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How to Read a Financial Report: Wringing Vital Signs Out of the Numbers by John A. Tracy

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17
FINANCIAL STATEMENT RATIOS
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124 Financial statement ratios
The main purpose of fi nancial reporting is to provide up - to - date
nancial information about a business to its investors and lend-
ers, who are its sources of capital and have a right to and need
for the information. Others also may be interested in the fi nan-
cial affairs of a business for example, its employees and its other
creditors. When they read the fi nancial report, they should keep
in mind that fi nancial reports are directed to the owner - investors
of the business and its lenders. Financial reporting standards
have been developed with this primary audience in mind.
According to estimates, there are about 10,000 publicly owned
businesses in the United States. Their capital stock shares and
other securities are traded in public markets. The dissemination
of fi nancial information by these companies is governed by fed-
eral law, which is enforced mainly by the Securities and Exchange
Commission (SEC). The New York Stock Exchange, Nasdaq, and
other securities markets also enforce many rules and regulations
regarding the release and communication of fi nancial information
by companies whose securities are traded on their markets.
Securities of some 12,000 foreign businesses are traded in
stock markets around the world. Each country has its own gov-
ernment enforcement agencies. The European Union (EU)
regulates fi nancial reporting by its member states. Almost all
countries, including the United States, are moving rapidly
toward adopting a set of international fi nancial reporting and
accounting standards , which I discuss in Chapter 19 .
In the United States and other countries, a business cannot
legally release information to some stockholders or lenders but
not to others, nor can a business tip off some of them before
informing the others. The laws and accepted standards of fi nan-
cial reporting are designed to ensure that all stockholders and
lenders have equal access to a company s fi nancial information
and fi nancial reports.
A company s fi nancial report may not be the fi rst source of
information about its profi t performance. In the United States,
most public corporations issue press releases of their most recent
earnings results. These press releases precede mailing the hard
copy of the company s fi nancial report to its stockholders and
lenders. Most public companies put their fi nancial reports on
their web sites at the time of or soon after the press releases.
Private businesses do not usually send out letters to their owners
and lenders in advance of their fi nancial reports, although they
could, of course. Also, private companies generally do not put
their fi nancial reports on their publicly accessible web sites.
This chapter examines what stockholders and lenders do with
nancial statements once they have access to them. The chapter
centers on the annual nancial statements. (Quarterly fi nancial
reports are abbreviated versions of the annual reports.) In partic-
ular, this chapter focuses on certain ratios that are useful to inves-
tors and lenders.
Purpose of Financial Statements
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