Successful Investors Understand The Business Language

Warren Buffett addressed students at the University of Nebraska at Lincoln in 2003, saying: “Accounting is the language of business, and you have to learn it like a language. You can’t be comfortable in the country if you aren’t comfortable with the language. To be successful at business, you have to understand the underlying financial values of the business.”

To be a successful investor, like Warren Buffett himself, you cannot run away from accounting. But you do not need in depth knowledge how it is produced. What you need to know is that what it does mean to you as an individual investor. Along the way in this blog, you will learn about ratio and its meaning. As for introductory to accounting, you need to understand 3 terminologies:

1. Balance Sheet – It represents the wealth of a company. All assets, liabilities and Equities are reported in this section. Just remember the famous equation: Assets = Liabilities + Equities. Equities is where the investors’ money in. Company can use investors’ money to buy asset for business and operation. Company can owe money to their vendor, borrow money from banks.
   

   Balance Sheet Equation
2. Profit & Loss – This will give a sign how healthy is a company. Sales, Revenue, income, earning versus expenses, dividends will be displayed here.
   

   Sample Statement Of Account – Dutch Lady Milk Industries
3. Cash flow – This represents the condition of a company. This is the blood line for a company. It will capture cash transaction for operation cash flow in and out against cash in hand (cash in banks). A company can survive if had negative flow for a year or two. If the condition continued to be negative, it is a bankrupt signal.
   

   Cash Flow Example
   
   

Imagine yourself is a company. Every month, you will receive a pay check from your employer. What do you do with your money?

• If 10% of your net salary allocate for saving, then, it will be parked under Balance sheet as your asset.
• If 5% of your net salary to pay bills and utilities, this will be under your expense for Profit and Loss.
• If you borrowed money from banks to buy house for RM100k, RM100k will be recorded under your liabilities in balance sheet. Once you fully pay the liabilities, House will be transferred to you asset in balance sheet
• the result of your cash money in and out would be the cash flow.

Kapish?? Feel free to ask.

What is Stock, Share and Equity?

Before you begin your Stock Investment journey, you must understand some terms that being used. They are 3 terms that are commonly used in stock market: Stock, share and equity. What is Stock?

“Stock” is a general term used to describe the ownership certificates of any company, in general, and “Shares” refers to a the ownership certificates of a particular company. So, if investors say they own stocks, they are generally referring to their overall ownership in one or more companies.

“Equity” means the value of an ownership interest in something.

Technically, if someone says that they own shares – the question then becomes – shares in what company?

Bottom line, stocks, equities and shares are the same thing. The minor distinction between stocks, equities and shares is usually overlooked, and it has more to do with syntax than financial or legal accuracy.

Let’s create a simple a scenario for better understanding. I have a company – Soy Bean Sdn Bhd – that sell Soy beans and it has been doing so well. I want to expand the business globally but I don’t have enough capital or fund to do so. In order to get capital, I have to find investors to inject capital into my company. Assuming I need RM1 million in order to expand the business. I manage to find 10 investors that equally invest RM100k. these 10 investors of course do not blindly give money to me. they seal an agreement with me as the company owner to protect their money. The agreement can be in the sense of Profit sharing and Ownership. Once these 10 investors invest the money, may be they expect 50% profit from the business. Or, I cannot simply use the money unless I get a written consent from investors first.

From the above scenario:

1. Agreement between owner and investor – Stock
2. 10 investors seal agreement with Soy Bean Sdn Bhd . Meaning they shares ownership in Soy Bean Sdn Bhd
3. The value of this agreement is RM1 million (10 investors x RM100k). Simpler term, Equity.

Imagine the above exercise involved 1 billion shares, Equity value of RM10 billion with 100k of investors. It gets more and more complex.

In capital market, a stock is being traded in stock exchange which is regulated and supervised by Securities Commissions. The agreement part has been simplified and computerized. You no longer receive certificates.

Sample Stock Certificate

But what you will receive is a statement of No. of shares that you own from a certain company. For Malaysia, particularly, the certificates is being shown in the form of statement that  generated and sent to investors by Bursa Malaysia (as below screen shot).

CDS Statement of Account

Remember, by buying shares, you become part of the ownership even if only 0.001% of total equity.

We would like to remind you that there are some companies provide investment scheme but not registered and supervised under securities commission to collect money from public. These could be scam and fraud scheme. Please avoid in putting your in this kind of company. Do your background check before you put your money. You are responsible for your own investment.

Set Your Investment Target

Assuming you have RM50,000.00 now in your saving account or under your pillow. What will happen if you kept it that way in the next 10 years? Your money will lose its value. For simple illustration, in the 1980’s, RM1.00 can buy a decent good breakfast. Nowadays, RM1.00 can’t even buy a cup of tea.

Let’s go back to our investment topic with RM50,000. If you wanted to grow 50k into 1 million, you need a structured way. What do you need to grow your money? The answer is Compound Interest or Growth.

Using Compound Annual Growth Rate (CAGR) formula – as illustrated below

How to interpret the above CAGR finding?

1. If you had RM50k and you want to grow into RM1 million within 15 years, you will need an investment that can provide 22.11% return on yearly.
2. If your investment can only give 10% return annually with time frame of 15 years with same amount initial investment RM50k, you will only get RM208k.
3. Similarly, having the same amount RM50k and grow it into RM1 million with 10% growth rate of capital appreciation, you will need 31 years to get it.

Now, ask yourself these questions:

• How old am I? When I want to retire? Assuming you are 40 years now, you want to retire by age of 55. It means you only have 15 years.
• Where can I find investment that can provide return at least 22.11% annually? Is your annual growth rate target reasonable with your time frame?
  • Stock market?
  • Property?
  • Unit Trust?
  • Commodities (Gold, Silver)?

Of course, my obvious choice is stock market investment. You can play around with the CAGR calculator to fit your investment objective, time frame and return. The earlier you begin your investment journey, the better it is!!

You can download the CAGR calculator in the below link:

CAGR calculator