Thursday, February 12, 2009

Income Statement and Balance Sheet

The Series 65 and 66 will likely ask several questions requiring you to know the difference between a company's income statement and balance sheet. A company's income statement shows the results of operations over a financial quarter or over the fiscal year. It starts with revenue then deducts every cost and expense including taxes until we get to the "bottom line," known as "profit" or "net income after taxes." If you want to see the company's sales (revenue) and profits, look on the income statement.
If you want to see the company's financial health, look at the balance sheet. The balance sheet is a snapshot of the company's financial condition. Assets such as cash and securities, inventory, and equipment are listed on the "plus side," with liabilities such as deferred wages and accounts payable listed on the "minus side." The difference between a company's assets and liabilities is the net worth of the company, called "stockholders' equity" or "shareholders' equity."
Who reads income statements and balance sheets? Fundamental analysts. A fundamental analyst looks at the fundamentals of the company, including: revenue, earnings-per-share, book value, dividend payout, and profit margins. A fundamental analyst studies financial statements. He or she could invest in growth stocks, value stocks, a blend of each, whatever. But if he arrives at his stock picks through this school of thought, he is a fundamental analyst, and he is an active investor. A passive investor would not try to pick one company over another--he or she would use indexes almost exclusively.
Many students struggle with the difference between fundamental and technical analysis. We've already sketched fundamental analysis. Notice how it involves looking at a company's fundamentals. Technical analysis, on the other hand, studies the market data connected to the stock itself. A technical analyst doesn't care what the company makes or does, he just tracks the movement of the company's stock in terms of price, volume, and other market data. If he's talking about support and resistance, the 200-day moving average, or a head-and-shoulders pattern, he's a technical analyst. He's just tracking the stock price or movement of a particular index. A fundamental analyst, on the other hand, studies a particular company or industry sector in terms of sales, profits, growth trends, etc.

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