How do I Analyze a Company's Financial Earnings?

The financial earnings of a company are provided in the annual financial statements and quarterly earnings reports. This information is published for all publicly traded companies that are listed on the stock market. Privately held companies release their statements only to financial institutions or potential investors, as needed.

To properly analyze the financial earnings, there are three methods: price to earnings ratio, balance sheet analysis, and cash flow analysis. Accountants, financial analysts, and investors who need to determine the financial strength of a company traditionally rely on these methods. To evaluate the earnings of a firm, the values have to be placed in the context of overall performance.

To calculate the price to earnings ratio, use the earnings report that is issued every quarter. These reports list the net sales and income, operation earnings and earnings per share. Use the share price of the stock at the date the report was issued and divide it by the earnings per share on the report. This is the price to earnings ratio.

A high ratio indicates high expectations of the stock performance. A low ratio indicates lower expectations. It is important to remember that these expectations can be unrealistic or based on unsubstantiated rumors or gossip.

A complete balance sheet analysis looks at total revenue and liabilities. A detailed review of this report gives context to the amount of debt the firm is holding, revenue streams, investments, and inventory levels. Remember that there are several easy methods to increase general ratios by providing an inflated valuation for inventory, understating liabilities, and other well-known practices.

Read the notes to the financial statements to get real insight into the company’s operations. Look at the amount of tax liability, any pending lawsuits, patent filing, or takeover bids. All these items have impact on the financial earnings. Cash flow analysis uses computations of accounts receivable collection, bad debt write off, cash, short-term instrument holdings, and account balances to determine the current cash position. Look at this report to identify how highly leveraged the firm is and their long-term risks.

If you are going to invest in a firm by purchasing stock in the company, you should take the time every quarter to review the financial earnings, compare them to the previous quarter projections, and adjust your investment accordingly. Stock prices tend to rise or fall the week before the earnings report and become more stable three weeks later. During this period of volatility, avoid trading your stocks. Wait until after this time period has passed and then reevaluate.