A company is an arrangement that turns inputs into something people pay more for than the inputs cost. Everything in equity analysis is an attempt to work out how durable that gap is, and what somebody should pay today for a share of it.
| Statement | Answers | Easiest to manipulate |
|---|---|---|
| Income statement | Did it make a profit over this period? | Most — profit depends on many judgements |
| Balance sheet | What does it own and owe right now? | Moderate |
| Cash flow statement | Did money actually move? | Least — cash is cash |
A company can report growing profits while burning cash — by booking sales customers have not paid for, or capitalising costs that are really expenses. It can also report a loss while generating strong cash, because a large non-cash write-down passed through the income statement. Neither is automatically wrong; both are worth understanding before drawing a conclusion.
operating margin = operating profit / revenue
What proportion of each dollar of sales survives the cost of running the business. Rising margins with flat revenue means efficiency; falling margins with rising revenue means growth is being bought.
Common belief
"Revenue growth means the company is doing well."
What is actually true
Revenue can be bought with discounts, marketing spend or acquisitions. Growth that comes with collapsing margins and rising debt is a company buying its own top line. Read revenue, margin and cash together or you learn nothing from any of them.
Both grow revenue 25%. The first holds its operating margin at 18% and generates positive free cash flow. The second sees margin fall from 18% to 6% and raises debt to fund working capital. The headline is identical. The businesses are not remotely comparable.