, this rating is given when a company is not sure
whether or not it will meet its guidance even though it’s making respectable
profits.
Underperform rating implies that a company’s stock is likely to get worse than
the market average or the benchmark index. In that case, traders are advised to
stay away from the stock. This is often expected when a company’s growth slugs
more than the previous quarter.
Outperform rating implies a stock is expected to yield higher returns than the
benchmark index or market average. Typically, this rating says that this is a good
buying opportunity for a particular stock.
That said, it is your responsibility as a trader or investor to do your due diligence
because analyst ratings are just a starting point but are far from fail-proof.
ETFS
This refers to a set of securities that track a specific set of equities. They trade
the same way stocks do and just like an index; they track equities. Investors who
purchase shares of ETFs gain exposure to a basket of equities ad limited
company-specific risks associated with a single stock, hence offering them cost-
effective ways to diversify their portfolio.
 PART 2
UNDER THE SURFACE
Enterprise value (EV)
his refers to the measure of a company’s overall value. This metric is

T often used as a comprehensive alternative to equity market cap.

To calculate EV, use the formula:
EV = MC + Total Debt – C
Where:
MC is the market capitalization, equal to the current stock price multiplied
by the number of outstanding stock shares.
Total debt is the sum of both short- and long-term debts.
C is the cash and its equivalents, which includes the company’s liquid
assets and not the marketable securities.
If the market cap is not readily available, simply multiply the number of
outstanding shares by the current stock price.
Perhaps you are thinking, “what does EV tell me?”
Think of the EV as the theoretical takeover price of the company were to be
bought. This is different from a simple market cap in various ways and may be
considered an accurate representation of the firm’s value. For instance, the value
of a company’s debt must be paid off by the buyer when they take over the
company. Hence, EV offers a more accurate takeover valuation because it factors
in debt in calculating value.
So, why doesn’t market cap accurately represent a company’s value?
The truth is, market cap leaves out some of the most important factors like
company debt and cash reserves. In that case, EV serves as a modification of the
market cap because it incorporates these factors when determining a company’s
total value. This explains the reason EV is popularly used as a basis for many
financial ratios measuring a company’s performance.
That said, before you use the EV formula, you must beware of its downsides.
Knowing EV considers the total debt, you must think of how the company has
used this debt. For instance, in capital-intensive companies, businesses tend to
shoulder a huge amount of debt, which is used to spur growth. Therefore, while
EV calculation may be skewed against these companies in favor of companies in
low/zero debt industries, you are likely to miss the bigger picture if you rely
solely on EV.
EBITDA
This refers to a measure of a company’s ability to generate revenue. This is
majorly used as an alternative to net income or simple earnings in certain
situations. To calculate EBITDA, use the formula:
EBITDA = recurring earnings from continuing operations + interest + taxes
+ depreciation + amortization
That said, this value can be quite misleading because it strips out the cost of
capital investment – like equipment, property, or plant. In that case, you can
choose to use EBIT, which is a similar financial metric that does not have the
downside of eliminating depreciation and amortization expenses associated with
equipment, property, and plant. When EV and EBITDA are combined, you get a
valuation tool that efficiently compares a company’s value – including debt – to
a company’s cash earnings – minus non-cash expenses. This is ideal for analysts
seeking to compare companies within the same industry.
That said, EBITDA has a number of drawbacks;
First, in cases where the working capital is growing, this metric will overstate
the cash flows from operations. It will also ignore how different revenue
recognition policies affects a company’s cash flow from operations. Secondly,
considering that free cash flows to the company captures the number of capital
expenditures, it is highly linked with the valuation theory than EBITDA, which
typically is an adequate measure if capital expenses are the same as depreciation
expenses.
Trailing and forward p/e
The price-to-earnings ratio, P/E ratio, is a metric that compares the price of a
company’s stock to the earnings generated by the company. This comparison
plays a critical role in helping one understand whether the markets are
undervaluing or overvaluing stocks.
To obtain the P/E ratio, simply divide the stock price by the stock’s earnings.
I like to think of it this way – the market price of a stock tells you how much
people are willing to pay to own shares. However, the P/E ratio will tell you
whether the price is an accurate reflection of a company’s earning potential or its
value over time.
Let us consider an example – if a company’s stocks are trading at $50 per share
and the company generates $5/share in annual earnings, then the P/E ratio of the
company’s stocks would be (50/5), which equals 10. In other words, given the
company’s current earnings, it would take 10 years for the accumulated earnings
to equal the investment cost.
Considering that prices keep fluctuating, it is safe to say that the P/E ratio of
stocks and stock indices never stand still. This value also changes as the
company reports earnings – typically, every quarter.
There are two variants of P/E ratio;
Trailing P/E ratio
This is a measure of the EPS of stocks for the past 12 months. To calculate this
value, use the formula;
Trailing P/E ratio = Current per share price of a stock/EPS from the
previous year
This ratio accounts for a company’s actual earnings rather than its projected
earnings, hence why it is considered the most accurate way of determining a
company’s value. In a perfect market, the trailing P/E ratio offers a fair stock
valuation.
Forward P/E ratio
This is a metric that forecasts a company’s likely earnings per share for the next
12 months.
Forward P/E ratio = Stock’s current share price / future earnings
The difference between the trailing and forward P/E ratios is that the former is
based on actual performance stats while the latter is based on performance
estimates.
Determining P/E ratio is specifically important to investors because it reveals
what is paid per dollar that a company logs in its bottom line. If an investor can
tap into the profits for a fairly low price, there is a clear bargain to be obtained.
However, if the cost is high compared to the earnings, you must ask the reason
behind it.
The good thing about the forward P/E ratio is that it helps a company compare
its present earnings to those already on track to make in the future. As new
figures trickle in, investors must pay close attention to the forward-looking
indicators. The only downside is that most investors try to beat the system by
claiming higher earnings at first and then adjusting the figure towards the next
announcements. Alternatively, they claim lower earnings figures in one quarter
to ensure that the next quarter beats their estimates.
Peg ratio
Peg ratio stands for price/earnings to growth ratio. It refers to a stock’s P/E ratio
divided by the growth rate of its earnings over a specific duration. This ratio is
used to determine the value of stocks considering a company’s expected earnings
growth. Most analysts believe that the peg ratio offers a complete picture than
the standard P/E ratio we discussed earlier.
To calculate the Peg ratio, use the formula:
PEG ratio = EPS growth price / EPS
Where EPS stands for earnings per share.
Just like any ratio, the accuracy of peg ratio depends on the inputs used. If
considering using a company’s peg ratio from a publication, you must find out
the growth rate that was used in the calculation. Realize that using historical
growth rates tends to give an inaccurate PEG ratio if you anticipate that the
growth rate will change in the future.
While a low P/E ratio tends to make a stock look like a good buy, incorporating a
company’s growth rate in calculating the peg ratio tells a different story. The
lower the peg ratio, the higher the chances of stocks being undervalued given the
future earnings expectations. By adding a company’s expected growth rate, you
adjust the results, especially if the company has a high growth rate and a high
P/E ratio.
Price to sales
This is a valuation ratio comparing a company’s stock price to its revenues. It
serves as an indicator of the company’s value that financial markets have placed
on every dollar of its revenues or sales.
This ratio demonstrates how much investors are willing to pay per dollar or
sales. To calculate it, you can either divide the company’s market cap by the total
sales over a period of 12 months; or calculate it on a per share basis by dividing
the stock price by the sales per share. The P/S ratio is also known as revenue - or
sales multiple.
Just like any other ratio, the P/S ratio is relevant when comparing companies
within the same industry/sector. When the ratio is low, it means the stocks are
undervalued. However, if it is significantly above average, it may suggest stock
overvaluation.
To calculate the P/S ratio, use the formula;
P/S ratio = MVS / SPS
Where:
MVS is the market value per share; and
SPS is the sales per share.
That said, the P/S ratio does not consider whether a company makes any
earnings or will ever make any earnings in the future. Therefore, comparing
companies in different sectors can be pretty difficult. For instance, a company
that makes video games have different capabilities of turning profits compared to
a company that deals with groceries. Additionally, this metric does not account
for debt loads the company’s balance sheet status. A company with virtually no
debt is considered more attractive compared to one that is highly leveraged, even
if the P/S ratios are the same.
Price to book (P/B ratio)
This is one of the most widely used financial ratios that compares a company’s
market price to its book value. In other words, the P/B ratio shows the value
given by the market for every dollar of a company’s net worth. In most high-
growth companies, their P/B ratios tend to be above 1.0. On the other hand,
those facing severe distress tend to have P/B ratios of below 1.0.
To calculate the P/B ratio, use the formula:
P/B ratio = Market price per share / Book value per share
The company’s book value refers to the tangible net asset value calculated by
subtracting intangible assets – like goodwill and patents – from total assets. If
the P/B ratio is low, it suggests that the stock is undervalued. It could also mean
that something is fundamentally amiss with the company. Just like most ratios,
the P/B ratio varies across industries. It also indicates that you are paying too
much for what would remain if the company is declared bankrupt.
This metric reflects the value market participants attach to a company’s equity
relative to the equity’s book value. While the stock’s market value is a forward-
looking metric of a company’s projected cash flows, the book value is based on
the cost principle and mirrors the past issuance of equity, augmented by losses or
profits and reduced by share buybacks and dividends.
If a company is liquidated and all its debts paid, the remaining value would be its
book value. In other words, it offers a reality check for investors looking for
growth at a reasonable price and is looked at in relation to the return on equity
(ROE), which is a reliable growth indicator. Let us consider an example –
assuming a company has $150 million in assets and $100 million liabilities. The
company’s book value would be ($150-$80), which equals $50. If there are $10
million shares outstanding, each share will represent $5.00 of the book value. If
the share price is $10, then the P/B ratio would be 2 x (10/5).
That said, if the accounting standards used by companies differ, the P/B ratio is
likely to be non-comparable, especially in cases where the companies are in
different countries. This metric may also be less useful for companies with little
tangible assets on their balance sheet. Additionally, this value can be negative
because of a long series of negative earnings, making it useless for relative
valuation.
50-day and 200-day moving average
A moving average refers to an arithmetic mean of a number of data points. A 50-
day moving average is the sum of the past 50 data points divided by 50. On the
other hand, a 200-day moving average is the sum of the past 200 days’ data
points divided by 200.
Therefore, the difference between these two moving averages is the number of
time periods used in their calculation. The reason many technical traders use
these moving averages is to help them choose whether to enter or exit a position,
making these levels strong support or resistance measures.
You must note that moving averages are often viewed as low-risk areas to set a
transaction because they correspond to the average price a trader is paid over a
specific duration. For instance, a 50-day moving average equals the average
price all investors pay to obtain assets over a duration of 10 weeks. Similarly, a
200-day moving average equals the average prices over a duration of 40 weeks.
Once the prices fall below these averages, it acts as a resistance. This is mainly
because individuals who have taken a position may consider closing their
position to avoid suffering a significant loss.
Held by insiders
Insider is a term that is used to describe senior officers or directors of a publicly
traded company. It is also used to describe any entity that beneficially owns
more than 10% of a company’s voting shares or has non-public knowledge. The
thing with insiders is that they must comply with strict disclosure requirements
regarding the purchase or sale of a company’s shares.
In the US, the securities and exchange commission (SEC) makes the rules about
insider trading. Insider trading is not always an illegal activity as insiders can
legally sell, buy, or trade stocks in their company if they notify SEC.
According to SEC, an insider is any investor that gains insider information
through their work as officers, corporate directors or employees of a company. If
these people share information with their friends, family, or business associates,
and they go ahead and exchange stocks in the company, they are termed as
insiders. Insider trading is considered a violation of trust investors place in the
stock market because it undermines fairness in investing.
Held by institutions
This is also termed institutional ownership. It refers to the amount of a
company’s available stocks owned by insurance companies, pension funds,
mutual funds, private foundations, investment firms, or endowments, among
other large entities managing funds on others’ behalf.
In most instances, stocks held by institutions are considered favorable. Large
institutions often employ a team of analysts who perform comprehensive and
costly financial research prior to purchasing a large block of a company’s stock,
making the decision influential to potential investors.
Considering the investment made in research, most institutions are not quick to
sell their position. However, when they do, it is often viewed as a judgment on
the value of stock, which drives down their prices. On the other hand,
institutions may drive the share prices high once they own the stock through TV
adverts, presentations, articles in high-profile publications, or investor
conferences, which ultimately move the stock higher and thus increasing the
value of their position.
Realize that when an institution represents a majority of ownership in a given
security, several issues may arise. With the available resources, it is possible for
almost all outstanding shares of a security to be controlled by these entities. It is
this concentration of ownership that contributes to peak ownership with little
room for new retail investors or reasonable trading activities.
Payout ratio
This is a financial metric that shows the proportion of earnings a company pays
its shareholders as dividends – also termed the dividend payout ratio. This
payout ratio is expressed as a percentage of a company’s total earnings.
This metric is often used in determining a company’s dividend payment
program’s sustainability. Typically, a higher payout ratio – of over 100% - means
more sustainability. Conversely, a lower payout ratio suggests that a company is
choosing to reinvest a significant amount of its earnings in expanding operations.
Historically, if a company has the best long-term dividend payment records, its
payout ratios are considered stable over time.
To calculate the payout ratio, use the formula:
DPR = Total dividends / Net income
That said, no single number that defines the ideal DPR mainly because its
adequacy depends largely on the industry/sector a company operates in. In most
cases, companies operating in defensive sectors boast stable earnings and cash
flow able to support high payouts over a long duration. However, companies that
make less reliable payouts face macroeconomic fluctuations that make their
profits vulnerable.
Ex-dividend date
This is also referred to as the ex-date. It is the day stocks start trading without
the value of its next dividend payment. Typically, this is one business day prior
to the record date. This means that an investor buying stocks on its ex-date or
later is not eligible to receive the declared dividends. In other words, the
dividend payment is made to the person or entity that owned stocks a day before
the ex-date. The ex-date happens before the record date because a stock trade is
settled ‘T+1’, which means that transaction’s record is not settled for one
business day.
For instance, if an investor owned the stock on Thursday, January 14 but sold
them on Friday, January 15, they are considered the shareholder of record on
Monday, January 18, because the trade has not fully settled. However, if the
investor sold on Thursday, January 14, then the trade would have settled on
Friday, January 15, which is before the record date of Monday, January 18; and
the new buyer would be entitled to receiving the dividend payment.
As an investor, if your investment strategy is focused on income, you must know
when the ex-date happens so that you plan your trade entries better. That said,
considering the stock price declines by about the same value of dividends,
buying the stock just before the ex-date should not result in any profits.
Similarly, investors who buy stocks on the ex-date or after getting a discount are
not entitled to dividends.
Fiscal year-end
This refers to the completion of any 12-months accounting time other than a
typical calendar year. Once a company chooses its fiscal-year end, often when
they incorporate or form a company, it must stick with year after year to allow
for consistency of accounting data with respect to time frame. If a company’s
fiscal year-end is the same as its calendar year-end, it means the fiscal year ends
on 31, December.
That said, every company has the ability to choose the best fiscal year-end based
on their needs. Annually, every public company must publish its financial
statements to be reviewed by SEC. These documents play a critical role in
updating investors on the company’s performance compared to previous years. It
also offers analysts a better understanding of the company’s business operations.
These financial statements are published after the company’s fiscal year-end,
which differs from one company to another.
Fiscal year
This refers to a one-year duration in which companies and governments do
financial budgeting and reporting. In most cases, the fiscal year is used for the
preparation of financial statements. Even though a fiscal year can begin on the
1st of January and end on the 31st of December, not every fiscal year corresponds
with the calendar year.
Think about it – a college often starts and ends their fiscal year based on the
school year, right?
In the case of publicly traded companies and their investors, it serves as a time
when revenues and earnings are measured, making year-to-year comparisons
possible. A company may choose to report its financial information on a non-
calendar fiscal year depending on the nature of its revenue cycle.
Profit margin
This is a profitability ratio that measures the extent to which a company or
business makes money. In other words, it is a representation of a company’s
sales that are turned into profits. For instance, if a company reports a 40% profit
margin in the previous quarter, it means its net income was $0.40 of every dollar
of sales generated.
There are four levels of profit margins; operating profits, gross profits, net
profits, and pre-tax profits. All these are reflected in a company’s income
statements in this order; a company takes in sales revenue and pays direct costs
of their products or services and is left with gross margins. After that, it pays
indirect costs and is left with an operating margin. Then it pays interest on debt,
adds unusual inflows or minuses charges and is left with pre-tax margin. It then
pays taxes and is left with net margin, which is also termed as net income as its
bottom line.
Profit margin is a key indicator of a company’s financial health, growth
potential, and management skills. While the profit margins vary from one sector
to another, caution must be taken when comparing the figures for different
companies and businesses.
To calculate the profit margin, use the formula;
Profit margin = 1 – (Expenses / Net Sales)
Let us consider an example;
If a company generates sales worth $200,000 by spending $100,000, the profit
margin would be [ 1 – ($100,000/$200,000)], which equals 50%. If the cost of
generating the same sales declines to $50,000, it means the profit margin shoots
to [1 – ($50,000/$200,000), which equals 75%.
In short, when cost declines, the profit margin increases. Therefore, to improve
the profit margin, a company must reduce costs and increase sales. Theoretically,
increasing sales can be achieved by increasing the volume of units sold,
increasing the prices, or both. That said, an increase in price should only happen
to the extent to which a company does not lose its competitive edge in the
marketplace.

Operating margin
This is a measure of how much profit a company makes on a dollar of sales once
it pays for the variable cost of production before paying interest or tax. In short;
Operating margin = Operating earnings / revenue
If the ratio is higher, it is considered better because it suggests that a company is
efficient in its operations and is good at turning sales into profits. Operating
margin serves as a good indicator of how well a company is managed. It shows
the amount of revenue available to cover non-operating costs, explaining why
investors, analysts and lenders pay close attention to it.
If the operating margin is highly variable, it tells you how risky the business is.
By taking a close look at a company’s past operating margin, you can measure
its performance and tell whether it has been doing well or not. To improve the
operating margin, one must ensure better management controls, improved
pricing, efficient resource mobilization, and effective marketing.
Let us consider an example;
If a company has revenues of $1 million, administrative expenses of $250,000,
and COGS of $350,000, its operating earnings would be [$1 million –
($250,000+$350,000)], which equals $400,000. In that case, the operating
margin would be ($400,000/$1 million), which equals 40%. However, if a
company negotiates better prices with its suppliers to significantly lower the
COGS to $250,000, there will be a significant improvement in its operating
margin to 50%.
That said, operating margin must only be used in comparing companies
operating in the same sector because ideally, they have similar business models
and annual sales. However, if the companies are in different sectors, their
business models and annual sales are wildly different and comparing their
operating margin is only meaningless – It’s like comparing apples and oranges.
Return on assets (ROA)
This is an indicator of how profitable a company is relative to its total assets.
This metric offers analysts, managers, and investors an idea on how efficient a
company’s management is as far as generating income and using assets. The
higher the ROA, the better.
Think about it – every business is all about efficiency – making the most of
limited resources. By comparing profits to revenue, you can tell so much about a
business’ operations. To calculate ROA, use the formula;
ROA = A company’s net income / Total assets
The higher the ROA, the better because it suggests that the company is more
asset efficient.
Let us consider an example;
Samuel and Peter both start a grocery store. Samuel spends $3,000 on his
container stall, while Peter spends $30,000 on his grocery store in a mega mall.
Assuming these are the only assets each investor deployed if over a duration
Samuel earns $300 while Peter earns $2,400. This would mean Peter has a more
valuable business, right? But Samuel would have a more efficient business. This
is because Peter’s ROA would be $2400/$30000, which equals 8%. Samuel’s
ROA would be $300/$3000, which equals 10%.
Return on equity
This is a measure of financial performance that is obtained by dividing net
income by shareholder equity. Considering shareholder equity is equal to a
company’s assets less the debt, ROE stands for the return on net assets. This
metric is considered a measure of a company’s profitability in relation to
stockholder’s equity.
To calculate ROE, use the formula;
ROE = Net income / Average shareholders’ equity
Here, the net income is the amount of income, taxes, and net taxes a company
generates over a specified duration. On the other hand, shareholders’ equity is
the sum of equity at the start of the duration. The start and end of the duration
must coincide with the period during which the company earns net income. The
net income and shareholder’s equity are on the income statement and balance
sheet, respectively.
It is best practice to calculate ROE based on average equity over time because of
the mismatch between the balance sheet and income statements. That said, what
is considered normal among stock peers determines whether the ROE is good or
bad. The rule of thumb is to work towards an ROE that is equal to or above the
average of peer groups.
Realize that a high ROE might not always be a good thing because it could
suggest a number of issues like excessive debt or inconsistent profits. On the
other hand, a negative ROE due to net loss or negative shareholder equity may
not be used in analyzing the company, nor can it be used in comparing it to
companies with a positive ROE.
 PART 3
BEHIND THE SCENES
INCOME STATEMENT (statement of operations)
his is one of the three important financial statements used by a company

T to report its financial performance over a specific period. It is also

termed as the profit and loss statement. Its primary focus is on the
company’s revenues and expenses over a particular duration. The income
statement offers a deeper insight into a company’s operations, efficiency of its
management, and sectors that are underperforming relative to other industry
peers.
The income statement must be submitted to the Securities and Exchange
Commission (SEC). There are four key areas the income statement focuses on;
Revenue
Expenses
Profits
Losses
However, it does not differentiate between cash and non-cash receipts. Instead, it
starts with sale details and works down to calculate the net income and earnings
per share (EPS). In short, it accounts for a company’s net revenue generated and
how it is transformed into net earnings – profits or losses. On the income
statement, these details are shown;
Operating revenue – the revenue generated through primary activities of the
company. If a company is manufacturing products, distributing, or retailing, the
revenue derived from its primary activities is obtained from the sale of its
products. Similarly, for a service business, revenue is the money drawn from the
company’s primary activities or earned through the exchange of offering those
services.
Non-operating revenue – is the revenue obtained through secondary, non-core
business activities. In other words, they are sourced from activities outside the
purchase and sale of goods and services. They include the capital lying in the
bank, rental income from company property, income from advertisement display
set on a company’s property.
Profits/gains – refers to the money earned from other activities like the sale of
long-term assets. Like selling old transportation vans, unused land, or subsidiary
companies.
That said, revenue must not be confused with receipts. You must note that
revenue is accounted for in the period when sales are made or services are
delivered.
Expenses and losses – refer to the cost of a business continuing its
operations and turning profits. Some of the company’s expenses may be
written off on a tax return and must meet the guidelines given by the IRS.
The primary activity expenses are all expenses incurred for earning the
normal operating revenue associated with the business’ core activities.
Some of the items that make up this list include employee wages, utility
expenses, and sales commissions.
The secondary activity expenses are all expenses associated with non-core
business activities – including interest paid on loan.
Losses as expenses are all expenses incurred on loss-making sale of long-
term assets, unusual costs, or one-time expenses.
Revenue
This refers to the income generated from running a normal business operation. It
includes the discounts and deductions made on returned merchandise. In short, it
is the top of the line income figure from which we subtract costs in determining
the net income.
Revenue = Sales price x Number of units sold
On an income statement, revenue is termed as sales. If you run a startup
business, it is critical that you make positive revenue as early as possible.
Revenue is also called price-to-sales ratio. In most cases, revenue is known as
the top line because it appears as the very first thing on an income statement. On
the other hand, net income is considered the bottom line because it is revenue
less expenses. When revenue exceeds expenses, it means a company is making
profits.
A company’s revenue can be classified into various divisions. For instance, a
company can have different divisions that serve as a separate source of revenue.
It can also be divided into operating revenue derived from a company’s core
business; and non-operating revenue, which is obtained from secondary sources.
The non-operating revenues are often non-recurring and unpredictable – often
one-time gains.
In real estate investment, revenue is the income generated from property – like
parking fees, rent, or even on-site laundry costs. In non-profit organizations,
revenue is the gross receipts – like donations from foundations, individuals, or
companies. In the case of governments, revenue is the money obtained through
taxation, fines, fees, sale of securities, minerals, or intergovernmental grants.
Cost and expenses
Cost means that you have expended resources in order to acquire something,
take to a location, and set it up. However, it doesn’t necessarily mean that the
items you have acquired have been consumed. Until an expended resource has
been consumed, it is termed as an asset.
Let us consider an example;
To acquire an automobile, you need to pay $40,000 – that is the cost of
acquisition – which is likely to include sale taxes and delivery charges. If you are
building a product, the sum total of the expenditure you used in building it –
including materials, manufacturing overhead, and labor – is termed as cost.
On the other hand, an expense refers to a cost whose utility has been consumed.
For instance, the automobile you just purchased for $40,000 will be charged to
expense through depreciation over time, while the product you created will be
charged to the cost of goods and services sold when it is eventually sold.
The other way you can think of an expense is any expenditure made in order to
generate revenue. As soon as any related revenue is recognized, the cost is
converted into an expense. In other words, the difference between cost and
expense is that cost identifies an expenditure, while an expense suggests
consumption of the acquired item. The reason most people treat cost as an
expense is because most expenditures are consumed immediately.
Depreciation and amortization
Depreciation refers to the expensing of a fixed asset over its lifetime. Realize
that fixed assets are tangible – like equipment, vehicles, buildings, office
furniture, machinery, or land. Considering tangible assets might have some value
at the end of their life, you can calculate depreciation by subtracting the asset’s
salvage value from the original cost. The difference is what depreciates evenly
over the years. The amount of depreciation that happens annually is considered a
tax deduction for the company until the useful life of an asset is expired.
For instance, a company can use an office building for many years before it is
rundown or sold. In that case, the cost of building is spread out over the
building’s predicted lifetime, with a fraction of that cost being expensed in every
accounting year.
Amortization is the practice of spreading the cost of an intangible asset – like
trademarks and patents, organizational cost, franchise agreement, or proprietary
processes, etc. – over its useful life.
Unlike depreciation, this is expensed in a straight-line basis. In other words, a
similar amount expensed in every period over an asset’s useful life; and the
assets expensed this way don’t have resale or salvage value.
Total cost
The total cost is the sum of variable and fixed costs of a batch of goods or
services. To obtain the total cost, you can use the following formula;
Total cost = (Average variable cost + Average fixed cost) x number of units
sold
Let us consider an example;
If a company incurs $20,000 of fixed cost to produce 1,000 units. Then the
average fixed cost per unit is ($20,000/1000 units), which equals $20 per unit. If
the variable cost per unit is $4, the total cost at the end of the production of
1,000 units would be ($20 + $ 4) x 1,000 units, which equals $24,000.
That said, the total cost is accompanied by a number of limitations;
There is a limited range for average fixed cost
Variable purchasing costs are based on volume
Direct labor is fixed and yet it is not considered this way
To correct these issues, you must recalculate the total cost whenever there is a
change in the unit volume by a significant amount.
Income (loss) from continuing operations
First, we must understand that continuing operations refer to all business
operations, excluding any segments that have been discontinued. These
operations generate revenue through sales, which is reported in a multi-step
income statement. Therefore, income from continuing business operations refers
to company earnings after expenses have been deducted. If this value is positive,
then the business is making profits. However, if the value is negative, then the
business is making losses.
To calculate the income from continuing operations, you subtract the cost of
goods sold and other operating expenses. Let us consider an example;
If a company reports $360,000 of sales, $160,000 cost of sold goods, and
$30,000 of operating expenses, then the income from operations will be
($360,000 – ($160,000+$30,000)), which equals $170,000.
That said, when calculating the income from operations, you must exclude
earned/paid interest and taxes. You must not include any gains or losses derived
from irregular business activities like sales or purchase of business assets.
Income or loss from operations must not be confused with net income. This is
mainly because net income includes the income from continuing operations,
income from discontinued operations, and unusual or irregular income.
However, the income from continuing operations accounts for the revenue
generated from regular business activities only. Recognizing this difference
offers insight into the company’s profitability.
Net income (loss) from continuing operations
Net income from continuing operations is a line item on the income statement
detailing the after-tax earnings a business generates from its operational
activities. Considering that discontinued operations and other one-time events
are excluded, the net income from continuing operations is considered a key
indicator of a company’s financial health.
Net Loss
When expenses exceed income or total revenue generated over a given duration,
you get a net loss. Net loss is often referred to as a net operating loss (NOL).
Realize that companies that incur a net loss are not necessarily declared bankrupt
because they may choose to use their retained earnings or take a loan to stay
afloat. However, this strategy is only short-term because a company that is not
profitable will not survive in the long-term.
Think of the net loss as a company’s bottom line. To calculate net loss, use the
following formula;
Net profit or net loss = Revenues generated – Expenses incurred
Considering revenues and expenses are matched over a given duration, a net loss
is considered an example of the matching principle – an integral component of
the accrual accounting technique. Any expenses related to the income earned
over a given duration are included/matched to that duration irrespective of when
they are paid. When the profits decline below the level of expenses and cost of
goods sold, it results in a net loss. However, if the profits go above the level of
expenses and cost of goods sold, it results in a net profit.
In short, low revenues contribute to net losses. Some of the revenues that
contribute to low revenues include; unsuccessful marketing strategies, stiff
competition, inefficient marketing staff, not keeping up with the market
demands, or even weak pricing strategies. When the revenue is low, it translates
to low profits, and when the profits fall below the expenses and COGS over a
given duration, it results in net losses.
Let us consider an example; if company A makes $250,000 in sales, and has
$190,000 in COGS, and $130,000 in expenses, then it makes a gross profit of
($250,000-$190,000)=$60,000. However, the expenses exceed the gross profit;
hence the company makes a net loss of $70,000.
Net income attributable to
Net income attributable to shareholders refers to one step down from the net
income reflected in the income statement. Remember, the net income of a
company refers to all the revenues a company generates less expenses, which
includes taxes and interest expenses. Therefore, the net income attributable to
shareholders is the net income less non-controlling interests – also called
minority interests.
Earnings (loss) per share attributable to and diluted EPS
This is a company’s net profit divided by the number of common outstanding
shares. The resulting figure tells us whether the company is making profits or
losses. The higher the EPS, the more profitable a company is, and vice versa. In
other words, EPS tells us how much money a company is making per share of its
stock; hence widely used as a metric for estimating the value of a company.
When the EPS value is high, investors are likely to pay more for a company’s
shares, especially if they think that the company has higher profits relative to the
share price. To calculate the EPS, use the following formula;
Earnings per share = (Net income – Preferred dividends) / End-of-period
common shares outstanding
EPS is one of the most important indicators when picking stocks. If you are
interested in stock trading or investing, the next thing is to choose a broker that
matches your investment style. Realize that comparing EPS in absolute terms
may not be meaningful because an ordinary shareholder doesn’t have direct
access to the earnings. The trick is to compare EPS with the stock share price
when determining the value of earnings and how you feel about the company’s
future growth.
Conversely, diluted earnings per share serves as a key metric in conducting
fundamental analysis to measure the quality of a company’s EPS – assuming that
all convertible securities – outstanding convertible shares, equity options,
convertible debts, and warrants – have been exercised.
To calculate the diluted EPS, use the following formula;
Diluted EPS = (Net income – preferred dividends) / (WASO+CDS)
Where:
WASO is the weighted average shares outstanding
CDS is the conversion of the dilutive securities
You must note that dilutive securities are not common stock but securities that
can be converted to common stock. When you convert these securities, the EPS
declines; hence, the diluted EPS tends to always be lower than EPS. In other
words, diluted EPS serves as a conservative metric indicating a worst-case
scenario in relation to EPS. This is because a diluted EPS considers what would
happen in case dilutive securities were exercised. For instance, if they increased
the weighted number of shares outstanding, there would be a decline in the EPS.
Let us consider an example;
A company ABC had $100 million in net income over the past year. However,
the company did not pay any dividends. Assuming a company has $30 million
common shares. The company also has employee stock options, which could be
converted to $2 million common shares and convertible preferred shares that
could be converted to $6 million common shares. The resulting diluted EPS
would be;
[($100 million - $0) / ($30 million + $2 million + $6 million)] = $2.63/share.
On the other hand, the basic EPS would be;
[($100 million -$0) / $30 million)] = $3.33
This means, if the company has convertible securities, the diluted EPS is less
than its basic EPS.
 BALANCE SHEET
Assets
his is a resource that possesses an economic value, which an individual,

T country, or company controls or owns, anticipating that it will offer

benefits in the future. Assets are reported on a balance sheet and are
created or bought to increase the value of a company and benefit its operations.
Think of an asset as something that in the future promises to generate cash flow,
lower expenses, and boost sales.
For a company to possess assets, it must have the rights to it as of the date of its
financial statements. Realize that an economic resource is something scarce and
can produce economic benefits by lowering cash outflows and increasing cash
inflows.
Assets are classified into various categories;
Current assets
Financial investments
Fixed assets
Intangible assets
Currents assets are also termed short-term assets. They are economic resources
anticipated for conversion into cash within a year. They include cash and cash
equivalents, inventory, accounts receivable, and other prepaid expenses.
Fixed assets refer to long-term resources like buildings, equipment, and plants.
For a fixed asset, an adjustment for aging is made based on periodic charges
called depreciation. According to generally accepted accounting principles
(GAAP), depreciation happens in two ways; the straight-line method, which
assumes that the rate at which a fixed asset loses its value is directly proportional
to its useful life; and the accelerated method, which assumes that a fixed asset
loses its value faster during its initial years of use.
Financial assets are investments in assets and securities of other companies.
They include sovereign and corporate bonds, stocks, preferred equity, and other
hybrid securities. They are valued based on how an investment is classified and
the motive behind it.
Finally, intangible assets are resources that don’t have a physical presence – like
trademarks, patents, goodwill, and copyrights. Accounting for these assets varies
depending on the type of asset, and they can be amortized or tested for annual
impairment.
Current assets
These are all assets a company expected to be conveniently consumed, sold,
used, or exhausted through standard business operations within a year. They
appear on a company’s balance sheet. They include cash and cash equivalents,
inventory, accounts receivable, current accounts, and other prepaid expenses.
The importance of current assets to companies is that they are used to fund daily
business operations and payment of outgoing operating expenses. Considering
this is reported as a dollar value of all assets and resources easily convertible to
cash in a short duration, it also represents a company’s liquid assets.
That said, you must exercise caution to include only qualifying assets capable of
liquidation at a fair price over the next one year. For example, there is a high
chance that fast-moving consumer goods produced by a company can be sold
easily over the next one year. While inventory is included in the current assets, it
may be challenging to sell heavy machinery or land, hence why they are
excluded from the current assets.
Depending on the nature of the business and its products, current assets can be
anything from barrels of crude oil, work in progress inventory, fabricated goods,
foreign currency, or raw materials.
Accounts receivable refer to the money due to a company for delivery of goods
and services; or used but not yet paid for by clients as long as they are expected
to be paid within a year. Therefore, if a company offers long-term credits to its
clients, a fraction of its accounts receivable may not be included in the current
assets. There is also a possibility that some accounts may never be settled in full.
Inventory refers to the finished products, raw materials, and various other
components. That said, its consideration may require more careful thought.
Different accounting methods can inflate the inventory and may not be as liquid
as other current assets based on the industry sector or product in question.
Prepaid expenses refer to advance payments a company makes for goods and
services expected to be received in the future. While these expenses may not be
converted to cash, they are considered payments already made to free up the
capital for other uses. They include contractors and insurance payments. On the
balance sheet, current assets are displayed in order of liquidity, with those that
are highly likely to be converted into cash ranked higher.
To calculate current assets, use the formula;
Current assets = C + CE + I + AR + MS + PE + OLA
Where;
C = Cash
CE = Cash Equivalents
I = Inventory
AR = Accounts Receivable
MS = Marketable Securities
PE = Prepaid Expenses
OLA = Other Liquid Assets
Let us consider an example; A leading retail company’s total current assets for
the fiscal year ending March 2020 is a sum of $8 billion cash, $6.2 billion
accounts receivable, $47.25 billion inventory, and $4.23 billion other current
assets. The total current assets is ($8 billion+$6.2 billion+$47.25 billion+$4.23
billion), which equals $65.68 billion.
Cash and cash equivalents
This is a line item on the balance sheet that reports the value of a company’s
assets by looking at its cash or those convertible into cash immediately. Cash
equivalents include treasury bills, commercial paper, and short-term government
bonds, and other marketable securities with maturities of less than 90 days and
bank accounts. Often, cash equivalents don’t include stock holdings or equity
because they tend to fluctuate in value.
The good thing about cash and cash equivalents is that they help companies with
their needs for working capital, considering they can be used to pay off current
liabilities like short-term debts and bills.
Cash is the money that is in the form of currency. They include coins, bills, and
currency notes. There are companies that hold more than one currency, hence
likely to experience currency exchange risk. Any foreign currency must be
translated to the reporting currency for financial reporting reasons. The results
obtained from these conversions must be comparable to those that would have
been obtained if the business had completed operations using one currency only.
That said, translation losses from the devaluation of a foreign currency is not
reported with the cash and cash equivalents but instead are reported in
accumulated other comprehensive income category.
Cash equivalents refer to investments readily convertible to cash. These
investments are often short-term, with a maximum investment period of 90 days
or less. If the investment matures in more than 90 days, it is classified under
other investments. Cash equivalents are highly liquid and easily sold in the
market, making their buyers easily accessible.
That said, all cash equivalents must have known market price and must not be
subject to price fluctuations. Their value must not be expected to change
significantly before maturity or redemption. Depending on their maturity date,
certificates of deposit may be considered. Cash and cash equivalents don’t
include credit collateral or inventory like most people like to think.
Receivables
They are also referred to as accounts receivable. They are debts owed to a
company by its clients for delivered or used but not yet paid goods and services.
Receivables are created by extending a customer’s line of credit and reported as
current assets on the balance sheet. Considering they can be used as collateral in
securing a loan for one to meet their short-term obligations, they can be
considered as liquid assets.
Additionally, receivables are considered as part of a company’s working capital.
Effectively managing receivables involves follow ups with clients who have not
paid and then discussing potential payment plan arrangements where necessary.
This is critical in providing extra capital to support operations and lower net
debts.
For a company to improve their cash flows, they must reduce their credit terms
for their receivable accounts. This way, their cash conversion cycle is reduced.
The company may also sell receivables at a discount to a factoring company,
which takes over responsibility for collecting money owed and takes on the risk
by default – an arrangement termed as accounts receivable financing.
To measure how effective a company is at extending credit and collecting debt
on that credit, analysts focus on a number of ratios;
Receivable turnover ratio, which is the net value of credit sales over a
given duration divided by the average accounts receivable – sum of the
value of accounts receivable at the beginning of the desired period to the
value at the end of the period; divide by two – during that same duration.
Days sales outstanding (DSO), which is the average number of days it
takes for payments to be collected after a sale has been made.
Inventories
This is a term used to describe the available goods for sale and the raw materials
used in the production of those goods. An inventory represents the most
important asset because its turnover is the primary source of revenue generation
and the subsequent earnings for the company’s shareholders. It serves as a buffer
between manufacturing and fulfillment of orders.
The mistake most businesses make is holding an inventory for long durations.
This is mainly because of storage costs and the threat of obsolescence. That said,
inventory can be valued in three ways;
The first-in, first-out methods (FIFO), which suggests that the cost of sold
goods is based on the cost of the materials purchased earlier; while the
cost of remaining inventory is based on the materials purchased last.
The last-in, first-out method (LIFO) suggests that the cost of sold goods is
valued by looking at the cost of the materials purchased last, while the
value of the remaining inventory is based on materials purchased earliest.
The weighted average method, which requires that valuing of both the
inventory and the cost of goods sold should be based on the average cost
of all materials purchased during that period.
Inventories are classified into three;
Raw materials – the unprocessed materials used in production process like
steel and aluminum in car manufacturing, crude oil for oil refineries, or
flour for bakeries.
Work-in progress – the partially processed goods waiting for completion
or resale. It is also termed as inventory on the production floor. They
include half-assembled cars or airliners, etc.
 Finished goods – the complete products ready for sale. Typically, this is a
merchandise – for instance, clothes, electronics, or cars.
Other current assets
This is a class of valuable things a company owns, benefits from, or uses to
generate revenue that is convertible to cash within a business cycle. The reason
they are referred to as “other” is because they are insignificant or uncommon,
unlike typical current assets. In a balance sheet, OCA accounts are listed as
components of a company’s total assets.
At times, a one-off situation in a company’s 10-K filings results in the
recognition of other current assets. Because of these assets, the net balance in the
OCA account is typically small. Some of the OCAs include restricted cash or
investments, advances paid to employees or suppliers, cash surrender value of
life insurance policies, or a piece of property being prepared for sale.
Let us consider an example – for a company’s quarter ending May, 31, 2020, the
recorded total assets on its balance sheet was $276.82 billion. Of this total, 62%
were attributed to current assets. Other current assets made up a small fraction of
$135.23 billion of the current assets. These assets were listed at $7.80 billion,
which accounts for about 4% of the company’s liquid assets.
Intangible assets
This is an asset that is not physical – like intellectual property, goodwill, or
recognition. These assets exist in opposition to tangible assets like vehicles,
inventory, or equipment.
Intangible assets can either be definite or indefinite. For instance, a company’s
brand name is considered an indefinite intangible asset considering it stays with
the company as long as it’s in operation. On the other hand, an example of
definite intangible asset is a legal agreement to operate under another company’s
patent without necessarily extending the agreement. In this case, the agreement
has a limited life, hence a definite asset.
While intangible assets don’t have the obvious physical value, it proves valuable
and critical to its long-term success or failure. For instance, Coca-Cola company
wouldn’t be nearly as successful if not for the money generated through brand
recognition. While brand recognition is not a physical asset – seen or touched –
it has a meaningful impact in sale generation.
The good news is that companies can create or acquire intangible assets and
write off its expenses in the process – like hiring a lawyer or filing a patent
application. Additionally, all the expenses incurred along the way in creating the
intangible asset are expensed. That said, these expenses don’t appear on the
balance sheet and there are no records of their book value. Because of this, when
a company is sold, the purchase price is likely to be above the book value of the
assets reflected in the balance sheet.
Total assets
These are the total amount of assets owned by a person or an entity. They are of
economic value and are expended over time to benefit the owner. If they are
owned by a business, they are recorded in the accounting records and will be in
that business’ balance sheet. Typically, you will find them in various categories
like cash, inventory, prepaid expenses, marketable securities, good will,
intangible assets, among other assets.
Based on the accounting standards applicable, assets that comprise total assets
may or may not be recorded at their current market values. Generally, the
international financial reporting standards are amenable to stating the assets at
their current market values, while GAAP is less likely to accommodate these
restatements.
Most owners look at their assets with respect to being converted to cash fast. An
asset is more liquid if it can be sold readily to cash. A potential buyer will focus
on various types of assets listed on a company’s balance sheet with an emphasis
on whether the asset’s value on the balance sheet corresponds to the actual value
of the asset. If they find that the actual value is lower, they are likely to lower the
size of their bid. However, if the asset’s value is higher, they will be more
interested in acquiring the business and are likely to increase their offer price.
Liability
This is something – usually money – that an individual or company owes.
Liabilities are often settled over a duration through the transfer of money, goods,
or services. On a company’s right side of a balance sheet, you will find liabilities
listed – like mortgages, loans, warranties, deferred revenues, accounts payable,
or bonds.
Typically, a liability acts as an obligation between one party and another not yet
paid for. Liabilities are classified into two;
Current liabilities
 Non-current liabilities
Liabilities are considered critical for a company because they are used to pay for
large expansions or running financial operations. They also make transactions
between the company and other businesses more efficient. For instance, if a
winery sells wine to a restaurant, it doesn’t demand payment upon delivery of
wine. However, the restaurant invoices the winery for the purchases to make
drop-off efficient and paying easier. Here, the outstanding payment the restaurant
owes the winery is considered a liability. On the other hand, the winery considers
this amount owed an asset.
Current liabilities
These are a company’s short-term financial obligations due within a year or
within a normal cycle of operations – also known as the cash conversion cycle,
which is the time it takes a company to purchase inventory and then convert
sales into cash. A good example of a current liability is money that is owed in
the form of accounts payable.
Typically, current liabilities are settled using current assets like accounts
receivable or cash. The ratio of current assets to current liabilities is critical in
determining a company’s continuing ability to pay off debts as they are due.
One of the largest current liability accounts is accounts payable, which
represents unpaid supplier invoices. Most companies try matching payment dates
for accounts payable so that their accounts receivable is collected before they are
due.
For instance, a company might have a 90-day term for money owed to their
suppliers. This means they require their clients to pay debts within the 90-day
term. Similarly, current liabilities must be settled by creating a new current
liability like a new short-term debt obligation.
Current liability accounts tend to vary from one company to another across
industry sectors and based on the government’s regulations. Most analysts and
creditors use the current ratio to measure a company’s ability to pay their short-
term financial debts or obligations. This tells how well a company manages its
balance sheet, especially when it comes to settling short-term debts and
payables. Additionally, this ratio helps investors and analysts know whether a
company has adequate current assets on its balance sheet to pay off or satisfy
their current debt, among other payables.
Once a company determines it received an economic benefit that needs to be
paid within a year, it must record credit entry immediately. Based on a
company’s received benefits, an accountant must categorize it as an expense or
asset to receive a debit entry.
Let us consider an example; a large electronics manufacturer receives a shipment
of audio speakers from its vendors with whom it must pay $20 million within 60
days. Considering these materials are not placed into production immediately,
the company’s accounting office records a credit entry to accounts payable and
debit entry to inventory, an asset account for $20 million. Once the company
settles the balance due to suppliers, it debits accounts payable and credit cash for
$20 million.
Accounts payable
This is an account in the general ledger representing a company’s obligation to
pay off a short-term debt to its suppliers. It also refers to a company’s division or
department responsible for making payments owed to its suppliers and other
creditors. In the balance sheet, the total accounts payable appears under current
liabilities, mainly because they are debts that must be settled within a specified
duration without fail.
At the corporate level, accounts payable are short-term debt payments due to
suppliers. In other words, it is an IOU from one company to another. In that case,
the other entity would record the transaction as an increase to the accounts
receivable in the same figures.
The accounts payable are important figures in a company’s balance sheet. If it
increases over a prior duration, it means the company is purchasing more goods
or services on credit instead of making cash payments. On the contrary, if the
accounts payable decreases, it means the company is paying on its prior period
debts faster than it is purchasing new items on credit.
In other words, accounts payable is a company’s way of knowing how they are
managing its cash flow. If using indirect method in preparing cash flow
statements, a net increase or decrease in accounts payable from the previous
period must appear in the top section as the cash flow from operating activities.
In that case, a company’s management can use accounts payable to manipulate
its cash flow to a certain degree.
For instance, if the company wants an increase in their cash reserves for a given
duration, they may opt to extend the time the business takes to pay all
outstanding accounts in accounts payable. However, this payment flexibility
must be weighed against the relationship between the company and its vendors.
Good business practice requires payment of bills by their due dates.
Other long-term liabilities
This is a line item that lumps together obligations not due within a year on a
balance sheet. The difference between this and other liabilities is that they are
less urgent to repay but are classified as “other” because a company doesn’t see
them as important enough to warrant individual identification.
While they are liabilities – meaning debts a company owes, long-term liabilities
are not urgent for at least 12 months or a time a company defines as its operating
cycle. There are companies that choose to disclose the composition in their
footnotes to financial statements if they think it can be used as material.
Examples of other long-term liabilities include; pension liabilities, capital leases,
deferred credits, customer deposits, and deferred tax liabilities. If it is a holding
company, it will have intercompany borrowings, which are loans made from one
company division to another.
Equity
Typically, this is also referred to as shareholders’ equity. It is the money that
would be returned to a company’s shareholders if all assets were liquidated and
all the company’s debt was paid off in liquidation. In acquisition, it is the value
of a company’s sale less liabilities owed by the company but not transferred with
the sale. Additionally, it can represent a company’s book value. Sometimes,
equity is offered as a payment-in-kind.
To calculate equity, simply use the following formula;
Shareholders’ Equity=Total Assets−Total Liabilities
This information is present on the balance sheet, where these steps must be
followed;
First, locate a company’s total assets for the first period
Secondly, locate the total liabilities listed separately on the balance sheet
Thirdly, find the difference between total assets and total liabilities to
obtain the shareholders’ equity
Finally, note that the total assets equal the sum of liabilities and total
equity
Shareholders’ equity can also be expressed as retained earnings and share capital
less treasury shares’ value. However, this method is not commonly used.
Although both methods give the same figure, the use of total liabilities and total
assets is more illustrative of a company’s financial health.
Retained earnings
This is a key concept in accounting that refers to historical profits earned by a
company less dividends it paid in the past. The term “retained” suggests that
because these earnings were not paid out to shareholders as dividends, they were
retained by the company instead. Because of this, retained earnings decline when
it loses money or pays dividends and rises when net profits are generated. Profits
give the company room to use the surplus money earned – by paying
shareholders or reinvesting it back into the business for growth and expansion.
RE = BP+ Net Income (or Loss)−C−S
where:
BP=Beginning Period RE
C=Cash dividends
S=Stock dividends
When retained earnings is expressed as a percentage of total earnings, it is
termed retention ratio, which equals (1 – dividend payout ratio). Although the
last option of debt repayment leads to money leaving the business, it still has a
great impact on the company’s business account – like saving for the future
interest payments
Total equity
This is the difference between assets and liabilities. Total equity is often found
on a company’s balance sheet. Some of the asset line items include cash,
marketable securities, accounts receivable, prepaid expenses, inventory, fixed
assets, goodwill, and other assets. On the other hand, the liability items to be
aggregated include; accounts payable, accrued liabilities, short-term debts,
unearned revenue, long-term debt, and other liabilities.
To calculate the total equity, use the following formula;
Total equity = Assets – Liabilities
Therefore, every asset and liability item listed on the balance sheet must be
included in calculating total equity. That said, there is an alternative approach for
calculating equity by summing all the line items in the shareholders’ equity
section of the balance sheet – like retained earnings, common stock, additional
paid-in capital, less treasury stock.
Essentially, total equity refers to the amount investors invest in a company in
exchange for stocks, including all subsequent business earnings but less all
subsequent dividends paid out. Most smaller businesses are strapped for cash
and have never paid dividends, which means total equity is the sum of invested
funds and all subsequent earnings.
Let us consider an example;
The balance sheet of company XYZ contains a total asset value of $1 million
and total liabilities of $600,000. Total equity is ($1 million - $600,000), which
equals $400,000.
The derived amount can be used by lenders to determine whether there is enough
amount of funds invested in the company to offset its debt. For investors, this
amount is used to determine whether there is adequate equity piled up to press
for dividends. Finally, a supplier would use this amount to warrant being given
credit.
 CASH FLOW
ash flow refers to the net amount of cash and cash equivalents that is

C moved in and out of a business. The cash received by the company is

termed inflow, while that spent is termed outflow. A company’s cash
flow is reflected on its cash flow statement, which measures the amount of cash
generated or spent by the company over a given duration.
The cash flow statement has three major sections:
Cash flow from operations (CFO) shows the amount of cash a company
brings from its regular operations or business activities. This includes
amortization, accounts receivable, depreciation, accounts payable, and
other items.
Cash flow from investing (CFI) shows a company’s sales and purchases of
capital assets. It is the aggregate change in the business’ cash position
because of losses or profits derived from investments in such things as
equipment or plant.
Cash flow from financing activities (CFF) measures the flow of cash from
one company to another or to its investors, owners, or creditors. It also
shows the net flow of money used in running the business, including
dividends, equity, and debt.
Cash provided by operations
This refers to the amount of money a company brings in from ongoing business
operations like manufacturing or selling goods and services. It does not include
capital expenditure, expense, or investment revenue. The finance officers focus
mainly on the core business, which is referred to as net cash from operating
activities or operating cash flow (OCF).
Cash flow accounts for the total amount of money transferred into and out of the
business. Considering this affects a company’s liquidity, it allows the owners and
operators to check where the money is going and where it is coming from. It also
helps them come up with the necessary strategies to help them generate and
maintain steady cash flow for efficient business operations and in making
financing decisions.
A company’s cash flow details is found in the cash flow statements, which is part
of a company’s annual and quarterly reports. If the cash flow from operating
activities is positive, it means that the core business activities are thriving. It also
offers an additional potential for profitability.
Investors take an interest in the cash flow from operating activities to determine
where a company is getting its money from. There are two ways the cash flow
from operating activities is displayed on a cash flow statement;
Indirect method – where the company starts with the net income on accrual
accounting basis and then works backwards to obtain the cash basis figure for
that duration. Here, revenue is recognized when earned and not necessarily when
cash is received.
Let us consider an example;
If a customer purchases widget on credit at $1000, the sale has been made but no
cash has been received. Here, the revenue is still recognized in that sale month
and it will be shown in the company’s net income statement as part of its net
income. In that case, the net income is overstated by $1000 on a cash basis. Once
this amount is offset, it appears on the balance sheet as part of accounts
receivable.
Direct method – where a company records all transactions on a cash basis and
the information is shown on the cash flow statement using actual cash inflows
and outflows during the accounting period. The direct method examples of cash
flows from operating activities include salaries paid out to employees, cash paid
to vendors and suppliers, cash collected from customers, interest income and
dividends received, and income tax paid and interest paid.
Of the two methods, most accountants prefer the indirect method for its
simplicity in preparing the cash flow statements by deriving information from
the company’s balance sheet and income statements. However, the financial
accounting standard board (FASB) prefers the direct method because it gives a
clearer picture of the cash flowing in and out of the business.
To calculate cash flow from operating activities, use this formula;
Cash Flow from Operating Activities = Funds from Operations + Changes
in Working Capital
Where funds from operations is the sum of net income, depletion, depreciation &
amortization, investment tax credit & deferred taxes, and other funds.
Let us consider an example;
The cash flow details from a leading technology company for the fiscal year that
ended November, 2020 had a net worth of $60.34 billion. Depreciation,
Depletion, & Amortization was $13.3 billion, Deferred Taxes & Investment Tax
Credit of -$23.43 billion, and Other Funds of $6.7 billion. Using the indirect
formula, the summation of this gives $56.91 billion. The net change in working
capital for that period was $23.76 billion. If you add it to the funds from
operations, you get the cash flow from operating activities to be $80.67.
Cash used in investing activities
This is one of the sections on a cash flow statement that reports how much cash
has been created or spent from various investment-related activities – purchases
of physical assets, investing in securities, or the sale of securities or assets – for a
given duration.
If the cash flow figure is negative, it means the company is performing poorly.
However, a negative cash flow from investing activities indicates that a large
amount of cash is invested in long-term health of a company – like research and
development.
Examples of operating activities include any spending or sources of cash that's
involved in a company's daily activities. Cash flows from investing activities
accounts for the cash used in the purchase of non-current assets or long-term
assets that is expected to deliver value in the future.
Just like any financial statement analysis, the trick is to analyze the cash flow
statement in tandem with the balance sheet and income statements to give a full
picture of a company’s financial wellbeing.
Borrowing base
This refers to the amount of money a lender is willing to loan a company. It is
often based on the value of the collateral the company pledges. To obtain the
borrowing base, "margining" is done by determining a discount factor, which is
then multiplied by the value of the collateral in question. The figure obtained
represents the amount of money a lender will loan out to the company.
Some of the assets that can be used as collateral include accounts receivable,
inventory, and equipment. If a company borrows money from a lender, the
lender assesses the company's strengths and weaknesses. Depending on the
perceived risk, the lender associates it with loaning money to this company. In
that case, a discount factor is then determined—say 80%. Considering the
discount factor, if the borrower offers $250,000 worth of collateral, the
maximum amount of cash the lender will give the company is 80% of $250,000,
which equals $200,000.
You must note that a lender is more comfortable giving a loan that is rooted in
borrowing bases because they are made against specific sets of assets. Moreover,
the borrowing base is adjustable downward to offer protection to the lender. For
instance, a decline in the value of the collateral means a decline in the credit
limit. Alternatively, should the collateral value rise, the borrowing base also
increases to a predetermined limit.
Dividends
This is the distribution of a company’s earnings to its shareholders’ class as
determined by its board of directors. Typically, the common shareholders are
eligible as long as they own the stock before the ex-dividend date. Dividends
may be paid out as cash or in the form of additional stock.
The shareholders must approve dividends through their voting rights. While cash
dividends are the most common, dividends can be issued as shares of stock or
other property. It is considered a token reward paid to its shareholders for
investing in a company’s equity, and it typically comes from the company's net
profits.
Considering a good fraction of the profits is kept by the company as retained
earnings, the remainder amount can be given to shareholders in the form of
dividends. In other cases, a company may still give dividends even though they
are not making suitable profits for the sake of maintaining their established track
record of making regular dividend payments.
Dividend payments tend to follow a chronological order of events, and the dates
are used to tell which shareholder qualifies to receive dividend payments. For
instance;
The announcement dates is when dividends are announced by company
management and must be approved by the shareholders before they can be
paid.
Ex-dividend date is when the dividend eligibility expires. Here, the
 shareholders who buy the stock on or after this date don’t qualify to
receive dividends.
The record date determines which shareholders are eligible for a
dividend.
The Payment date is when money is credited to investors' accounts.
That said, companies pay dividends for many reasons, which have different
implications and interpretations for investors. It can be viewed as a reward to
investors for their trust in a company. In that case, a company honors this
sentiment by delivering a robust track record of dividend payments.
Most shareholders prefer dividend payments because they are treated as tax-free
income in many countries. Conversely, capital gains realized through the sale of
a share whose price has increased is taxable income.
If the dividends is of high value, it means the company is doing well and has
generated good profits. However, it can mean that the company does not have
suitable projects to generate better income in the future, which explains why
they use their cash to pay shareholders instead of reinvesting it into its growth
and expansion.
If the dividend amount decline, it does not necessarily mean bad news about a
company. It may mean the company has better plans for investing the money,
given its financials and operations.
Reduction of borrowings
This is also termed debt reduction or debt relief. It refers to a process of reducing
the debt balance by a company using a systematic approach of repayment or a
financial maneuver that boosts your debtor position. The best strategies used to
reduce borrowings are refinancing and reorganization of debt, making payoff
more efficient.
Refinancing – is a maneuver used by businesses to improve their financial
position. It involves utilizing funds for a new loan to settle the existing
loans. It is commonly used with mortgages to help investors get out of a
higher rate loan and into a lower-rate loan. Certain refinancing options
offer cash-out components that allow the investor to get equity of their
property or asset to use in paying off the high-interest borrowing.
Reorganizing – refers to a formal process a business uses to avoid
dissolution or being declared bankrupt. While this method has drawbacks,
 it gives companies the opportunity to manage part of their overwhelming
debt load that is standing in the way of their business stability and growth.
Reduction of borrowings offers a wide range of psychological and financial
benefits. First, a debt reduction makes it more feasible for a company to keep up
with their monthly debt payments by avoiding delays, which risks additional
fines. A lower debt balance reduces the amount of interest to be paid both in the
short- and long-term. In turn, this adds up to a significant amount of savings.
The healthiest way to reduce borrowings is by paying it fast and efficiently. The
sooner a company is able to pay its debt, the less risk they run if the situation
gets out of control. Reduction of borrowings calls for discipline and strategic
approaches that go above and beyond meeting the minimum monthly payment
requirements.
Repurchases of common stock
Also known as share buyback.
This refers to a transaction where a company buys back its shares from the
marketplace, perhaps because the management thinks they are undervalued.
Alternatively, the company may choose to offer its shareholders the option of
tendering its shares directly to the company at a fixed price. This way, it lowers
the number of outstanding shares and increases the demand for the shares and
the price.
Considering a share repurchase reduces the number of shares outstanding, the
earnings per share (EPS) increases. If the EPS is high, the market value of the
remaining shares also goes up. Once they have been repurchased, they are
canceled or held as treasury shares. This lowers a company’s available cash,
which is shown on the balance sheet as a significant reduction in the amount
spent on buybacks. Simultaneously, the share repurchases lowers shareholders’
equity by an equal amount on the liabilities side of the balance sheet. Any
investor who is interested in finding out how much a company has spent on
share repurchases can examine the company’s quarterly earnings reports.
The most important thing to note is that if a business pays out the same amount
of money to shareholders in dividends every year, and the total shares reduce, it
means every shareholder will receive a larger number of dividends annually. If
the business grows its earnings and total dividend payouts, reducing the number
of shares will increase the growth of dividends. A shareholder expects that a
company will maintain regular dividend payouts.
The advantage of buybacks is that they raise the share price, make a company’s
financial statements appear stronger, and hide a slight decline in the net income.
If the share repurchases lowers the shares outstanding to a greater degree than a
decline in net income, there is a high chance the EPS will rise regardless of a
company’s financial situation.
That said, buybacks are also thought to be ill-timed in most cases. In other
words, a company buys back shares when it has lots of cash or when its financial
health is good in the stock market. At such a time, the stock price is highly likely
to be high, and the prices are likely to drop after a buyback, implying that the
company is not that healthy after all.
Additionally, a share repurchase tends to give investors the impression that a
company lacks other profitable opportunities for growth, which is a great issue
for someone looking to generate revenue and increase profits. A company is not
obligated to repurchase shares because of economic or marketplace changes
because this puts it in a precarious situation if the economy were to downtown.
Cash provided by (used in) financing activities
This is also called cash flow from financing activities (CFF). This shows the net
flow of cash used to run a company. Examples of financing activities include
dividends, equity, and debt. The CFF is critical in offering investors a deeper
insight into the company’s financial strength and how well its capital structure is
managed.
To calculate the cash flow from financing activities, use the following formula;
CFF = CED – (CD + RP)
Where;
CED is the cash in-flow from debt or issuing equity
CD is the cash paid as dividends
RP is the repurchase of equity and debt
Let us consider an example;
Company ABC has the following information in the financial activities section
of its cash flow statement:
Payments of dividends: $800,000 (cash outflow)
Proceeds from long-term debt: $6,000,000 (cash inflow)
 Repurchase stock: $2,000,000 (cash outflow)
Payments to long-term debt: $1,000,000 (cash outflow)
The CFF = $6 million – ($2 million + $ 1 million + $800,000) = $2.2 million.
The most important point to note is that CFF will show you the means by which
a company raises cash to maintain or grow its business activities. A company’s
source of capital can be equity or debt. A company takes on debt by issuing
bonds or taking loans from the bank. The key is to make interest payments to its
creditors and bondholders to compensate them for loaning their money.
If a company decides to take the equity route, it simply issues stock to investors
who are interested in owning a share of the company. Other companies choose to
make dividend payments to its shareholders, hence representing a cost of equity
for the company. A positive cash flow from financing activities means that more
money is flowing into the company compared to what is spent, hence increasing
its assets. On the other hand, if the CFF is negative, it means the company is
servicing debt, retiring debt, paying dividends or making stock repurchase.
For an investor, if a company turns to new debt or equity for cash frequently, it is
a sign that it is not generating enough revenue. An increase in interest rate means
that the debt servicing cost also increases. The key here is that an investor digs
deeper into the numbers because a positive cash flow does not necessarily mean
a good thing but that a company is saddled in large debts.
Conversely, a company that is frequently repurchasing stock and issuing
dividends when its underperforming is a warning sign. It could mean that the
company’s management might be trying to prop up its stock price to keep
investors happy when their actions will negatively affect the company in the
long run.
Note that any significant changes in the cash flow from financing activities
should prompt any investor to look into the company’s transactions. When
analyzing a company’s cash flow statement, you must consider every section
contributing to the overall change in its cash position.
Cash equivalents
These are short-term investment securities with high credit quality and high
liquidity. They are also known as cash and equivalents that are one of the three
asset classes in financial investing. These securities are low-risk, low-return in
nature.
Cash equivalents are one of the most important indicators of a company’s
financial health. This tells investors whether it is good to invest in a company or
not by looking at its ability to generate cash and cash equivalents. The cash
equivalents tell investors whether a company can pay its bills for a short
duration.
There are five major types of cash equivalents:
Treasury bills – also called T-bills, are securities issued by the
government’s departments of treasury. When they are issued to companies,
the companies essentially lend their money to the government. Typically,
they are sold for a minimum of $100 to a maximum of $5 billion. They
don’t pay interest. Instead, they are offered at a discounted price. The T-
bills yield is the difference between purchase price and the redemption
value.
Commercial paper – are commonly used by big companies to obtain funds
that help them settle their short-term debt obligations. Typically, they are
issued to companies that promise to fulfil the face amount on the stated
maturity date.
Marketable securities – refer to financial assets and instruments that are
readily convertible to cash. They are highly liquid because their maturities
tend to happen within a year or less, and their trading rates have minimal
effect on prices.
Money market funds –are like checking accounts paying high interest
rates given by the money deposited. They offer an efficient and effective
tool for companies to manage their money because they are stable
compared to other types of funds. This fund’s share price is always
constant at $1/share.
Short-term government bonds – are funds given by the government
towards its projects. Typically, they are issued using the country’s
domestic currency. An investor must look at political risks, inflation, and
interest rate risks before investing in government bonds.
Restricted cash
This is money held for a specific purpose and is not available to the company’s
immediate or general use. In other words, it is the money not readily or freely
available for the company to invest or spend.
On a company’s balance sheet, it appears as a separate item from cash and cash
equivalent. The main reason why it is restricted is disclosed in a company’s
financial statement. Some of the reasons may include capital investment or debt
reduction.
Restricted cash can be classified into two;
Current asset, which is used up within a year
Non-current asset, which is long-term
Typically, restricted cash appears on a company’s balance sheet as “other
restricted cash” or “other assets.” While there are various reasons companies
restrict a fraction of their cash, the two most common uses of restricted cash
include:
Capital expenditure
Loan and debt payments
 CONCLUSION
hank you for taking the time to buy my book. I hope this book brought

T you the information you were looking for. I hope you share this with
those close to you so that we may spread the influence and knowledge to
everyone.
If you are looking to be an investor or executive, fundamental analysis will make
a large part of your everyday life. There is no way you will be an investor
without understanding the basic terminology. With the right basic terminology,
you can easily look at any data expected to impact the price or perceived value
of stocks and understand the information.
The key to fundamental analysis is understanding terminology. Without an
understanding of what each term means, it can be challenging to dig through
financial statements and draw any conclusions. To help you visualize the
importance of stock terminology, imagine yourself in a shopping mall. Stocks
are the items on sale in the retail outlets. Understanding stock terminology
means you can tell the difference between the different items on the shelf. The
last thing you want is to be dismissed as an unreliable, emotional shopper with
no inkling of the real value of the goods on sale.
An understanding of the stock terminology will help you move through the
stores seeking the best deals.
So, what are you still waiting for?
It’s time to master the language of stocks, invest wisely, and attain your success!

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