A glossary for the two core statements
Graham defines the line items and ratios needed to read the balance sheet and income statement. The book is a plain reference for interpreting a company's condition and earning power.
The interpretation of financial statements
6 ideas
Working capital and the current ratio
Liquidity is judged by current assets minus current liabilities and the ratio between them. Graham treats these as first checks on financial soundness.
Statements as evidence of intrinsic value
Figures are read not as ends but as inputs to estimating a business's underlying worth. Numbers serve the value investor's search for a margin of safety.
Judge earnings over years, not one
A single year's reported profit can be distorted by nonrecurring items, cyclical peaks or troughs, and accounting choices about depreciation and reserves. The analyst should average earnings over several years, often seven to ten, to estimate true earning power. That average, not the latest figure, is the proper basis for judging a security's value.
Current ratio tests short-term debt safety
Divide current assets by current liabilities to judge whether a company can meet obligations due within a year. Graham treats roughly two dollars of current assets per dollar of current liabilities as the traditional standard for an industrial company. A quick-asset test, which excludes inventories, checks whether bills can be paid without relying on selling stock.
Book value is not liquidation value
Balance sheet asset figures record historical cost less depreciation, not what the assets would fetch if sold. Plant and equipment in particular may be worth far more or far less than their carrying amount. Treat stated book value as an accounting starting point, not an estimate of real worth.