How to understand company accounts

How to understand company accounts and figures

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A company’s accounts can tell you a lot about how healthy it is and what its prospects are in coming months. Here’s a guide on how to understand company accounts and figures.

How to understand company accounts and figures

Company accounts are a record of what the company has received by way of income, what it’s paid out and how much profit (or loss) it’s made during its financial year. There’s normally a report that goes alongside the accounts, and a statement about the outlook for the future.

Company accounts and figures explained

Balance sheet: This is a snapshot of a company’s assets and liabilities (e.g. debts) at a particular time. This could include shares owned by shareholders and property, stock, plant or machinery owned by the business.

Company report: This is the company’s own view of how it’s done so it may be rather more rose tinted than that of the investors. Companies can’t hide what’s happened, but they can move the bad news further down the report. So, if you’re going to read it, don’t just read the first paragraph!

SAVVY TIP: You can find information about a company’s accounts going back five years on the London Stock Exchange website. This can be useful to give you an idea of whether the profit trend is going in the right direction.

EBITDA: this stands for earnings before interest, tax, depreciation and amortisation. The key part is ‘interest’ as it means that the company isn’t including the money it’s paying to service its debts. Rodney Hobson, who’s a financial writer and who’s written a beginner’s guide to investing called Shares Made Simple’ says that any company that tries to push the EBITDA rather than another profit figure probably has a lot of debt. “I wouldn’t touch it with a barge pole,” he says, with conviction.

Gross profit margin: this is the sales revenue a company has received, minus the cost of making sales, divided by the revenue and expressed as a percentage.

Normalised profit: this removes any one-off expenses or other costs that could distort the overall picture. Rodney Hobson, says that this is a good figure to look at as it removes any ‘kinks’ in the company’s performance.

Operating profit: this gives you an indication of how the underlying business is performing. It shows you the sales figures, minus any costs associated with sales. Helal Miah from The Share Centre says that is a useful indicator of how the company is doing.

Pre-tax profit: As it sounds, this is the profit before tax is paid. It’s also sometimes called profit before tax.

Other company numbers and what they mean

Share price: If a company is listed on a stock exchange, its shares will be traded on a stock market. The share price is the value of one of its shares, as quoted on the stock exchange at any given time.

Dividend cover: the dividend is a share of the profits that a company pays to its shareholders. It is shows you how much more profit a company is making compared to the amount it’s paying out as a dividend. So if you have a dividend cover of 2 or more it means that the company is keeping back some of its profits and not paying it all out as a dividend.

Dividend yield: the dividend is normally expressed as a ‘pence’ figure. The dividend yield is the dividend amount, divided by the cost of a share expressed as a percentage. Michelle McGrade, chief investment officer at TD Direct Investing says that the average dividend yield from a company in the FTSE 100 is around 4%.

Earnings per share: this gives you an idea of a company’s profitability. You divide the net profit (profit after tax) by the number of shares that have been issued.

Market capitalisation: This figure is the share price multiplied by the number of shares issued. In itself it doesn’t really reveal much, but it will give you an idea of the value of a particular company. Companies are categorised according to their market capitalisation. Some companies are ‘large cap’ (the biggest), others are ‘mid cap’ or ‘small cap’.

Price-earnings ratio or p/e ratio: This is a measure of the company’s profitability compared to its share price. You divide the share price by the earnings per share. So, if a company has a share price of £50 and it made a profit of £2 per share, the price earnings ratio would be 25. Helal Miah from The Share Centre says it gives you an indication of how much an investor is willing to pay for each £ of profit (earnings).

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