How to read a company in ten minutes

Three statements describe a company completely. The income statement says what it earned. The balance sheet says what it owns and owes. The cash flow statement says whether any of it was real. Read them in the wrong order and you will be misled; read them in the right order and most companies give themselves away in ten minutes.

1. The cash flow statement, the honest one

Profit is an opinion. Cash is a fact. The cash flow statement tracks actual money moving in and out, which is very much harder to massage than an accounting profit.

• Operating cash flow is cash generated by the actual business. This is the number that matters most. It should broadly track net income over time.
• Investing cash flow is mostly capital expenditure: money spent on factories, equipment, acquisitions. Heavy, persistent capex means the business must keep feeding itself to stand still.
• Financing cash flow is borrowing, repaying, dividends and buybacks. Consistently positive financing cash flow means the company is surviving on other people's money.

2. The balance sheet, the survival check

The balance sheet is a photograph taken on one day. It answers a single blunt question: if things go wrong, does this company survive?

• Current ratio (current assets ÷ current liabilities). Below 1 means it cannot cover the next twelve months from short-term resources. Not automatically fatal, but you should know why.
• Debt to equity. How much of the business is funded by lenders rather than owners. High leverage magnifies both outcomes, and lenders are paid first.
• Goodwill. The premium paid over book value in past acquisitions. A balance sheet stuffed with goodwill is a record of expensive shopping, and it can be written off in a single brutal quarter.

3. The income statement, read last

Read top to bottom and watch the margins, because each line tells you something the previous one did not.

• Revenue. Is it growing? Is the growth from selling more, or charging more, or buying companies?
• Gross margin. Revenue minus the direct cost of what was sold. This is a measure of pricing power. Falling gross margin usually means competition is arriving.
• Operating margin. After the cost of running the business. This is the one that reveals whether scale is actually producing efficiency.
• Net income. The bottom line, and the most manipulable line on the page. Treat it as the beginning of a question, not the end of one.