Conclusion | Stock Investment Income

Painful though it may have been, you've j ust gained something very valuable: You now know enough about financial statements to meaningfully analyze a company. Although you can (and should) spend much more time learning the nooks and crannies of financial reporting, understanding how a company generates cash is now within your grasp, and that's what really matters. The details aren't nearly as important as the basic concepts that we've just walked through. Now that you've made it through most of this chapter, you're already ahead of the pack.

To wrap things up, let's follow a dollar through Dell to see what happens to it. A customer—let's call him Steven, just for kicks—buys a computer for $1,000 from Dell. Dell turns around and uses $821 to pay manufacturing employees and parts suppliers (cost of goods sold). How do I know this? Look at Dell's income statement (Figure 5.24): The firm spent $29,055/335,404, or 82.1 percent, of every dollar in sales paying for the cost of manufacturing the computer, and 82.1 percent of Si,OOO is $821. So. Dell has $179 of the $1,000 it received for the computer left over after paying for the cost of making the computer.

Now, look at the rest of the income statement (Figure 5.25) to see what happens to the remaining $179. About $86 is spent on television ads and corporate overhead (selling, general, and administrative), $13 goes to research and development, and another $25.50 goes to Uncle Sam. After adding back a little


Dell Computer Corporation: Partial Income Statement
Net revenue Cost of revenue	2003 $35,404 29,055
Gross margin	6,349


Dell Computer Corporation: Partial Income Statement
	2003
Operating expenses
Selling, general, and administrative	$3,050
Research, development, and engineering	455
Special charges	—
Total operating expenses	$3,505
Operating income	2,844
Investment and other income (loss) — net	183
Income before income taxes and cumulative effect of change in	3,027
accounting principle
Provision for income taxes	905
Income before cumulative effect of change in accounting principle	2,122
Cumulative effect of change in accounting principle — net	—
Net income	$2,122

bit of stock investment income generated by Dell's huge cash balance, we're left with about $6o in net profit from the $i,OOO computer sale. That $6o can be reinvested In the business, used to buy back stock, or simply kept In a bank account until a good opportunity comes along. You can calculate every single one of these numbers yourself right from Dell's income statement—just divide the line item by total sales, and multiply the resulting percentage by $i,ooo.

What do we now know about Dell's business? For one thing, "we know that the profit margins are pretty low—with only about $6o in net profits of every $1,000 in sales, we can see that most of Dell's revenue goes right back out the door to the folks "who build the computers, supply the parts, and run the company.

We also know that Dell doesn't spend much on R&D or marketing, which makes sense because the company is striving to be the low-cost producer in a commodity market. If Dell were a pharmaceutical company and spent only 1,5 percent of revenue on research, we'd get mighty worried. But R&D isn't all that important to Dell, so we're not too concerned about it.

There's much more you can learn about a company than this, and that's exactly what we do in the next chapter—we take what we've learned about financial statements and use it to generate analytical insights into how a business is functioning.

But don't overlook the power of this simple test: If you can't understand how a dollar flows from a company's customers back through to shareholders, something's amiss. Either the company's business model is too confusing or you need to do more digging before committing any of your money.