Walking through doesn’t necessarily involve saying which sheet is most important. For valuation, you want to know what current assets are worth, and what kinds of cash flows can be expected from owning them. The balance sheet is where you start to get an idea of the former, the income statement helps you see how the balance sheet changes between two time periods, and the cash flow statement gives probably the best picture of whether operations and cash flows can be considered “sustainable” over the long term. The statements also give you a picture of risk. The balance sheet gives you the leverage info which helps you see how changes in sales transfer into changes in equity values. The income statement separates out how much of income is from normal operations and how much is random wierd stuff (and long term you can see how often random wierd stuff tends to happen with this management). Comparing cash flows with earnings can give you a sense of whether there are accounting shenanigans going on. You could walk a dollar of sales through the income statement and show how it ends up as partly COGS, part SG&A, part interest, part taxes, part extraordinary stuff, part dividends, and part retained earnings on the balance sheet. Explaining how it goes int cash flow statements is a little trickier.
the income statement indicates a company’s ability to price goods in excess of the cost to produce them. operating cash flows indicates whether the company is lying. investing cash flows reveal management’s ambition, and financing cash flows show whether that has been effective. the balance sheet freezes all of this at one point in time, and is a scorecard of financial risk.
It doesn’t matter which sheet is most important–they are all interconnected–though most ratios derived for comps come from the B/S. Has there ever been a situation where you have to choose one of the three to come up with a company valuation/recommendation?
joekinde Wrote: ------------------------------------------------------- > the income statement indicates a company’s ability > to price goods in excess of the cost to produce > them. operating cash flows indicates whether the > company is lying. investing cash flows reveal > management’s ambition, and financing cash flows > show whether that has been effective. the > balance sheet freezes all of this at one point in > time, and is a scorecard of financial risk. i like this. boom, just committed it to memory.
daj224 Wrote: ------------------------------------------------------- > joekinde Wrote: > -------------------------------------------------- > ----- > > the income statement indicates a company’s > ability > > to price goods in excess of the cost to produce > > them. operating cash flows indicates whether > the > > company is lying. investing cash flows reveal > > management’s ambition, and financing cash flows > > show whether that has been effective. the > > balance sheet freezes all of this at one point > in > > time, and is a scorecard of financial risk. > > > > i like this. boom, just committed it to memory. spank bank?
juventurd Wrote: ------------------------------------------------------- > It doesn’t matter which sheet is most > important–they are all interconnected–though > most ratios derived for comps come from the B/S. > Has there ever been a situation where you have to > choose one of the three to come up with a company > valuation/recommendation? I have been asked this in an interview in the past. I think is used as an open ended question to find out more about the way the candidate thinks.
joekinde Wrote: ------------------------------------------------------- > the income statement indicates a company’s ability > to price goods in excess of the cost to produce > them. operating cash flows indicates whether the > company is lying. investing cash flows reveal > management’s ambition, and financing cash flows > show whether that has been effective. the > balance sheet freezes all of this at one point in > time, and is a scorecard of financial risk. I like
joekinde Wrote: ------------------------------------------------------- > the income statement indicates a company’s ability > to price goods in excess of the cost to produce > them. operating cash flows indicates whether the > company is lying. investing cash flows reveal > management’s ambition, and financing cash flows > show whether that has been effective. the > balance sheet freezes all of this at one point in > time, and is a scorecard of financial risk. I agree, very nicely put. You’re the first person that’s broken down the interpretation of the investing and financing portions of the cash flow statement, and you reminded me of the profitability info that you need to extract from the income statement.
If anyone ever asks me which statement is the most important, i’ll say all 3 statements are important, and they compliment each other. Analyzing only one statement is unwise - companies can tweak one statement, but it is harder to tweak all three. For example, companies can tweak their COGS in income statement, and you can detect this by checking against their inventory in the balance sheet. The reverse is also true. Tweaking SCF is also possible (level 2 CFA).