• The balance sheet tells you how much a company owns, how much it
owes, and the difference between the two, which represents the value of the
money that shareholders have invested in the firm. Shareholders' equity in
a firm is the value of the firm's assets minus its liabilities.
• Because the balance sheet must balance at all times, any change in assets
or liabilities will cause a corresponding change in equity. If a firm gener-
ates huge profits that drive an increase in assets, equity will also increase.
• Keep an eye on the trend in accounts receivable compared with sales. If
the firm is booking a large amount of revenue that hasn't yet been paid
for, this can be a sign of trouble.
• When you're evaluating a company's liabilities, remember that debt is a
fixed cost. A big chunk of long-term debt can be risky for a company be
cause the interest has to be paid no matter how business is doing.
• Be wary of companies that report "nonrecurring" charges, particularly if
they make a habit of it. All kinds of expenses can be buried in "one-time"
charges.
• The statement of cash flows is the true touchstone for corporate value cre
ation because it shows how much cash a company is generating from year
to year—and cash is what counts. Look at the cash flow statement first.
• When you're analyzing a company, make sure you can understand how a
dollar flows through the business. If you can't do this, you probably don't
understand the company well enough to buy the stock.
