Introduction

This Guide provides basic information on how to read the financial statements in a company’s annual report.
The Guide discusses key numbers in each of three statements common to all annual reports and offers
suggestions from experienced investors on making sense of these numbers.

Like any new and complex subject, the language of financial statements may at first seem mysterious, even
intimidating. This Guide can help you begin to gain a basic financial vocabulary and to understand the
subject. Topics cover only the fundamentals of accounting and financial reporting, and the Guide and its
Glossary explain the terms and ideas you'll need to understand these topics.

So, even if you never take up a permanent residence in the realm of finance, you'll at least be comfortable
as an occasional visitor.

What’s an Annual Report?

PURPOSE

An annual report is exactly what it sounds like - a formal report on a company’s performance in the
preceding year. A public company produces an annual report for its stockholders, the people and institutions
that own the company.

Other interested parties, such as customers and potential investors, read this report, too. In fact, the
Securities and Exchange Commission (SEC), a U.S. government agency, requires a public company to keep
stockholders informed regularly on the state of its business.

An annual report is one of the most important documents a company produces and is often the first
document someone consults when researching a company. It reports how the company did financially and
often explains the scope of its business mission and management philosophy.

For these reasons (and because the SEC requires publication of much of the information in the annual
report), companies take the development of an annual report seriously. They carefully consider its design
and construction and even the paper to print it on. Today, many companies also produce Web and CD-ROM
versions of their annual reports.

ANATOMY OF AN ANNUAL REPORT

While most annual reports contain optional elements, all reports contain information the SEC requires.
Optional elements include:

Financial highlights. Probably the most often-read section of any annual report, these highlights give a
quick summary of a company’s performance. The numbers appear in a short table, usually accompanied by
supporting graphs.

Chairman’s letter. This letter may be from the chairperson of the board of directors, the chief executive
officer, or both. It can provide an analysis and a play-by-play review of the year’s events, including any
problems, issues and successes the company had. It usually reflects the business philosophy and
management style of the company’s executives and often it lays out the company’s direction for the next
year.

Corporate message. Some analysts, business executives and stockholders consider this message an
advertisement for the company; others find it useful. However, it almost always reflects how a company sees
itself, or how it would like others to see it. Here, the company can explain itself to stockholders, using
photographs, illustrations and text. This message may cover the company’s lines of business, markets,
mission, management philosophy, corporate culture and strategic direction.
Board of directors and management. This list gives the names and position titles of the company’s board
of directors and top management team. Sometimes companies include photographs.

Stockholder information. This information covers the basics – the company’s corporate office
headquarters, the exchanges on which the company trades its stock, the location and time of the next
annual stockholder’s meeting, and other general stockholder service information. Stockholder information is
usually in the back of the annual report.

Auditors’ report. This summary of the findings of an independent firm of certified public accountants shows
whether the financial statements are complete, reasonable, and prepared consistent with generally accepted
accounting principles (GAAP) at a set time.

SEC-required elements include:

Report of management. This letter, usually from the board chairperson and the chief financial officer, takes
responsibility for the validity of the financial information in the annual report, and states that the report
complies with SEC and other legal requirements. The discussion attests to the presence of internal
accounting control systems that cover effectiveness of operations, reliability of financial reporting, and
compliance with federal laws.

Management discussion. This series of short, detailed reports discusses and analyzes the company’s
performance. It covers results of operations, and the adequacy of liquid and capital resources to fund
operations.

Financial statements and notes. These statements provide the raw numbers for the company’s financial
performance and recent financial history. The SEC requires three statements — statement of earnings,
statement of financial position, and statement of cash flows — all covered in this Guide. (The statement of
stockholders’ equity is not addressed here.) These statements include a comprehensive set of related notes
that provide explanations, additional detail, and supplementary financial information.

Selected financial data. This information summarizes a company’s financial condition and performance
over five years or longer. Data for making comparisons over time may include revenue (sales), gross profit,
net earnings (net income), earnings per share, dividends per share, financial ratios such as return on equity,
number of shares outstanding, and the market price per share.

OTHER FINANCIAL REPORTING

The financial statements and related notes in the annual report are primary sources of financial information
available to investors, financial analysts, and the public. Other primary financial information sources include
SEC Form 10-K, which the SEC requires companies to submit yearly. This audited form contains more
detailed information than the financial statements in the annual report. Companies also provide interim
financial reports to stockholders and file an unaudited SEC Form 10-Q quarterly. These quarterly reports
provide briefer, more aggregated data for the quarter and year to date.

About the Statements?

Purpose

The financial statements and their accompanying notes explain a company’s financial performance and
recent financial history. Financial analysts use these statements in several ways: to evaluate a company’s
overall performance, identify strengths and weaknesses, anticipate future successes or problems, and
ultimately help them decide if the company is a good investment opportunity.

Note: In this Guide, financial statement names are statement of earnings, statement of financial position,
and statement of cash flows. For synonyms, visit the Glossary.

What’s in them?

Annual reports include at least three financial statements:

Statement of earnings summarizes results of the company’s business operations (revenue and expenses)
Statement of financial position lists the company’s assets and the claims against them: liabilities and
stockholders’ equity

Statement of cash flows measures the flow of cash into and out of the company

The statements contain the financial information for a publicly held company. If a company is composed of
many subsidiaries, divisions, and other companies, it presents the financial information of all its holdings as
one “consolidated” company. So IBM, for example, publishes a “consolidated statement of cash flows” and
other “consolidated” financial statements, representing all the parts of its very large organization.

To learn a little more about other parts of an annual report, visit What’s an annual report?

Who prepares them?

The people who prepare the statements may differ from company to company. Usually, the accounting staff
prepares them, but others, such as investor relations staff, review the statements and related notes.

Regardless of who the prepares are, federal securities laws require publicly owned companies to follow a
set of rules and financial reporting guidelines. Associations — such as the Financial Accounting Standards
Board (FASB), a private organization of accounting professionals, and the Securities and Exchange
Commission (SEC), a U.S. government agency — develop the rules and guidelines. These generally
accepted accounting principles (GAAP) help ensure that the financial information reported is reliable and
consistent in form with the reports all other companies prepare. GAAP also helps safeguard against investor
fraud.

Although all companies follow common standards and requirements, they report on their financial
performance in varied ways. Many decisions — from the statements’ names to the accounts within them and
the ways management calculates the numbers — are left to companies’ discretion.

What’s the auditors’ report?

The auditors’ report is a summary of the results of an audit, or examination, of the financial statements by an
independent firm of certified public accountants. The audit is an attempt to determine whether a company’s
financial statements report the company’s financial status accurately and reliably. During an audit, for
example, the auditors investigate a company’s internal accounting controls, confirm the existence of many
assets, and gather supporting information from external sources. The auditors make sure the financial
statements are complete, reasonable, and prepared consistent with GAAP at a set time. If the auditors
consider the statements are fair presentations of the company’s financial position in relation to GAAP, they
issue an “unqualified” opinion.

The notes

The notes are required reading to understand the financial statements. Companies use notes to explain how
they arrived at the numbers in the financial statements and to describe any significant events or changes in
procedures that may affect the numbers. Notes also explain items in the statements and report details of the
company’s financial performance not shown in the statements.

A note might explain, for example, that a company’s accounting methods have changed from the previous
year or differ significantly from methods other companies in the same industry use (assuming they follow
GAAP). Analysts might examine why the company changed accounting methods, probing, for example, to
learn whether the change distorts the company’s financial results.

Another note might disclose an acquisition that may have a material effect on the company’s financial
condition, both short term and long term. For example, with its acquisition of Lotus in 1995, IBM incurred
costs and assumed liabilities associated with this significant event.

Finally, a note might provide additional detail on an item in a financial statement. For example, a note on
“Investments and sundry assets” on the statement of financial position lists the assets IBM includes in this
category. (One listing is the intangible asset called goodwill).
Statement of Earnings
Purpose

The statement of earnings shows how much revenue a company brings into the business by providing
goods or services, or both, to its customers for a set time (usually one year). It also shows the costs and
expenses associated with earning that revenue during that time.

In an annual report, the statement of earnings shows sales revenue and expenses for at least the last three
years. The net earnings (or loss), often literally the "bottom line" on the statement, show how much the
company earned (or lost).

Key numbers

The statement of earnings shows two main categories of information for each year covered:

• the revenue from products and services sold

• the expenses, or costs, of doing business

• To interpret this information, analysts look at several key numbers:

Revenue

Companies earn revenue in one or more of the following ways:

• by selling products or services, or both

• by leasing and renting equipment or property to others

• by receiving interest from loans to other companies or individuals

Some companies have only one source of revenue; others have several. For example, IBM reports revenue
from its products, such as computer hardware and software. It also reports revenue from its services, which
include maintenance, rentals, and financing.

Gross profit

A rule of business is, "It takes money to make money." Typically, producing goods for sale is the greatest
cost of generating revenue. For example, a computer manufacturing company must buy wiring and other
raw materials to make computers; pay wages to workers and managers; and spend money on overhead —
power, facilities, and maintenance.

A company deducts these costs (cost of sales, cost of goods sold) from revenue, showing gross profit (or
loss).

Operating income

In addition to the expenses directly related to producing goods and services, companies incur operating
expenses. These include advertising, salaries, rent, research and development, office supplies, and any
other administrative amounts spent. A company deducts these operating expenses from gross profit,
resulting in operating income (or loss).

Operating income represents a company’s revenue minus all expenses required to obtain that revenue.
From this key number, companies deduct costs relating to debt financing and tax expenses. The remainder
is called net earnings.

Net earnings

Net earnings are the "bottom line" (often literally the last line on the statement). After a company deducts all
costs and expenses from revenue, the statement of earnings shows the net earnings (or loss). When
revenue exceeds costs and expenses, the bottom line shows a profit. When costs and expenses exceed
revenue, the bottom line shows a loss.

Growth in net earnings usually signals that a company is doing well.

Earnings per share

Earnings per share (EPS) shows how much money stockholders would receive for each share of stock if the
company distributed all net earnings to its stockholders. For example, if the net earnings are $1 million and
500,000 shares are outstanding, the earnings per share are $2 ($1 million ÷ 500,000 shares = $2).

Although all net earnings really belong to the stockholders, a company almost never distributes the full
amount to them directly. A company needs money to grow, so it takes part of the net earnings and reinvests
that money in itself. The total amount of a company’s net earnings since its inception, minus any payments
made to stockholders, is called retained earnings.

Although the term may suggest a large pool of cash, that image is misleading. Retained earnings is actually
part of stockholders' equity and represents the portion of a company’s assets that is financed from profitable
operations rather than from selling stock to investors or borrowing from external sources. If the company
reinvests those earnings profitably, the stockholders benefit from that reinvestment over the long term.

A second way stockholders benefit from retained earnings is through dividends. A company’s board of
directors, with the advice of management, decides on the amount of dividends per share to pay. Companies
usually pay dividends quarterly; however, many companies don't pay dividends at all, and a few pay
dividends irregularly.

Statement of Financial Position

Purpose

The statement of financial position reports a company’s financial status at a set date noted on the statement.
The statement is like a snapshot because it shows what the company is worth at that set date. The
statement shows:

• what the company owns

• what the company owes

• what belongs to the owners

Analysts often call the statement of financial position a balance sheet because of the way one part — assets
— is in balance with the sum of the other two parts — liabilities and stockholders' equity.

In an annual report, the statement of financial position includes information for at least the last two years to
allow comparison of changes between years.

Key Numbers

The statement of financial position shows three main categories of information for each year covered. To
interpret this information, analysts look at three key numbers related to these categories:

Assets (what the company owns)

Companies own things, called assets. These things might be physical assets such as buildings, trucks,
inventories of products, equipment, and cash. Or things might be intangible assets such as goodwill,
trademarks, and patents.

Assets are either current or noncurrent. Current assets are things a company expects to convert to cash
within one year. Examples are accounts receivable or inventories of products to sell. Finally, current assets
include cash and securities such as treasury bills and certificates of deposit the company expects to convert
to cash within the year.
Noncurrent assets are things a company does not intend to convert to cash or that would take longer than a
year to convert. Noncurrent assets include fixed assets, often listed as "Property, plant, and equipment"
because that’s what they usually are. Companies use fixed assets to manufacture, display, store, and
transport products.

The amounts of fixed assets vary by company and industry. For example, manufacturing companies
generally have a large investment in fixed assets because making things requires property, plant, and
equipment. Service companies usually have fewer fixed assets.

Liabilities (what the company owes)

On the statement of financial position, debts are called liabilities. All companies have liabilities. Examples of
liabilities include:

• money owed to banks and other lenders

• money owed to suppliers of goods and services (accounts payable)

• taxes owed to government authorities

• rents owed to owners of land and buildings

Liabilities are either current (short term) or long term. Current liabilities are due within one year. Long-term
liabilities are due after one year.

Although liabilities are a necessary part of doing business, companies must manage their liabilities carefully.
If a company cannot make interest payments on time and repay the principal when due, the company can
be forced to declare bankruptcy and either reorganize or disband.

Stockholders' equity (what belongs to the owners)

Stockholders' equity is the amount owners invested in new stock plus the earnings the company retained
since it started. (Retained earnings is the amount of profit kept after dividends are paid). On the statement of
financial position the amount of stockholders' equity always equals the value of all the assets minus all the
liabilities. For example, if a company’s assets are valued at $10,000 and liabilities total $6,000, the equity is
$4,000.

Statement of Cash Flows

Purpose

The statement of cash flows reports the flow of cash into and out of a company in a given year.

Cash is a company’s lifeblood. Cash includes currency, checks on hand, and deposits in banks. Cash
equivalents are short-term, temporary investments — such as treasury bills, certificates of deposit, or
commercial paper — that can be quickly and easily converted to cash.

A company uses cash to pay bills, repay loans, and make investments, allowing it to provide goods and
services to customers. If all goes well, a company uses cash to generate even more cash as a result of
higher profits.

Key numbers

The statement of cash flows reports the company’s sources and uses of cash and the beginning and ending
values for cash and cash equivalents each year. It also includes (near the bottom of the statement) the
combined total change in cash and cash equivalents from all sources and uses of cash.
 Key numbers in this statement show results of transactions in three categories that are sources and uses of
cash:

Net cash provided (or used) by operating activities

A company generates cash just from operating its business. Therefore, the first key number is net cash
provided from operating activities. This total includes some items from the statement of earnings; for
example:

• net earnings, showing the company’s profit (or loss)

• depreciation expense

This key number also includes changes in some items from the statement of financial position:

• Inventory changes. (Increases in inventories use cash and reductions provide cash).

• Changes in accounts receivable, the sales the company has not yet been paid for. (Again, increases use
cash and decreases provide cash).

• Changes in accounts payable, the cash a company owes its vendors and suppliers. (In this area,
increases provide cash and decreases use cash).

The statement of cash flows adds the net cash from each type of operating activity and reports the
company’s total net cash provided (or used) by all operating activities.

Net cash provided (or used) by investing activities

The second key number might include investments in property (land), plant (factories and assembly plants),
and equipment (machines, trucks, computer systems, telephone systems). Investing in such assets is a use
of cash. Selling them is a source of cash.

Examples of investing activities are overhauling trucks to extend their years of use or renovating factories
and assembly plants to be more highly productive.

The statement of cash flows adds the net cash from each type of investing activity and reports the
company’s total net cash provided (or used) by all investing activities.

Net cash provided (or used) by financing activities

The third key number includes the sources and uses of cash for financing activities. Sources of cash include
what a company raises by selling stocks and bonds and by borrowing from banks.

Uses of cash include buying back stock from stockholders, paying dividends to share profits with
stockholders and repaying borrowed cash.

The statement of cash flows adds the net cash from each type of financing activity and reports the
company’s total net cash provided (or used) by all financing activities.

Analyzing the Statements

Overview

When financial analysts evaluate a company for possible investment, they look both at the information in the
 financial statements and at other information that puts these numbers into a larger context.

Analysts can make more reliable investment decisions by taking the basic information in the financial
statements and extending it to identify:

• a company’s internal strengths and weaknesses

• company and industry trends

• performance in the larger business environment

Brokerage firms offer the results of their analysts’ research to individual investors as part of their service.
Additionally, many professional analysts sell their evaluations and recommendations. Examples of sources
of financial analysis are Moody’s, Standard & Poor’s, and Value Line.

Interpreting the numbers

Analysts usually begin evaluating a company by studying its financial statements. These sources present
recent financial history in a concise format, making it easy to see short-term changes in key numbers.
Financial statements are also fairly standard within an industry, making it easy to compare the performance
of a company to that of its competitors.

Analysts interpret the numbers on each financial statement using a variety of ratios and other comparative
measures. Analysis covers:

• Statement of earnings

• Statement of financial position

• Statement of cash flows

Analysis: statement of earnings

Analysts use the statement of earnings to examine a company’s profitability. For example, analysts look at
trends in revenue, operating income, and gross profit rates (or margins). Other measures include calculation
of return on assets and return on equity. To view IBM’s performance over recent years, see the Historical
Charts.

Analysis: statement of financial position

Analysts use the statement of financial position to examine a company’s liquidity and to gain insight into the
state of the company’s debt and inventory. One measure analysts use is the current ratio, a comparison of
current assets with current liabilities. Analysts also look at the relationship of this statement with the
statement of earnings. For example, they may explore the relationships of accounts receivable with sales,
and of inventory with the costs of sales. Collection of accounts receivable is a task financial analysts also
watch closely. If customers take long to pay for goods and services, accounts receivable may become large,
forcing the company to borrow money (and pay interest) to finance these receivables. The longer it takes to
collect accounts receivable the less valuable they are.

Analysis: statement of cash flows

 Analysts use the statement of cash flows to determine how effectively a company generates and manages
cash. Analysts look most closely at the cash from operating activities in evaluating a company’s potential for
long-term success because this figure shows how efficiently the company can produce and sell its primary
product or service.

Analysts also evaluate cash flows in relation to earnings figures (from the statement of earnings). For
example, in some cases, a company can report positive earnings on the statement of earnings and still
report a negative net cash flow on the statement of cash flows. This situation may occur when a company is
unable to meet the current demand for its products and consequently invests its profits, or even borrows
additional money, to expand its manufacturing capability (for example, by purchasing equipment or new
facilities). When such a situation occurs, analysts look for the implications. They try to determine if the
prospective demand for the company’s product is great enough to justify the expenditures and new debt.

Looking at other information

Most analysts agree that the financial statements, financial ratios, and other comparative measures offer the
best starting points for evaluating a company. However, they look at these items to provide only a portion of
the information required to adequately evaluate a company for investment.

Analysts begin to put the key numbers into a larger context by looking at two other critical parts of the annual
report itself:

• The notes to the financial statements offer further explanation of the numbers on the statements. For
example, for the statement of earnings, notes might describe changes in a company’s investment in
research and development (R and D). For the statement of financial position, notes might describe
significant liabilities and contingencies.

• The management discussion section provides management’s perspective on the company’s financial
operation and performance. Reading this section in consecutive annual reports also allows analysts to
gather more subjective information about a company, such as its ability to articulate and consistently
pursue long-term goals.

For company financial information not contained in the annual report, such as that in copies of Form 10-K or
Form 10-Q filed with the Securities and Exchange Commission, analysts and investors frequently contact
the company’s investor relations department for copies of those forms.

Finally, analysts extend the scope of their financial information comparisons beyond the two to three year
figures in a single set of financial statements. Instead, they look at the same ratios and performance
measures over five to ten year periods. To see changes in IBM’s financial record over time, visit the
Historical Charts.

Analysts also compare these figures with several other numbers from other sources of business and
economic information. For example, they:

• Compare many growth figures, such as growth in sales, with the rate of inflation, and look for rates that
exceed that of inflation.

• Look at figures for competing companies to determine a company’s strength in its industry.
• Examine industry averages to gain a historical perspective in order to evaluate a company’s chances for
long-term success.

accounts payable. Amounts companies owe suppliers for goods and services. Listed in the current
liabilities section on the statement of financial position.

accounts receivable. Amounts customers owe a company from sales of goods or services that the
company expects to collect within one year. Listed in the current assets section on the statement of financial
position.

annual report. A report a company publishes for its stockholders at the end of each fiscal year. The report
includes required elements such as an auditors’ report and the company’s statement of earnings, statement
of financial position and statement of cash flows. The report also includes elements such as letters and
articles by the company’s executives, information on its financial condition and significant events.

assets. Anything companies own. These things might be physical assets such as buildings, trucks,
inventories of products, equipment, and cash. Or these things might be intangible assets such as goodwill,
trademarks and patents. Listed as a category on the statement of financial position. See also accounts
receivable, current assets, fixed assets, noncurrent assets.

auditor. A firm of certified public accountants a company hires as an independent third party to review its
financial information. The auditor’s main purpose is to make sure the statement of earnings, statement of
financial position and statement of cash flows fairly present the company’s financial condition, and that they
comply with GAAP.

auditors’ opinion. A summary of the findings of a firm of certified public accountants that audits, or
examines, a company’s financial statements. This report is included in the company’s annual report. Also
called auditors’ report and report of independent accountants.

auditors’ report. A summary of the findings of a firm of certified public accountants that audits, or examines,
a company’s financial statements. This report is included in the company’s annual report. Also called
auditors’ opinion and report of independent accountants.

backlog. The amount of a company’s unfilled orders at the end of the year. When the company fills the
orders the following year, it records the revenue on the statement of earnings. Frequently, a company will
give its perspective on backlog in the management discussion section in the annual report.

balance sheet. A financial statement that reports a company’s assets and the claims against them —
liabilities and stockholders’ equity — at a set date noted on the statement. Also called statement of financial
position.

bond. A form of debt security a government or corporation issues, promising payment of the original
investment plus interest on specifiedfuture dates. See also marketable securities.

book value. The value of an asset, a liability, or a stockholders’ equity account. For a fixed asset, it is
typically the cost of the asset minus accumulated depreciation. As companies continue to use fixed assets to
generate revenue, the book values lessen, and sometimes ultimately reach zero. See also depreciation.

C
cash. Currency and checks on hand and deposits in banks. Listed in the current assets section on the
statement of financial position. See also cash equivalents.

cash equivalents. Short-term, temporary securities that can be quickly and easily converted to cash. Listed
in the current assets section on the statement of financial position. See also cash.

consolidated statements. Financial statements of a company that presents the financial information of all
its holdings as one company.

current assets. Assets a company can convert to cash within one year. Examples are accounts receivable
and inventories of products to sell. Listed in the assets category on the statement of financial position. See
also accounts receivable, assets, fixed assets.

current liabilities. Obligations a company has to others, such as creditors, suppliers, and tax authorities,
payable within one year. Listed in the liabilities category on the statement of financial position. See also
accounts payable, debt, income taxes.

debt. Money a company has borrowed and must repay, frequently with interest. Listed in the liabilities
category on the statement of financial position.

depreciation. An allowance for wear or age made to the value of a fixed asset, allocating its cost over its
estimated useful life. Listed in the assets category on the statement of financial position. See also book
value.

dividends. Cash or stock payments from a company’s profits distributed to stockholders, an equal amount
for each share of stock owned. Listed as dividends on the statement of stockholders’ equity.

earnings per share (EPS). The portion of a company’s profit assigned to each share of stock. For example,
if the profit is $1 million and 500,000 shares are outstanding, the earnings per share would be $2 ($1 million
÷ 500,000 shares = $2). Listed in the per share of common stock amounts category on the statement of
earnings.

earnings report. A financial statement that reports the results of a company’s business operations (revenue
and expenses) for a set period, usually one year. Also called an income statement, statement of earnings,
statement of operations and statement of profit and loss.

equity. The part of a company’s assets that belongs to the stockholders. In other words, the amount that
would remain if a company sold all of its assets and paid off all of its liabilities. Listed as stockholders’ equity
on the statement of financial position and on the statement of stockholders’ equity.

expenses. Costs such as salaries, rent, office supplies, advertising and taxes. Listed in the operating
expenses category on the statement of earnings.

Financial Accounting Standards Board (FASB). An association of accounting professionals that decides,
maintains and communicates generally accepted accounting principles (GAAP).

fixed assets. Anything companies use for more than one year to manufacture, display, store and transport
products. Often called “Property, plant, and equipment” because that’s what fixed assets usually are. Listed
after current assets in the assets category on the statement of financial position. See also assets,
noncurrent assets.

footnotes. An annual report section that provides information essential to fully understanding the financial
statements. Notes explain the financial statements’ numbers and any significant events affecting them.
Notes also provide additional detail and provide supplementary financial information. Also called notes.

Form 10-K. A financial report the SEC requires companies to submit yearly. This audited form contains more
detailed information than the financial statements in the annual report.

Form 10-Q. A financial report the SEC requires companies to submit quarterly. This unaudited form includes
briefer, less detailed financial statements than those in the annual report.

generally accepted accounting principles (GAAP). A set of rules and financial reporting guidelines
companies must follow to prepare and present the financial information on the statements. See also
Financial Accounting Standards Board (FASB).

goodwill. An intangible asset that adds value to the worth of a company; for example, the reputation of its
products, services, or personnel. Listed in the assets category (sometimes as “Investments and sundry
assets”) on the statement of financial position. See also asset, intangible assets, noncurrent assets.

gross income. The difference between a company’s total sales and its cost of sales. Listed as a category
on the statement of earnings. Also called gross profit.

gross profit. The difference between a company’s total sales and its cost of sales. Listed as a category on
the statement of earnings. Also called gross income.

income statement. A financial statement that reports the results of a company’s business operations
(revenue and expenses) for a set period, usually one year. Also called an earnings report, statement of
earnings, statement of operations and statement of profit and loss.

income taxes. Fees placed by federal, state, local and foreign governments on a company’s earnings.
Listed on the statement of earnings.

intangible assets. Anything nonphysical, such as goodwill, trademarks and patents, that have value for a
company. Listed in the assets category (sometimes as “Investments and sundry assets”) on the statement of
financial position. See also asset, fixed assets, goodwill.

inventories. All goods and materials available for sale (in the case of wholesalers, retailers, and distributors)
or raw materials and supplies, work in process and finished goods (in the case of manufacturers). Listed in
the current assets section on the statement of financial position.

investments. A company’s equity ownership in unconsolidated subsidiaries and affiliates. Listed in the
category of assets (for example, “Investments and sundry assets”) on the statement of financial position.

investor relations. The division of a company that answers stockholders’ questions and sends them regular
updates about the company’s performance.

leverage. A company’s use of debt, instead of its equity, to support its assets and grow.

liabilities. A company’s debts to a lender, a supplier of goods and services, a tax authority, a landlord and
others. Listed as a category on the statement of financial position.

liquid asset. An asset that can be quickly converted into cash. Examples include cash and marketable
securities. See also cash equivalents.

long-term debt. Debt a company will repay after one year. Listed in the liabilities category on the statement
of financial position.

market value. The amount two unrelated parties agree one of them will pay for something the other has.
Also, the value of a company determined by multiplying the total number of outstanding shares by the
market price per share. For example, if a company has 4,000,000 shares of stock outstanding and the
current price per share is $50, the company’s market value is 4,000,000 x $50 or $200 million.
marketable securities. Financial assets, such as stocks and bonds, that companies can convert to cash.
Listed as assets on the statement of financial position.

net earnings. A company’s total revenue less total expenses, showing what a company earned (or if lost,
called net loss) for a set period, usually one year. Listed often literally as the “bottom line” on the statement
of earnings. Also called net income and net profit.

net income. A company’s total revenue less total expenses, showing what a company earned (or lost, called
net loss) for a set period, usually one year. Listed often literally as the “bottom line” on the statement of
earnings. Also called net earnings and net profit.

net profit. A company’s total revenue less total expenses, showing what a company earned (or lost, called
net loss) for a set period, usually one year. Listed often literally as the “bottom line” on the statement of
earnings. Also called net earnings and net income.

net sales. A company’s total sales less returned merchandise and discounts. Listed on the statement of
earnings.

net worth. The amount of a company’s stockholders’ equity. Listed as total stockholders’ equity on the
statement of financial position.

non current assets. Anything of long-term value to a company, including fixed assets and intangible assets.
Listed in the assets category (after current assets) on the statement of financial position. See also fixed
assets, goodwill, intangible assets.

notes. An annual report section that provides information essential to fully understanding the financial
statements. Notes explain the financial statements’ numbers and any significant events affecting them.
Notes also provide additional detail and provide supplementary financial information. Also called footnotes.

operating expenses. Costs related to a company’s operations. Examples are salaries, advertising, sales
commissions, travel and entertainment. Listed as a category on the statement of earnings.

operating income (or loss). The result of deducting the cost of all sales and operating expenses from a
company’s net sales. Listed on the statement of earnings.

price earnings ratio (P/E ratio). A ratio used to evaluate the relationship between a company’s price per
share and the earnings per share (EPS). For example, if a company’s stock is selling for $12 per share and
the earnings per share is $2, the P/E ratio is 6 (12 ÷ 2 = 6).

ratio. A measure of the relative size of two numbers. Usually, financial ratios are expressed as a times
multiple (x) or a percentage (%). Ratios provide a quick way to compare a company to its performance over
time, to other companies in the same industry, and to the industry average.

report of independent accountants. A summary of the findings of a firm of independent certified public
accountants that audits, or examines, a company’s financial statements. This report is included in the
company’s annual report. Also called auditors’ report and auditors’ opinion.

retained earnings. The total amount of a company’s net earnings since its inception, minus any payments
made to stockholders. Retained earnings is actually part of stockholders’ equity and represents the portion
of a company’s assets that are financed from profitable operations rather than from selling stock to investors
or borrowing from external sources. Listed on the statement of financial position.

revenue. The total flow of funds into a company, mostly for sales of its goods or services. Listed as the first
category on the statement of earnings.
S

SEC. Abbreviation for Securities and Exchange Commission. A U.S. government agency responsible for,
among other things, ensuring publicly held companies report financial information to stockholders regularly.

SEC Form 10-K. A financial report the SEC requires companies to submit yearly. This audited form contains
more detailed information than the financial statements in the annual report.

SEC Form 10-Q. A financial report the SEC requires companies to submit quarterly. This unaudited form
includes briefer, less detailed financial statements than those in the annual report.

Securities and Exchange Commission (SEC). A U.S. government agency responsible for, among other
things, ensuring publicly held companies report financial information to stockholders regularly.

securities. Investments, including stocks and bonds. Listed as assets on the statement of financial position.

share. A certificate of ownership in a company. Also called stock.

statement of cash flows. A financial statement that reports the flow of cash in and out of a company for a
set period, usually one year. It reports the operating activities, investing activities and financing activities of
the company.

statement of earnings. A financial statement that reports the results of a company’s business operations
(revenue and expenses) for a set period, usually one year. Also called an earnings report, income statement,
statement of operations, and statement of profit and loss.

statement of financial position. A financial statement that reports a company’s assets and the claims
against them — liabilities and stockholders’ equity — at a set date noted on the statement. Also called the
balance sheet.

statement of operations. A financial statement that reports the results of a company’s business operations
(revenue and expenses) for a set period, usually one year. Also called an earnings report, income statement,
statement of earnings, and statement of profit and loss.

statement of owners’ equity. A financial statement that reports the changes in the owners’ interests
(equity); for example, by detailing changes in net earnings or dividends paid to stockholders. This statement
is usually separate but a company may prepare a statement of retained earnings instead. Also called
statement of stockholders’ equity.

statement of profit and loss. A financial statement that reports the results of a company’s business
operations (revenue and expenses) for a set period, usually one year. Also called an earnings report, income
statement, statement of earnings, and statement of operations.

statement of stockholders’ equity. A financial statement that reports the changes in the owners’ interests
(equity); for example, by detailing changes in net earnings or dividends paid to stockholders. This statement
is usually separate but a company may prepare a statement of retained earnings instead. Also called
statement of owners’ equity.

stock. A certificate of ownership in a company. Also called share.

stockholder. An owner of part of a company. Also called a shareholder.

trend. A pattern in a company’s financial performance over time. For example, if a company’s sales have
been increasing over many months or years, analysts would describe this pattern as a sales growth trend.