How to spot the real story from a company’s financial results

A company’s financial results can be lengthy and difficult to read but it isn’t too hard to get the true story if you know where to look.

Financial results must be published by all companies on the UK stock market twice a year. They are a document of the past six or 12 months’ trading and provide a snapshot into how management view the near-term prospects.

Full year results from supermarket giant Tesco, published on 13 April 2016, are a great example for how the true story is often different from the headline numbers. Companies love to give a positive message at the start of their results, but the best information is found once you dig into the numbers.

You may have been confused as to why Tesco’s shares fell nearly 8% on the day of its results, despite the company proclaiming it to be ‘a year of significant progress’. We now explain, using five of the most important areas in a company’s results. These five areas apply to any company’s results, not just Tesco’s.

1. Outlook statement 
Markets, made up of thousands of individual investors, are forward-looking. Although historic performance is important they want to know what will happen next. This makes the outlook statement which accompanies the results particularly important.

In Tesco’s case the share price decline in response to the results can largely be attributed to the outlook statement. It said:

‘We have made good progress over the last year. We are continuing to invest in our customer offer in order to improve our competitiveness in what remains a challenging, deflationary and uncertain market. This will be reflected in the pace of improvement in profitability in the current year, particularly in the first half.’

Sounds good, so why the share price fall? The guidance for slowing profitability in an extremely competitive grocery market disappointed investors and overshadowed the progress demonstrated elsewhere.

2. Dividend 
Not all companies on the stock market pay a dividend but this cash reward is a valuable insight into how management view the company’s prospects.

An increase in the dividend can usually be taken as a sign of management’s confidence in the future.

In Tesco’s case, shareholders had already been warned there would be no dividends for a while as the company works to rebuild its balance sheet.

3. Income statement 
The income statement is a summary of the company's finances over a period of time. 

Source: Tesco

The first number you see on the income statement is revenue, which is the total amount of money received by the company for goods sold or services provided during a certain period. 

Once the cost of achieving these revenues is subtracted, you are left with the operating profit. In isolation, this might not mean much but, by comparing it with the previous year's number (typically displayed alongside it), you can see if profits are rising or falling.

Pre-tax profit is another good indicator of performance when comparing year-on-year results. This figure takes into account financing activities (which includes interest earned or paid and one-off charges). It is one of the most widely used measures of a company's performance. 

In Tesco’s case the statement includes both statutory numbers and a figure before one-off items. For clarity we have focused on the statutory numbers. We have also ignored any profits from discontinued operations.

The margin, often expressed as a percentage, can be derived by dividing either operating profit or pre-tax profit by revenue.

Obviously there is a significant improvement on the previous year’s substantial loss. But despite the return to profitability, the implied pre-tax profit margin of just 0.3% is a long way from the margin upwards of 5% it enjoyed historically.

4. Cash flow
The cash flow statement tells us how much money is running in and out of a company.

Cash is the fuel to sustain a business. Unlike measures such as earnings per share (EPS) and pre-tax profit, which can be manipulated through clever accounting, it is difficult to misrepresent cash flow.

For a majority of companies, the pre-tax profit and EPS numbers are still valid indicators of how a business is performing as management teams recognise inflating returns will only work in the short-term.

Check if sales and profits are backed by cash flow. If not, this is cause for concern. 

The statement will run through three stages. First it reflects the amount of money coming in from operating activities.

Next the company will add or subtract cash flows from investing activities. This includes things like money received for the sale of property, investment in joint ventures and cash spent on new equipment.

Finally, cash flows from financing are taken into account. These will include things like cash raised from the sale of shares and money brought in as a result of loans as well as interest paid on existing debts and dividend payments to shareholders

Once all of these have been factored in you will get your net increase or decrease in cash.

Source: Tesco

Here the progress made by Tesco’s chief executive Dave Lewis is particularly evident.

A move to prioritise cash has been rewarded by an increase in net cash inflow from operating activities of £2.1 billion against just £484 million for the previous financial year. There was also an increase in cash and cash equivalents of £907 million compared with a net decrease of £717 million a year earlier.

5. Balance sheet
A balance sheet is a snapshot of the financial position of the company on the last day of the period covered by the results. It is made up of assets (what the company owns) and liabilities (what it owes). 

Assets come in two varieties: non-current and current. Typically, non-current assets include things like property, land, trademarks and money devoted to research. Current assets include stock and cash in the bank.

Liabilities are also split into the current and non-current categories. Current liabilities include debts which are due within a year, tax and unpaid bills while non-current liabilities are anything with a longer time frame and will likely include a company's pension obligations.

Source: Tesco

Most companies will also publish a net debt figure which shows the level of borrowings minus any cash.

In Tesco’s case net debt (excluding its banking operations) fell from £8.5 billion to £5.1 billion. This was largely thanks to the sale of its Korean business Homeplus.

The research pages on this site provide summary financial information for companies including an income statement, balance sheet, cash flow and dividend information. Just enter the company you are interested in researching in our site search and click on the company name to view this data.