What's your favorite financial statement and why?"
The question was spoken quickly and with a tinge of annoyance, as my interviewer eyed me disdainfully from his cushy black leather chair. The investment banker had little time to conduct these ridiculously long interviews that are standard fare for analyst candidates.
I shifted uncomfortably in my seat and scanned my frazzled brain for the "right" answer.
"Well, of course all three financial statements should be studied in conjunction with one another, but if I had to choose just one, it would be the balance sheet because it represents the foundation upon which a business is built."
That sounded good, right? Diplomatic, intelligent, maybe even a bit Wise. But did my interview answer hold any truth whatsoever?
Well, a little. It's true that each of the three financial statements -- income statement, balance sheet, and cash flow statement -- holds certain puzzle pieces that are essential to solving the mystery of how a business makes money. The income statement tells us how much product was sold; the balance sheet shows what resources were used to run the business; and the cash flow statement reveals the actual inflows and outflows of cash.
But let's get honest. In the real world of hurried lives, precious little spare time, and information overload, we investors need a fast and dirty way to evaluate a company's financial results. We don't always have time to do a comprehensive financial analysis of all three documents. We realize that by taking a shortcut, we won't get the whole story. But that's OK because sometimes all we want are the most critical pieces of data from the most important financial statement. Is there a solution?
Yes. For investors in stocks, what really matters is cash flow. Companies are valued on the basis of how much green stuff they can throw off over the life of the enterprise. Therefore, as we evaluate a company's investment potential, we need to focus on how much cash the business is capable of spitting out. So, where can we find that info? One place -- the cash flow statement, which is published right alongside the other financial statements on a quarterly basis as part of a public company's required SEC (Securities & Exchange Commission) filings.
Follow me, and let's go dig up Microsoft's (Nasdaq: MSFT) cash flow statement.
1) Click over to quotes.fool.com, or click the "Quotes/Data" tab at the top of this page.
2) On the left side of the page, under the "Data" heading, type "MSFT," and click the "SEC Filings" button. (You should find yourself on this page.)
3) You now face a list of documents with funky form names. You're looking for the most recent "10-Q" or "10-K." As of today, the most recent is the 5/14/99 10-Q.
4) A table of contents sits before you. The most direct route to the cash flow statement is the thankfully descriptive link "Cash Flow Statement." Alternatively, if you know you'll be glancing at all three financial statements, you can click "Item 1: Financial Statements." Either way, we've arrived!
You should be looking at something like what you see below. The following is the operating portion of Microsoft's cash flow statement for the first nine months of its fiscal year which ends in June. (For a more complete explanation of the cash flow statement, click back to the 8/23/99 Rule Maker Report.)
Microsoft Cash Flow Statement
($ millions) Nine Months Ended
Mar. 31, 1999
Net income $ 5,583
Depreciation and amortization 514
Gain on sale (160)
Unearned revenue 4,139
Recognition of unearned revenue
from prior periods (2,832)
Other current liabilities 471
Accounts receivable (192)
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