Investopedia

Reviewed by Amy Drury
Fact checked by David Rubin

Using trailing 12-month (TTM) figures is an effective way to analyze the most recent financial data in an annualized format. Annualized data is important because it helps neutralize the effects of seasonality and dilutes the impact of non-recurring abnormalities in financial results, such as temporary changes in demand, expenses, or cash flow.

By using TTM, analysts can evaluate the most recent financial data, rather than using older numbers from full-year annual reports. TTM charts are less useful for identifying short-term changes and more useful for forecasting.

Key Takeaways

• Trailing 12-month, or TTM, refers to the past 12 consecutive months of a company’s performance data used for reporting financial figures.
• By consistently evaluating trailing 12-month numbers, company financials can be evaluated both internally and externally without regard for the artificiality of fiscal year-end.
• TTM allows for a like comparison of a company’s performance trajectory that smooths away any inconsistencies.

TTM for Financial Reporting

Companies conducting internal corporate financial planning and analysis have access to detailed and very recent financial data. They use the TTM format to evaluate key performance indicators (KPI), revenue growth, margins, working capital management, and other metrics that may vary seasonally or show temporary volatility.

By keeping a running tab of TTM metrics, a firm’s management and stakeholders can understand how the company is doing at any point in time using an apples-to-apples comparison. In other words, by always looking at the previous 12 months, effects such as seasonality or one-time charges can be smoothed out.

TTM for Equity Research

In the context of equity research and valuation, financial results for publicly traded companies are only released on a quarterly basis in securities filings in accordance with generally accepted accounting principles (GAAP). Securities and Exchange Commission (SEC) filings generally display financial results on a quarterly or year-to-date basis rather than TTM.

TTM revenue (sales) and profitability metrics show how much money the company brought in and earned over the previous one-year period, regardless of which quarter’s financial statements are being released. Less frequently, firms provide monthly statements with sales volumes or key performance indicators.

Important

TTM figures can also be used to calculate financial ratios. The price/earnings ratio is often referred to as P/E (TTM) and is calculated as the stock’s current price divided by a company’s trailing 12-month earnings per share (EPS).

Example

To get a clear picture of the last year of performance, analysts and investors often must calculate their own TTM figures from current and prior financial statements. Consider General Electric’s (GE) Q1 2015 financial results.

In Q1 2015, GE generated $29.4 billion in revenue versus $33.5 billion in Q1 2014. GE logged $148.6 billion of sales for the full year of 2014. By subtracting the Q1 2014 figure from the full-year 2014 figure and adding Q1 2015 revenues, you arrive at $144.5 billion in TTM revenue.

It depends on business type, operating cycle, and management goals

Fact checked by Timothy Li
Reviewed by Erika Rasure

The amount of working capital a small business needs to run smoothly depends on three different factors: type of business, operating cycle, and the business owners’ goals for future growth. Large businesses can get by with negative working capital (because of their ability to raise funds quickly), but small businesses should maintain positive working capital figures.

Key Takeaways

• Working capital is the cash on hand used to keep a business operational, less liabilities and obligations.
• Depending on the line of business, working capital needs may be significant in order to procure raw materials and labor.
• Service businesses, on the other hand, rely far less on working capital and can operate with less overhead.
• Businesses looking to grow and expand will require larger levels of working capital than businesses looking to maintain their current size.
• A business’s operation cycle will also impact working capital needs; businesses with a shorter time frame from production to revenue generation require less working capital.

What Is Working Capital?

Working capital refers to the difference between a company’s current assets and current liabilities. Current assets are the items a business owns that can be turned into cash within the next 12 months, while current liabilities are the costs and expenses the business incurs within the same period.

Common current assets include checking and savings accounts, marketable securities (such as stocks and bonds), inventory, and accounts receivable. Current liabilities include the cost of materials and supplies (that need to be purchased to produce goods for sale), payments on short-term debt, rent, utilities, interest, and tax payments.

Important

Seasonal businesses require different amounts of working capital at different times of the year.

A company’s working capital is a reflection of its operational efficiency and budget management. If a business has more current liabilities than assets, its working capital is negative, meaning it may have difficulty meeting its financial obligations.

A company with a very high working capital figure, conversely, is easily able to pay all its expenses with ample funding left over. Whether a given business requires high working capital is determined by three key factors: business type, operating cycle, and management goals.

Business Type

Certain types of businesses require higher working capital than others. Businesses that have physical inventory—such as retailers, wholesale businesses, and manufacturers—often need considerable amounts of working capital to run smoothly.

Manufacturers must continuously purchase raw materials to produce inventory in-house, while retailers and wholesalers must purchase pre-made inventory to sell to distributors or consumers.

In addition, many businesses are seasonal, meaning they require extremely high working capital during certain parts of the year. Leading up to the winter holidays, for example, retail businesses— such as department stores and grocery stores—must increase inventory and staffing to accommodate the expected influx of customers.

Businesses that provide intangible products or services, such as consultants or online software providers, generally require much lower working capital. Businesses that have matured and are no longer looking to grow rapidly also have a reduced need for working capital.

Operating Cycle

Ideally, a business can pay its short-term debts with revenue from sales; however, the length of a company’s operating cycle can make this impossible. Companies that take a long time to create and sell a product need more working capital to ensure that financial obligations incurred in the interim can be met.

Similarly, companies that bill customers for goods or services already rendered, rather than requiring payment upfront, need higher working capital if collection on accounts receivable cannot be made promptly.

Management Goals

The specific goals of the business owners are another important factor that determines the amount of working capital required by a small business. If the small business is relatively new (and looking to expand), a higher level of working capital is needed compared to the working capital needed by a small business intending to keep its operations small.

This is particularly true for businesses planning to expand product lines to venture into new markets because the costs of research and development, design, and market research can be considerable.

How Do You Calculate Working Capital?

Working capital is calculated by subtracting current liabilities from current assets. Both current assets and current liabilities can be found on a company’s balance sheet as line items. Current assets include cash, marketable securities, accounts receivable, and other liquid assets. Current liabilities are financial obligations due within one year, such as short-term debt, accounts payable, and income taxes.

What Is Working Capital Used for?

Working capital demonstrates a business’s ability to fund its operations and pay its short-term expenses. When a business has enough liquidity to pay its short-term debt, accounts payable, and any other costs due within one year, it is functioning well and generating enough liquidity from its business operations to cover its costs. This is a sign of the company’s financial health.

How Can I Improve Working Capital?

Working capital can be improved by increasing assets and decreasing liabilities. Reducing your company’s reliance on debt, negotiating better terms with suppliers on accounts payable, managing expenses more efficiently, and cutting extraneous costs can all improve current liabilities. Collecting receivables faster, increasing the value of marketable securities, and improving inventory efficiency can all help improve your current assets.

The Bottom Line

Working capital demonstrates how efficiently a business is operating. Having a positive working capital (i.e. current assets exceed current liabilities) is important for a small business because small businesses don’t have many other options to fall back on if its assets don’t cover its expenses.

The amount of available working capital differs greatly depending on the type of company. Companies with a high inventory of physical goods require more working capital than ones with a low inventory. Similarly, businesses looking to grow will need more working capital than those looking to maintain their size.

Lastly, a business’s operating cycle determines the level of working capital it needs: Businesses that can produce and sell goods quickly need less working capital than those with a longer duration between production and revenue generation.

Fact checked by Amanda Jackson
Reviewed by Margaret James

Getting yourself on sound financial footing is a lot like building a successful business. It can be a decades-long enterprise requiring planning, skill, patience, and a little bit of luck. The proverbial millionaire next door is an overnight success 20 years in the making. Considering the long road ahead, you have every reason to get started today.

Key Takeaways

• Financial success requires a long-term strategy with short-term goals; a deliberate plan is essential for security and success.
• Similar to businesses investing in growth, individuals should invest in education and continuous skill development to enhance career prospects.
• Managing debt is crucial for financial success. Avoid consumer debt, pay off education before making large purchases like a home, and recognize the difference between productive and wasteful consumer debt.
• A shared financial outlook and planning in marriage can contribute to financial stability.
• Patience is vital in financial planning. Allow your investment to benefit from the compounding effect to grow over time.

Have a Plan

Financial security won’t happen by accident, and it won’t happen overnight. Just as businesses have quarterly goals, annual revenue targets, and five-year business plans, you need to approach your life with a long-term strategy made up of a series of short-term actions and goals. Success rarely happens at random. You need to have a plan.

Invest in Yourself

When businesses want to grow, they invest in themselves. The same logic applies to individuals. Before you even begin your career, an investment in education can provide an opportunity to increase your potential lifetime earnings. Going to college or a trade school can provide knowledge and credentials that make you a more attractive and higher-paid part of the workforce.

If circumstances or personal interests do make education an attractive option for you, consider starting a business. Entrepreneurs from all walks of life have started successful enterprises. Working for yourself can bring more satisfaction, more money, and greater control over your job stability than working for somebody else.

Keep in mind that investing in yourself is not a one-time effort. Think of it from a business perspective. Investments in research and technology, infrastructure, and physical plants are an ongoing part of the business. Keeping up with the times and the competition is part of the process of maintaining a successful business and a crucial part of building and growing the business to take it to the next level. Looking at the situation from a personal perspective, if you have a bachelor’s degree, going back to school at mid-career can provide a boost to your credentials and help you keep pace with the competition. If you have a trade, continuing your education can open up new opportunities.

Regardless of your profession, adding a new skill or designation can increase your revenue-generating opportunities. If you run a business, opening up a new sideline can increase your opportunities in the marketplace. If you don’t own a business, moonlighting at mid-career can provide a second source of income that serves as a backup to your primary career.

Learning new skills is an investment that should continue over the course of your lifetime. Expand your interests. Keep an eye out for opportunity. You can continue to build your skill set even during retirement. A second career is not only often more fulfilling than the first one, but it can set up a revenue stream that truly makes you successful in life. Even if you’ve been tremendously successful and no longer need to work, you can continue to invest in yourself by building your knowledge base. Learning about your investment portfolio, for example, can be an interesting and lucrative opportunity. In an age marked by scandal, there’s no better motto than “trust but verify.”

Get Out of Debt

Debt management is a critical exercise for every successful business, and there’s a reason for the saying “cash is king.” Be different. Buck the trend. Don’t rack up debt in the typical consumer fashion. The cost of an education and a primary residence are generally beyond most people’s ability to pay for in cash. Beyond that, if you can’t pay cash, don’t make the purchase. As far as education and the home, pay off the education before you buy the home.

As for the home, don’t stretch your budget. Buy what you can easily afford and pay it off as quickly as possible. Forget the advice about good debt and bad debt. All debt is bad. There’s a long list of financially strapped investors who had supposedly great and fool-proof ideas about going into debt to put the money to work in investments that would earn a greater rate of return than the cost of the interest rate to service the debt.

If you are an entrepreneur, debt may be a necessary tool. Putting your money into an appreciating asset is different than using debt to fund a new car, vacation, or wardrobe. Paying interest on consumer goods is simply a waste of money and undermines your financial foundation. Investing in your business is a way to increase your potential revenue.

Note

In Q4 2024, the Federal Reserve Bank of New York noted that American household debt had risen to $18.04 trillion and delinquency rates were stable but elevated.

Find a Like-Minded Partner

Getting married can give your life a powerful financial boost. Of course, more than a few marriages have ended in divorce over the topic of money. Shared values are the key to success. While it may not sound romantic, having the same outlook on money will go a long way toward creating both a secure financial future and a happy marriage. There aren’t many couples in divorce court complaining about the fact that they are financially secure, debt-free, and successful.

Approach the financial aspects of marriage as you would a business. Plan together and spend together. The purchase of big-ticket items should not be a surprise to either partner. Make decisions regarding debt and credit as a team. If one member of the team is opening up credit cards and the other member is working two jobs to pay for the debts, the team is headed for trouble. Save together. Set a goal of living on one income while using the other to pay down debts. Once you are debt-free, live on the lower income and invest the rest.

Be Patient

Patience is a virtue that holds particular significance in the realm of finance in several ways. In the financial landscape, the power of compound interest is a prime example of why patience is a valuable asset. By allowing investments to grow over time, the compounding effect can significantly amplify returns.

Patience can also serves as a way to overcome impulsive financial decisions that can lead to unnecessary risks and losses. In a world driven by instant gratification, there’s tremendous benefit to researching something, developing a long-term plan, then following steps to execute the plan.

On a broader scale, patience is so important in achieving financial goals and milestones. Whether it’s saving for a major purchase, funding education, or planning for retirement, the ability to stay patient throughout the journey can’t be overstate. Even if you make just a little bit of progress everyday, those small incremental steps can and will add up over time to a greater benefit you will one day be able to enjoy.

What Role Does an Emergency Fund Play in Financial Planning?

An emergency fund serves as a financial safety net, providing a cushion for unexpected expenses or income disruptions. It prevents the need to tap into long-term savings or accumulate debt during unforeseen circumstances such as medical emergencies, car repairs, or job loss. One of the first things you should consider doing, even before saving for retirement, is making sure you have a large enough emergency fund.

When Should I Start Saving for Retirement?

Starting to save for retirement early is advantageous due to the power of compound interest. Ideally, individuals should begin in their 20s or 30s, allowing their investments more time to grow. As mentioned in the ‘Patience’ section above, your portfolio has a greater chance of accumulation when you start investing earlier.

How Can I Improve My Credit Score?

Improving your credit score requires responsible credit management. Pay bills on time, reduce outstanding debt, and review your credit report regularly for errors. Demonstrating responsible credit behavior over time positively impacts your credit score, meaning you’re more likely to get cheaper debt in the future (which further perpetuates your positive financial health).

What Steps Can I Take to Increase My Income?

Increasing income involves a proactive approach to career development and financial growth. Pursue opportunities for career advancement, acquire new skills, and consider negotiating salary raises. Consider advancement opportunities at other companies if your current company does not have great upward mobility. In addition, don’t just focus on your income – you can also improve the amount of money you end up with each month by keying in on expenses.

The Bottom Line

Adopt the mindset and lifestyle outlined in these five points and you will be well on your way to building a secure financial future. While the journey is long and the road not always easy, be sure to take the time to appreciate what you have. Taking time to savor the small victories will help you stay on your long-term course. Enjoy each success, no matter how small. After all, you earned it.

Reviewed by Samantha Silberstein
Fact checked by Vikki Velasquez

Whether you have an established financial plan or are just beginning to consider how to put your money to work, you should keep in mind the differences between saving and investing. These terms are often used interchangeably, but they represent different approaches to your finances. Consider saving and investing at different points in your life, but the key is to understand the pros and cons of each and how they fit into the bigger picture of your financial journey.

Key Takeaways

• Understanding the purpose of saving and investing helps in making informed financial decisions.
• Factors such as time horizon, risk tolerance, and financial goals may influence your choice to save or invest.
• Saving offers low risk and quick access to funds, while investing provides the potential for higher returns and wealth growth.
• Determining the right approach requires evaluation of your personal financial situation, goals, and comfort with saving and investing.

The Basics of Saving and Investing

Most people tend to confuse saving and investing. It’s easy to see why, though, because both involve setting money aside. But, the reasons and ways you save and invest are different, which we highlight below.

Saving

Saving refers to setting aside cash in a low-risk, low-return environment. This could include traditional or online savings accounts, money market accounts, certificates of deposit (CDs), or even a situation in which you hold onto cash outside of a financial institution.

Money held in one of these settings is more liquid than money in most investment types, which means you can access it more quickly and easily if necessary for emergencies or short-term goals. However, in exchange for carrying a lower level of risk than investments, these methods of saving money also provide less of a reward—in this case, they offer lower rates of return.

One of the key characteristics of saving is that you won’t lose your money. Although the return is generally low, the money you set aside in one of these accounts is insured by the Federal Deposit Insurance Corporation (FDIC) or the National Credit Union Administration (NCUA).

Investing

Investing your money means buying any of several different investment vehicles that carry a higher risk and, potentially, a higher reward. Investments may include stocks, bonds, exchange-traded funds (ETFs), commodities, real estate, and more.

There are many ways to access investments, including through retirement accounts, mutual funds, individual stock trading, and more. However, regardless of the type of investment or its particular risk and reward profile, the goal of all investments is the same: to grow your wealth over the long term. Keep in mind that not all investment vehicles carry the same levels of risk and reward. Some, such as bonds, may require months or even years before reaching maturity.

Factors to Consider When Deciding to Save or Invest

Saving and investing involve setting aside money for a future goal or expense. However, the time horizon, level of risk, and most pertinent financial goals vary depending on whether you are looking at saving or investing your money. Looking at these factors can help you determine what to prioritize:

Time Horizon

One of the biggest considerations when deciding whether to save or invest is your time horizon. To realize short-term goals, keeping your money in a savings account or similar vehicle may make more sense because you won’t hold the money long enough for it to grow significantly in an investment setting.

Bradley Baskir, vice president and financial advisor at Morgan Stanley, says that saving is usually better “when the time horizon for liquidity is under 12 months.” He adds that saving for short-term goals by “depositing that pool of money in a savings account may make more sense than investing it because [you] can feel confident that the money will be there” when the goal arrives.

On the other hand, other financial goals may be more significant or more open-ended. If you’re planning for retirement, you are more likely thinking years or even decades ahead. Longer-term goals like this benefit from an investment-centered approach. The longer time horizon of these priorities means your money has the opportunity to grow more significantly if it is invested. As such, you won’t need it to be liquid until you get close to reaching the goal at some point in the future.

Risk Tolerance

Your risk tolerance is the degree of risk that you are willing to take on given the potential volatility of a financial decision. Saving your money is less risky than investing it. If you invest your money, you stand to potentially lose your principal or initial investment.

Consider a situation in which you’re looking ahead to a longer-term financial goal. Given your time horizon alone, you might be inclined to assume investing is the best approach. However, if you are uncertain about your job, periods of volatility in the market, or what your financial situation will be, it may be safest to put your money in a savings account instead.

Note

Each person has a different risk tolerance, which is distinct from that person’s risk capacity, or capability to take on risk. Your risk tolerance may be dependent upon factors such as your age, financial goals, and income, among other factors.

Financial Goals

Laying out clear financial goals will help you to decide when it is appropriate to save or invest—or a combination of both. Financial goals may be large, such as preparing for a down payment on a home, a new vehicle, college tuition, or planning for retirement. They may also be more modest, such as saving for a small purchase or a short weekend trip.

The nature of your financial goals will influence your decision to save or invest. If your goal requires quick access to cash, you’ll likely opt to hold money in a savings account or similarly liquid space. On the other hand, if you hope for better returns on your money than can be achieved with savings account interest rates and over a long time, then investing may be the answer.

Many financial advisors recommend setting aside an emergency fund in a liquid account before considering investing.

Pros and Cons of Saving

Saving offers security but lower potential for rewards.

Pros

• Low level of risk

• Money is FDIC or NCUA insured

• Accessibility to your funds

• Ease of use

Cons

• Lower potential returns

• May erode purchasing power

Pros Explained

• Low level of risk: Saving your money entails a low level of risk, which means your money is safe.
• Money is FDIC or NCUA insured: In the event of a bank run, the Federal Deposit Insurance Corp. or National Credit Union Administration insures your deposits. Keep in mind that only certain deposit accounts are covered.
• Accessibility to your funds: Savings and similar accounts typically make it easy to access your funds.
• Ease of use: Most savings vehicles do not require regular upkeep or observation.

Cons Explained

• Lower potential returns: You won’t get as much bang for your buck by saving compared to investing.
• May erode purchasing power: Savings accounts may fail to keep up with inflation, which can erode your purchasing power over medium- and long-term time horizons.

Pros and Cons of Investing

Investing offers both benefits and downsides. Baskir notes that “investing is by nature a trade-off between risk and return, so those who are willing to stay the course in a diversified portfolio, over long periods of time, in any market environment, should stand to be rewarded with returns that outperform that of cash equivalents earned from saving alone.”

Pros

• Potential for (significantly) higher returns

• Align with your investment strategies

• Choose where you invest:

Cons

• Less liquid

• High volatility

• May require more monitoring

• Subject to external factors

Pros Explained

• Potential for (significantly) higher returns: You stand a better chance of earning higher returns on your principal. As your investments grow, they allow you to take advantage of compounding to accelerate gains.
• Align with your investment strategies: Investing in different asset classes, such as stocks, bonds, mutual, and ETFs, can help you achieve your investment strategy goals.
• Choose where you invest: Investing your money allows you to buy into companies, industries, and sectors that interest you or that you support.

Cons Explained

• Less liquid: Investments are less liquid than savings. It may take more time to access your funds, and it could potentially cost you money, as in the case of withdrawing early from retirement accounts.
• High volatility: Markets for stocks, commodities, real estate, and other assets are often highly volatile, meaning that you may not achieve gains and may even lose some of your principal.
• May require more monitoring: Some approaches to investing are very hands-on and require both time and specialized knowledge.
• Subject to external factors: Investors can be swayed by biases and emotion-based decision-making, which can adversely impact their investments.

Determining the Right Approach

According to Baskir, “saving is to walking what investing is to running.” He adds that it’s vital to “have enough saved up for a rainy day, typically equal to three to six months worth of expenses in the event of a layoff, health issues,” or other unexpected changes to a financial situation before investing.

To determine what works best for you, consider this checklist:

• Do you have an adequate cash cushion to cover three to six months of fixed expenses? If not, start saving.
• Do you have other short-term goals requiring quick access to cash (like travel plans)? If so, start saving.
• Are you on track to reach your retirement goals by your desired age? If not, start investing.
• Do you understand the risks involved in investing this money for a long-term goal such as retirement? You may not be able to access it until age 59½ without taxes and a penalty, plus you’ll face volatility risk, etc.
• Are you comfortable waiting to access your money to take advantage of compounding? If so, you may want to start investing.
• Do you feel comfortable with your current split of saving and investing every month? Where does it feel like you’re falling short?

Saving vs. Investing: Example

Let’s say you’re in your late 30s, single, and earn six figures. You have about two months of expenses in savings and just over a year’s salary in your company-sponsored 401(k). You also recently paid off your student loans and have $500 to reallocate to your other financial goals, which include:

• Boosting your emergency fund to cover at least three months of expenses
• Increasing your retirement savings to ensure that you will be able to retire at age 67 with an income that covers your needs
• Putting aside extra money for travel

The amount you decide to contribute to each category depends on your priorities. It’s also subject to change. For instance, you might decide that in the short term, creating an emergency fund that covers three months of expenses is most important. Once that goal is funded, you can move on to putting more money toward retirement (and fun). 

When to Save vs. When to Invest

Saving may be the best option to establish a rainy-day fund for short-term financial goals, for access to your funds on short notice, or if your risk tolerance is low and you want to protect your principal. Investing may make sense if you already have an emergency fund, are planning for long-term financial goals, seek compounding interest, can hold your funds in a less accessible account, or have a higher risk tolerance.

Choosing a Savings Account

A variety of savings accounts are available, including traditional accounts, online-only accounts, high-yield accounts, money market funds, and more. Check out Investopedia’s in-depth guide for an overview of many of the most popular savings account options and suggestions on how to pick the right account for you.

Choosing a Brokerage Account

Selecting a way to invest your money can be a much more complex question than selecting a savings account. Most beginning investors will use a brokerage account to facilitate trades. Many of the leading brokerages offer an easy-to-use interface, free trades in certain cases, and access to a variety of assets including stocks, mutual and exchange-traded funds, and more.

It pays to consider the ways you plan to invest—actively or passively, what types of asset classes you will target, and so on—and to use Investopedia’s guide to select a broker.

What Are the Advantages of Saving Instead of Investing?

Some of the advantages of saving over investing include a lower level of risk, easier access to your funds, and a comparably straightforward process.

What Factors Should Be Considered When Deciding Between Saving and Investing?

Keep in mind your financial goals—large or small, necessary or discretionary—and what the time horizons of those goals are. Your appetite for risk is also important. You can also allocate some funds to saving and some to investing in order to achieve both short- and long-term priorities.

Can Saving and Investing Be Done Simultaneously?

Absolutely. Advisors recommend that individuals set aside an emergency fund of several months’ worth of expenses in a savings account or similarly liquid option before considering whether to invest additional funds. Further, you may consider saving for some types of financial goals while you also invest in an effort to achieve other goals.

The Bottom Line

Saving and investing are sometimes used interchangeably, but they represent different ways of using your money. Saving refers to holding your funds in a low-risk, low-return savings account, CD, or money market account, while investing refers to buying and selling stocks, bonds, ETFs, mutual funds, commodities, and/or real estate.

Saving is generally better for investors with short-term financial goals, a low risk tolerance, or those in need of an emergency fund. Investing may be the best option for people who already have a rainy-day fund and are focused on longer-term financial goals or those who have a higher risk tolerance.

Warren Buffett gained his reputation as a legendary investor and business leader not just for his financial expertise but also for his ability to form successful business relationships.

Buffett, the CEO of Berkshire Hathaway (BRK.A), has consistently compared successful marriages to thriving business partnerships because he sees them as grounded in similar principles. His straightforward, at times humorous, advice on relationships offers practical wisdom for anyone looking to build lasting connections, whether personal or professional.

Key Takeaways

• According to Buffett, low expectations are the key to lasting marriages and business partnerships.
• He has said that selecting the right spouse is one of the most important decisions you can make.
• He has argued that people tend to become like the people they spend time with, recommending that people associate themselves with those who are better than them.

The Power of Low Expectations

Pushing back on the conventional wisdom that suggests one should have high standards going into a relationship, Buffett advises the opposite. “Do you look for brains? Do you look for humor? Do you look for character? Do you look for beauty? No,” he told students at the University of Georgia’s Terry College of Business in 2001. “You look for low expectations. That is the marriage that’s going to last—if you both have low expectations.”

His advice isn’t about settling for less, but about creating a realistic foundation for your relationships. Buffett said he applies the same principle to his business partnerships. “I want my partners to be on the low side on expectations coming in because I want the marriage to last,” he said. “It’s a financial marriage when they join me at Berkshire, and I don’t want them to think I’m going to do things that I’m not going to do.”

Buffett suggests that disappointment often stems from unrealistic expectations. By starting with modest expectations, both parties can be pleasantly surprised rather than consistently disappointed.

Choose Your Partners Wisely

Buffett doesn’t mince words when discussing the significance of choosing the right spouse. “The most important thing is finding the right spouse. If you make the wrong decision on that, you will regret it,” he said in a 2008 conversation with Ivey Business School students. “If you make that one decision right, I will guarantee you a good result in life.”

While Buffett has made billions in the financial world, he still says personal relationships serve as the foundation for overall success and happiness in life.

Buffett famously chooses companies with stable fundamentals combined with leadership teams that share his principles and vision for the long term. He has said that business partnerships should be approached with the same thoughtfulness as one might have when entering a marriage. For both, he says it’s important to have values and objectives that are aligned.

Associate With People Better Than Yourself

Perhaps more importantly, Buffett said in 2017 that good relationships are crucial because you become more like your partners. “You will move in the direction of the people that you associate with. So it’s important to associate with people that are better than yourself,” he said in a conversation with Bill Gates at Columbia University. “And the most important person by far in that respect is your spouse. I can’t overemphasize how important that is.”

The right partner in business and life doesn’t just stand by your side—they inspire you to become better. Likewise, in the business world, surrounding yourself with colleagues who can bring fresh perspectives and a strong sense of ethics can create success unlikely to be found on your own. It’s why Buffett says he always valued the contrarian thinking of his longtime business partner, Charlie Munger, and why he carefully selects business partners who complement rather than merely echo his own approach.

The Bottom Line

Warren Buffett says that both marriages and business partnerships depend on genuine interactions and realistic expectations, and he encourages people to select personal and professional partners carefully. Successful relationships require mutual understanding and shared values, he argues, rather than unrealistic standards or expectations.

Reviewed by Samantha Silberstein
Fact checked by Vikki Velasquez

The arrival of a baby can be both exciting and financially overwhelming. A baby can mean big changes and major expenses for new parents. How much money can you expect to spend on your little one in the first year? What financial tools should you consider creating? Here we’ll show you how to financially prepare for your family’s newest addition before they arrive.

Key Takeaways

• The cost of the delivery largely depends on the location of the facility and the health insurance policy.
• One-time costs include a stroller and nursery furniture.
• Other things to consider include the cost of child care and college savings plans.
• It’s important to have an emergency fund, especially if one parent stays at home.

One-Time Expenses

With a first born, you’ll be starting from scratch, from nursery furniture to a stroller to toys. There’s also the one-time medical expense of delivery.

Medical Bills

It is important to remember that the cost of routine birthing care is highly variable based on your location and insurance coverage.

In the United States, a woman with insurance coverage can expect to pay an average of $2,854 in out-of-pocket costs from pregnancy to postpartum, which includes labor and delivery. That’s according to the Peterson-Kaiser Family Foundation (KFF) Health System Tracker. Delivering via cesarean section had a higher average out-of-pocket cost ($3,214) than a vaginal delivery ($2,655).

According to a 2022 research article published by the Healthcare Cost Institute, the average price of labor and delivery was $13,393 in 2020 (an average of $17,103 for a c-section, and an average of $11,453 for a vaginal delivery). Prices varied by state and by hospital. The state with the lowest average price was Mississippi ($7,639) and the highest was California ($19,230).

If you have an insurance policy, review it to determine your out-of-pocket costs for prenatal care, hospital stay, tests, and postpartum care. Unfortunately, it’s nearly impossible to accurately predict how much you’ll pay without reviewing the health coverage you have available to you. Then, call the hospitals to get pricing information. Compare the hospitals against one another.

Important

An insurance policy and location are important factors when determining how much the delivery of a baby will cost. If you lack a private insurance program, Medicaid or the Children’s Health Insurance Program (CHIP) could be options for you and your child.

Travel

To get out and about you will most likely want to purchase a stroller, an infant car seat (required by law), a baby carrier, and a diaper bag. Like many of the things on this list, there is a wide range of costs.

Some brands of strollers come with a $1,000 price tag—or even higher. On the other hand, more modest options can be purchased new for under $150. Used equipment can be even more affordable.

At the very least, it’s worth buying a new infant car seat, because there’s no way to ensure that a used one hasn’t been compromised in an accident.

Home

At the very least, you’ll need a bassinet and/or crib with a mattress and sheets. Other fixtures are for convenience and comfort: a changing table, a rocking chair, a monitor, and a diaper pail. To keep your child occupied, you may want to consider a portable swing, bouncer, and play mat. The costs for these items range based on your budget, and all of them can be bought second-hand.

Feeding

Feeding costs will vary based on your particular situation. A mother who has no issues breastfeeding around the clock will see very minimal costs for months before a high chair and dishes are required. A breastfeeding pillow may be helpful. Perhaps nipple balm, as well.

If the mother will be pumping and storing breast milk, then a range of items will be needed: a breast pump, bottles, cleaning equipment, and storage bags. The cost of formula will also add significant costs to your first year of parenting.

Adoption

Adoption comes with its own set of expenses. The costs vary but can go as high as $50,000 or more. Some employers offer adoption benefits, such as time off or financial assistance. There are also government programs that may be worth exploring.

Ongoing Expenses

Once your baby arrives, the regular expenses to care for your little one kick in. Factor the following costs into your budget.

Child Care

Your single biggest budget item may be child care. Your child care costs will vary by where you live, how much care you require, and what type of care you use.

The Care Index pegs in-center child care costs at just under $10,000 per year. The average cost of a nanny is around $28,350 a year, but again, that can be higher or lower based on your location.

Some costs might be offset by a tax credit: the child and dependent care credit. Be sure to confirm if you are eligible.

Food

Once you begin feeding your child solid food, you can expect to spend roughly $100 a month. The early food costs for children are relatively small compared to what you will see from a teenager.

Clothing and Diapers

According to the USDA’s most recent The Cost of Raising a Child report, new parents should estimate clothing costs at around $670 up to $1,110 for the first two years. The amount ranges greatly based on personal preference and budget, but the lower end falls around $56 a month.

Diapers also vary in cost, but experts advise that you should budget at least $1,000 for diapers and $450 for wipes for the first year alone. That’s approximately $120 a month. Parents who choose to use disposable diapers should also expect to go through as many as 3,500 diapers in their child’s first year alone.

Making homemade cloth diapers out of repurposed fabrics (either fabrics you have on hand, or inexpensive fabrics found at thrift stores) is an option that would reduce diaper costs significantly.

Medical Bills

Plan on six wellness visits the first year for evaluations, immunizations, etc., and a few additional visits for illnesses. Check your health insurance policy for your rates.

If One Parent Stays at Home

If you become a stay-at-home parent, there are important budget changes to consider. First, you’ll have a reduced family income. You’ll also lose your benefits. And if you eventually decide to try to re-enter the workforce, your earning potential may not be where it once was.

Under the Family Medical Leave Act (FMLA), certain employers must grant you up to 12 work weeks of unpaid leave for your baby’s arrival. (Note: Small businesses do not fall under the FMLA.) Check to see what type of leave you may qualify for with your employer. If you take unpaid leave, calculate your regular expenses during that period—mortgage, utilities, insurance, groceries, etc.—and determine how you will meet those costs.

It’s a good idea to practice living on one income before the baby arrives. And work hard to try to build up an emergency fund of three to six months’ worth of living expenses.

Financial Tools to Consider

With your child’s arrival, you’ll want to create financial tools to help provide for your child’s future. Determine your priorities to begin budgeting.

College Savings Tools

According to the College Board Report, the average cost per year for college in 2024 to 2025 ranged between $11,610 to attend a public four-year in-state school and $43,350 for a private four-year education. Start saving now through one of several college education investment tools, such as a 529 plan, a Coverdell Education Savings Account, or an UGMA/UTMA account.

There have been some changes to the way some accounts can be used—namely the 529 plan. The Tax Cuts and Jobs Act (TCJA) of 2017 and the Setting Every Community Up for Retirement Enhancement Act (SECURE) of 2019 have expanded the use of 529 plans to include K to 12 education, apprenticeship programs, and the ability to pay down student debt.

The SECURE Act 2.0, passed in January 2023, offers another newly expanded benefit for 529 plans. It allows beneficiaries of these plans to roll over up to $35,000 from any 529 accounts in their name to a Roth IRA in their name over the course of their lifetimes.

Life Insurance

If you do not have life insurance, now is the time to buy it if you can afford to do so. For just a few dollars a month, you can be assured that your child will have financial resources if you and/or your partner were to die unexpectedly. Talk to your employer or an insurance agent for options on both life insurance and disability insurance. 

Health Insurance

Without health insurance, just one serious accident or illness could deplete your savings and put you in significant debt. Investigate your insurance options if you don’t already have coverage, or budget for the increased monthly premium to add your child to your policy.

Flexible Spending Accounts (FSAs)

Flexible Spending Accounts (FSAs) enable you to use pretax dollars to pay for important family budget items, like child care and healthcare expenses. Talk with your employer or financial advisor about setting up a dependent-care FSA and/or healthcare FSA. 

Ways to Save Money

No matter your income, there are numerous ways to meet your new baby’s needs without breaking the bank:

• Consignment/Thrift Stores: Babies grow quickly. Instead of paying full price for their clothing, check out gently used and even new items at your local consignment or thrift store. Many stores will also buy back items after your child has outgrown them for cash or store credit. Online swap groups and parent networks can also provide quality goods for little money—and sometimes, it’s free. 
• Family/Friends for Back-Up Childcare: Instead of having to take a day off (possibly without pay) when your child is sick, make arrangements for family or friends to help out with emergency back-up daycare.
• Borrow Items from Friends: Ask friends with young children if you could borrow items—particularly big-ticket items they’re not using, like a crib, high chair, or rocking chair.
• Baby Shower Gifts: Register so party-goers can buy what you really need and avoid ending up with what you don’t.
• Downgrade Your Lifestyle: Having a child is going to change a lot of things, including your financial priorities. After reviewing your new budget, you may not be able to make the numbers add up. Consider closing the gap by downgrading in a few key areas. For example, think about trading in your vehicle for a more affordable model, shopping at less expensive stores, or buying more generic items.

How Much Does It Realistically Cost to Have a Baby?

From pregnancy to postpartum care, it costs an average of $18,865 to have a baby, according to the Peterson-Kaiser Family Foundation (KFF) Health System Tracker. That includes childbirth. For families with health insurance, the cost is much lower, with out-of-pocket costs averaging $2,854.

How Much Does Daycare Cost?

On average, daycare was $343 per week in 2024. (In 2023, it was $321 per week.)

How Expensive Is a Nanny?

In 2024, a nanny cost an average of $827 per week. (In 2023, it was $766 per week.)

The Bottom Line

Children are a wonderful gift—but an expensive one. Good health insurance can protect you from hospital bills for the most part, but only planning and budgeting can help you handle the rest.

Reviewed by Chip Stapleton
Fact checked by Suzanne Kvilhaug

Investors can monitor the financial health of a company by understanding its debt. Gross debt is the total of the book value of a company’s debt obligations. Net debt is the company’s gross debt minus any cash and cash-like assets on the balance sheet. Net debt tells investors how much remains on the balance sheet if the company pays all obligations with its existing cash balances.

Key Takeaways:

• Gross debt is the total book value of a company’s debt obligations.
• Net debt is the book value of a company’s gross debt minus any cash and cash-like assets on the balance sheet.
• Net debt is a liquidity metric used to determine how well a company can pay all its debts if they come due immediately.

What Is Gross Debt?

A debt is money borrowed from another entity. Debts typically involve paying interest to the lender and may include bank loans, mortgages, and bonds. Gross debt is the total debt a company has at a specific time. For example, if a small business borrows $40,000 from a bank and $10,000 from a family member and has no other debts, the gross debt is $50,000.

Burdensome debt loads can be problematic for company stakeholders. Just because a company has more debt does not necessarily mean it is financially worse off than a company with less debt. For example, what may appear to be a large debt load on a company’s balance sheet may be smaller than an industry competitor’s debt on a net basis. Investors can look to net debt to further evaluate the company’s books.

Note

Net Debt = Short Term Debt + Long Term Debt – Cash or Cash Equivalents

Evaluating Net Debt

Net debt reveals additional details of a company’s financial health beyond gross debt. Net debt compares metrics between industry peers. A company’s balance sheet is used to calculate net debt. Net debt also provides insights into a company’s operational strategy.

If the difference between net and gross debt is substantial, the company has a large cash balance along with significant debt. This may occur due to liquidity concerns, capital investment opportunities, and planned acquisitions. Therefore, net debt should be examined using an industry benchmark and company strategy.

Why Is Net Debt Important During an Acquisition?

Net debt is a key factor during a buyout. When a buyer is looking to acquire a company, net debt is more relevant than gross debt from a valuation standpoint. A buyer is not interested in spending cash to acquire cash. It is more meaningful for the buyer to use the target company’s debt net of its cash balances to accurately assess the acquisition.

What Is the Difference Between Short-Term and Long-Term Debt?

Short-term debt is due in one year or less and can include short-term bank loans, accounts payable, and lease payments. Long-term debt has a maturity date over one year and includes bonds, lease payments, and term loans.

What Is Enterprise Value?

Enterprise value (EV) measures a company’s total value. It measures the market capitalization of a company, its short-term and long-term debt, and any cash or cash equivalents on the company’s balance sheet. Enterprise value is often used as a more comprehensive alternative to market capitalization when valuing a company.

The Bottom Line

Gross debt is the total book value of a company’s debt obligations that includes short term and long term debt. Net debt is gross debt minus any cash and cash-like assets on the balance sheet. Net debt tells investors how liquid a company is and how well the business can pay its debts if they come due immediately.

Fact checked by Giselle Cancio

Many assume the ultra-wealthy pay sky-high inheritance taxes. In reality, most pay far less than expected—or even nothing at all. How? Through a mix of high exemptions, legal trusts, and strategic gifting that shift tax burdens away from their heirs.

By following the same key strategies that reduce inheritance taxes and learning the loopholes that keep wealth in the family, you may be able to take your estate planning up a notch.

Key Takeaways

• Wealthy individuals often use legal strategies like trusts, gifts, and charitable donations to minimize inheritance taxes.
• High exemptions mean most estates avoid federal estate taxes, but proper planning also ensures that heirs don’t face unexpected tax bills.
• Estate planning isn’t just for the super-rich—it helps families at all income levels protect their assets and ensure a smooth transfer to heirs.

How Inheritance Taxes Work

Inheritance taxes are often misunderstood, and for good reason. Depending on where you live, they might take a sizable chunk of an estate—or leave heirs with no tax bill. The federal threshold is so high that most estates fall well below the taxable limit.

For those who owe, strategies like trusts, gifting, and charitable donations can significantly lower their tax liability and, in some cases, eliminate it.

Inheritance Tax vs. Estate Tax

Though often confused, inheritance and estate taxes are distinct.

• Estate tax is taken from the total value of a deceased person’s estate before assets are distributed.
• Inheritance tax is paid by heirs on what they receive, but only in certain states. The federal government imposes estate taxes, while inheritance taxes depend on state laws and a beneficiary’s relationship to the deceased.

Federal vs. State Inheritance Taxes

As of 2025, the federal estate tax exemption, or the amount an individual can pass on tax-free, stands at $13.99 million. This high threshold means that many estates fall below the taxable limit, thereby reducing potential tax liabilities.

Only six U.S. states impose an inheritance tax, making it easier for wealthy individuals in most regions to avoid this tax altogether. Plus, federal tax thresholds are so high that many estates don’t reach them, further reducing tax liabilities.

Common Misconceptions About Inheritance Taxes

It’s a common misconception that wealthy individuals pay substantial inheritance taxes. In reality, tax exemptions, trusts, and smart financial strategies can significantly reduce their payments. Since only a handful of states impose inheritance taxes and the federal estate tax exemption is so high, most estates owe little to nothing. In many cases, careful planning can result in little to no inheritance taxes for heirs.

How Wealthy Families Minimize Inheritance Taxes

Wealthy families often pass down fortunes while paying little to nothing in inheritance taxes. They accomplish this through high estate tax exemptions, strategic gifting, and estate planning tools like trusts. All of these methods legally minimize tax obligations and, in some cases, eliminate them altogether. Here’s how they do it.

Tax Exemptions and Thresholds

The federal estate tax exemption is extremely high—$13.99 million in 2025—meaning estates below this threshold pay no federal estate tax. If an estate exceeds this amount, tax planning becomes essential to reduce the tax burden.

One key strategy used to minimize estate taxes is the step-up in cost basis, which can significantly reduce capital gains taxes for heirs. Jason Escamilla, CFA, founder, CEO, and Chief Investment Officer of ImpactAdvisor LLC, explains that with proper planning, inherited assets can transfer tax-free if they remain below the estate exclusion limits.

“That comes across completely tax-free when you do the proper planning and when you’re below the estate exclusion limits,” he said.

Trusts and Estate Planning Strategies

Dynasty trusts, revocable trusts, and other strategies allow wealthy individuals to transfer assets without triggering high tax liabilities.

Beyond trusts, estate planning strategies like wills, beneficiary designations, and family-limited partnerships can also help structure wealth transfers efficiently.

Proper planning allows your assets to be distributed according to your wishes while minimizing tax exposure and reducing legal complications.

Setting up a trust can help reduce inheritance tax liability and provide long-term financial benefits for your heirs. Learn how to create a trust fund for your family.

Gifting Strategies

Gift-giving is another tool used to reduce the size of taxable estates and pass on wealth to heirs with minimal tax liability. However, deciding when to give and when to hold assets does require careful planning. Every time you sell an asset and pay taxes, you have less wealth working for you.

Escamilla cautions, “It’s important to keep in mind, ‘every time I do that I have less wealth.’ And so it’s a constant trade-off to consider—do we just let it ride?”

Holding onto appreciated assets until inheritance can allow heirs to benefit from the step-up in cost basis, which eliminates capital gains taxes on past appreciation.

Charitable Giving As a Tax Shield

Charitable donations can not only help causes that matter but also reduce taxable estates. By giving to charity, wealthy individuals can lower their estate’s taxable value, which reduces their inheritance taxes.

Escamilla explained that tax planning around charitable giving allows people to be more intentional with their donations, making sure that they align with their long-term financial strategy.

“You can do tax planning around it and then you can be thoughtful and say…we really wanted to donate this anyway, you know, and so we’re going to donate it in a couple of years,” he said.

Valuation Discounts for Family-Owned Businesses

Family-owned businesses can use valuation discounts to reduce the taxable value of the estate and help heirs retain more wealth after inheritance. Valuation discounts allow certain assets, like family-owned businesses, to be appraised at a lower value for tax purposes, reducing the overall estate tax burden.

For example, a Discount for Lack of Marketability (DLOM) accounts for the difficulty in selling a privately-held business interest, while a Discount for Lack of Control (DLOC) reflects the reduced influence of someone with minority ownership.

The Bottom Line

For those managing inherited assets, a lack of awareness can lead to costly mistakes.

“People eventually take over management for their parents, and this is very important, but they’re not thinking about these things. When they take this stuff over, they might think, let’s blow out these stocks, and let’s do this,” said Escamilla. Selling assets haphazardly can trigger unexpected tax bills, reducing the value of the inheritance.

Careful tax planning is crucial. Wealthy folks often pay less thanks to strategies like high exemptions, trusts, gifting, and charitable donations. Learning how these strategies work can give you more control over your own estate planning, allowing you to reduce unnecessary taxes.

Whether you’re part of a high-net-worth family or simply looking to protect your own wealth, it’s never too early to start planning for a smoother transfer to your heirs.

It depends on who’s doing the garnishing

Reviewed by Anthony Battle
Fact checked by Vikki Velasquez

Can Social Security benefits be garnished? The answer is a definite no in some situations, but in others, it becomes a distinct possibility. Ultimately, it depends on who’s doing the garnishing. Certain government entities, such as the U.S. Treasury and the Social Security Administration can garnish your wages for unpaid debts, such as child support, federal student loans, and back taxes.

Key Takeaways

• The U.S. Treasury and the Social Security Administration can garnish your Social Security benefits for unpaid debts such as back taxes, child support, or a federal student loan that’s in default.
• If you owe money to the IRS, a court order is not required to garnish your benefits.
• You’ll have to shell out 15% of your Social Security for federal back taxes and as much as 65% for alimony or child support owed. 

What Is Wage Garnishment and How Does It Work?

Here’s how garnishing works. A commercial creditor to whom you are in debt takes you into court and wins a judgment against you. Then the creditor asks the judge for an order to garnish your wages, bank account, and any other assets you may have to satisfy that debt.

The judge approves the garnishment to square the debt. Are all your assets vulnerable, including Social Security and retirement benefits such as a 401(k) or an individual retirement account (IRA)?

When the Creditor Is a Commercial Entity

When it comes to federal benefit payments—Social Security benefits, Veterans Affairs benefits, railroad retirement benefits, federal student aid, and Office of Personnel Management retirement benefits—the answer is no.

A creditor who has issued you a credit card or an auto loan can’t garnish these federal benefits, even if your payment is late. Creditors holding medical bills, along with personal and payday loans, are also prohibited from garnishing these benefits.

401(k)s are generally safe from garnishment by commercial creditors as long as the money stays in the account, thanks to the Employment Retirement Income Security Act of 1974 (ERISA). IRAs are more vulnerable to garnishment.

If you’re not ordered to pay back taxes or child support, then the bank has to review a two-month history of your account(s). If your Social Security or other protected benefits have been directly deposited into your account(s) within that two months—the so-called “look-back period”—the bank must protect the funds.

However, your creditor can still garnish your wages and, depending on the state where you live, other allowable assets you may have, such as a house or car.

When the Creditor Is the Federal Government

Suppose that you owe the federal government back taxes. You’re going to have to hand over 15% of your Social Security benefits. Funds in a 401(K) or an IRA are also vulnerable.

If you owe alimony or child support, the federal government can get involved in that too: You may have to forfeit as much as 65% of your Social Security benefit. And the Internal Revenue Service (IRS) doesn’t need a court order to garnish your benefits.

When your bank receives the garnishment order, it has two business days to conduct a review and identify your accounts. Depending on the order, the bank may freeze those accounts.

You can avoid the garnishment if you arrange with the IRS to pay off back taxes. In that case, it will no longer garnish your Social Security benefits, though it retains the right to do so if you fail to hold up your end of the bargain.

Important

Retirement plans set up under the Employee Retirement Income Security Act (ERISA), such as 401(k)s, are generally protected from judgment creditors.

When the Credit Is a Federal Student Loan

If you become delinquent on a federal student loan, the government can take “the lesser of 15% of the monthly benefit payment, the amount by which the benefit payment exceeds $750 per month, or the outstanding amount of the debt.” This means the government is not entitled to the first $750 of your monthly Social Security and retirement benefits.

For example, if you receive $850 in benefits per month, 15% of that would be $127.50. Because you can’t be given less than $750 per month, the most that can be garnished from your benefits is $100. Note: This rule applies only to federal student loans, not private loans.

Are Pensions and Social Security Protected from Creditors?

Though Social Security benefits are generally exempt from garnishment and levies—as long as the direct deposit is used—the Department of the Treasury can collect the debt; it’s one exception. Up to 15% of your monthly Social Security benefit may be levied to pay overdue federal taxes.

How Much of My Social Security Can Be Garnished?

Up to 65% of your Social Security benefit can be garnished for child support or alimony that is 12 or more weeks late. For court-ordered restitution, it’s up to 25% of your monthly benefit. For delinquent student loans and overdue taxes, it’s up to 15%.

Is Retirement Income Protected From Garnishment?

It depends. Some retirement income, such as Social Security and 401(k)s, is protected from certain creditors, while vulnerable to others. Other retirement income, such as an IRA, is more vulnerable.

The Bottom Line

Only the federal government can garnish your Social Security and other federal retirement benefits. If you are in danger of such a scenario, get legal help. The American Bar Association provides links to free and low-cost lawyers who can advise you.

Reviewed by Andy Smith
Fact checked by Vikki Velasquez

Financial statements provide a snapshot of a corporation’s financial health at a particular point in time, giving insight into its performance, operations, cash flow, and overall conditions. Shareholders need financial statements to make informed decisions about their equity investments, especially when it comes time to vote on corporate matters.

Key Takeaways

• Financial statements provide a snapshot of a corporation’s financial health, giving insight into its performance, operations, and cash flow.
• Financial statements are essential since they provide information about a company’s revenue, expenses, profitability, and debt.
• Financial ratio analysis involves the evaluation of line items in financial statements to compare the results to previous periods and competitors.
• Liquidity and solvency ratios provide information about a company’s ability to repay its debts and obligations.
• Valuation ratios help determine a fair value or price target for a company’s shares.

Understanding Financial Statements

Financial statements are the financial records that show a company’s business activity and financial performance. Companies are required to report their financial statements on a quarterly and annual basis by the U.S. Securities and Exchange Commission (SEC). The SEC monitors the markets and companies to ensure that everyone is playing by the same rules and that markets function efficiently. There are specific guidelines that are required by the SEC when issuing financial reports so that investors can analyze and compare one company with another easily.

Financial statements are important to investors because they can provide information about a company’s revenue, expenses, profitability, debt load, and ability to meet its short-term and long-term financial obligations. There are three major financial statements.

Balance Sheet

The balance sheet shows a company’s assets (what they own), liabilities (what they owe), and stockholders’ equity (or ownership) at a given moment. It represents the financial position of a company at a specific point in time. For instance, you’ll often notice a company issues their balance sheet as of a certain date such as the last day of the calendar year (12/31/20xx). This report shows the exact amount of assets, liabilities, and equity that exist as of that specific day.

Income Statement

The income statement reports the revenue generated from sales, the operating expenses involved in creating that revenue as well as other costs, such as taxes and interest expense on any debt on the balance sheet. The net amount or the bottom line of the income statement is the net income or the profit for the period. Net income is revenue minus all of the costs of doing business.

As opposed to a balance sheet, the income statement represents a period of time. You may also notice a company issues an income statement with a certain date on it, such as “for the period ending 12/31/20xx)”. This means the report shows all of the sales and expenses for a period of time. Most commonly, for companies with a fiscal year that is equal to a calendar year, that period would be the entire calendar year.

Cash Flow Statement

The cash flow statement (CFS) measures the cash generated for a period, including all of the transactions added to or subtracted from cash. Cash flow is important because it shows how much cash is available to meet short-term obligations, invest in the company, or pay dividends to shareholders. Note that the components of the balance sheet and income statement can feed into the cashflow statement. It’s a way to translate operating results into how cash was directly impacted.

In addition to reviewing a company’s financial statements themselves, also pay attention to the information provided in the footnotes to the financial statements.

The Usefulness of Financial Ratios

Financial ratios help investors break down the enormous amount of financial data that are reported by companies. A ratio is merely a metric to help analyze the data and make useful comparisons with other companies and other reporting periods.

Financial ratio analysis analyzes specific financial line-items within a company’s financial statements to provide insight as to how well the company is performing. Ratios determine profitability, a company’s indebtedness, the effectiveness of management, and operational efficiency.

It’s important to consider that the results from financial ratios are often interpreted differently by investors. Although financial ratio analysis provides insight into a company, individual ratios should be used in tandem with other metrics and evaluated against the overall economic backdrop. Below are some of the most common financial ratios that investors use to interpret a company’s financial statements.

Profitability Ratios

Profitability ratios are a group of financial metrics that show how well a company generates earnings compared to its associated expenses. However, investors should take care not to make a general comparison. Instead, they will get a better sense of how well a company is doing by comparing ratios of a similar period. For example, comparing the fourth quarter of this year with the same quarter from last year will net a better result.

Return on Equity

Return on equity, or ROE, is a common profitability ratio used by many investors to calculate a company’s ability to generate income from shareholders’ equity or investments. Companies issue shares of stock to raise capital and use the money to invest in the company. Shareholders’ equity is the amount that would be returned to shareholders if a company’s assets were liquidated, and all debts were paid off. The higher the return or ROE, the better the company’s performance since it generated more money for each dollar of investment in the company.

​Return on Equity=Average Shareholders’ Equity/Net Income

Operating Margin

Operating profit margin evaluates the efficiency of a company’s core financial performance. Operating income is the revenue generated from a company’s core business operations. Although the operating margin is the profit from core operations, it doesn’t include expenses such as taxes and interest on debt.

As a result, operating margin provides insight as to how well a company’s management is running the company since it excludes any earnings due to ancillary or exogenous events. For example, a company might sell an asset or a division and generate revenue, which would inflate earnings. The operating margin would exclude that sale. Ultimately, the operating profit is the portion of revenue that can be used to pay shareholders, creditors, and taxes.

Operating Margin = Operating Earnings / Revenue

Liquidity Ratios

Liquidity ratios help shareholders determine how well a company handles its cash flow and short-term debts without needing to raise any extra capital from external sources, such as a debt offering.

Current Ratio

The most commonly used liquidity ratio is the current ratio, which reflects current assets divided by liabilities, giving shareholders an idea of the company’s efficiency in using short-term assets to cover short-term liabilities. Short-term assets would include cash and accounts receivables which are money owed to the company by customers. Conversely, current liabilities would include inventory and accounts payables, which are short-term debts owed by the company to suppliers.

Higher current ratios are a good indication the company manages its short-term liabilities well and generates enough cash to run its operation smoothly. The current ratio generally measures if a company can pay its debts within 12 months. It can also be useful in providing shareholders with an idea of the ability a company possesses to generate cash when needed.

Current Ratio = Current Assets / Current Liabilities

Note

Other liquidity ratios include the quick ratio (also known as the acid test) and the operating cash flow ratio.

Debt Ratios

Debt ratios indicate a company’s debt situation and whether they can manage their outstanding debt as well as the debt servicing costs, such as interest. Debt includes borrowed funds from banks but also bonds issued by the company.

Bonds are purchased by investors where companies receive the money from the bonds upfront. When the bonds come due–called the maturity date–the company must pay back the amount borrowed. If a company has too many bonds coming due in a specific period or time of the year, there may not be enough cash being generated to pay the investors. In other words, it’s important to know that a company can pay its interest due on its debts, but also it must be able to meet its bond maturity date obligations.

Debt-to-Equity Ratio

The debt-to-equity (D/E) ratio measures how much financial leverage a company has, which is calculated by dividing total liabilities by stockholders’ equity. A high debt-to-equity ratio indicates a company has vigorously funded its growth with debt. However, it’s important to compare the debt-to-equity ratios of companies within the same industry. Some industries are more debt-intensive since they need to buy equipment or expensive assets such as manufacturing companies. On the other hand, other industries might have little debt, such as software or marketing companies.

D/E = Total Liabilities / Total Equity

Interest-Coverage Ratio

The interest coverage ratio measures the ease with which a company handles interest on its outstanding debt. A lower interest coverage ratio is an indication the company is heavily burdened by debt expenses.

Interest Coverage = EBIT / Interest Expense

EBIT stands for earnings before income and taxes, and is also referred to as operating profit.

Efficiency Ratios

Efficiency ratios show how well companies manage assets and liabilities internally. They measure the short-term performance of a company and whether it can generate income using its assets.

Inventory Turnover

The inventory or asset turnover ratio reveals the number of times a company sells and replaces its inventory in a given period. The results from this ratio should be used in comparison to industry averages. Low inventory turnover ratio values indicate low sales and excessive inventory, and therefore, overstocking. High ratio values commonly indicate strong sales and good inventory management.

Inventory Turnover = Cost of Goods Sold / Average Inventories

Valuation Ratios

Price ratios focus specifically on a company’s stock price and its perceived value in the market.

Price-to-Earning (P/E)

The price/earnings (or P/E) ratio is an evaluation metric comparing the current share price of a company’s stock with its per-share earnings. Higher P/E values indicate investors expect continued future growth in earnings. However, a P/E that’s too high could indicate that the stock price is too high relative to the earnings or profit being generated. Investors use the P/E ratio to evaluate whether the stock price is fairly valued, overvalued, or undervalued.

The P/E ratio is most helpful when compared to historical P/Es of the same company and companies within the same industry.

P/E = Stock Price / Earnings per Share

Note

Trailing P/E uses a stock’s historical earnings relative to its market price, while forward P/E uses earnings forecasts.

Dividend Yield

The dividend yield ratio shows the amount of dividends a company pays out yearly in relation to its share price. The dividend yield provides investors with the return on investment from dividends alone. Dividends are important because many investors, including retirees, look for investments that provide steady income. Dividend income can help offset, at least in part, losses that might occur from owning the stock. Essentially, the dividend yield ratio is a measurement of the amount of cash flow received for each dollar invested in equity.

Dividend Yield = Annual Dividends per Share / Share Price

Why Do Shareholders Need Financial Statements?

Shareholders rely on financial statements to make informed investment decisions, assess company performance, and evaluate potential risks. They do so using the financial ratios mentioned above.

One of the primary reasons shareholders need financial statements is to assess a company’s profitability and growth using the profitability ratios. By comparing past and present earnings, shareholders can evaluate whether a company is growing sustainably or facing challenges. Profitability ratios, such as gross margin and return on equity, also help investors gauge how efficiently a company generates returns on its capital. Last, companies need financial statements to generate these metrics to compare a company against its competitors to see which one is doing the best at generating profits.

A strong balance sheet with healthy cash reserves and manageable debt levels indicates a company’s ability to withstand economic downturns or invest in future growth. On the other hand, excessive liabilities or declining assets may signal financial distress. Shareholders need the balance sheet to assess short-term health. Liquidity ratios like the current ratio can indicate whether a company can pay its short-term bills. The balance sheet also helps tell the story on whether certain debt covenants will be met or if the company will soon face regulatory complications.

Shareholders need the statement of cash flow to assess whether a company can pay dividends, reinvest in its operations, or handle unexpected financial challenges. This financial statement communicates what a company has done (and may do in the future) with the money it earns. Shareholders need to care about not only how much money a company earns but what exactly they do with their earnings.

Which Financial Statement Is Most Important to Shareholders?

No single financial statement is most important, since the balance sheet, income statement, and statement of cash flows all contain crucial pieces of information. Moreover, many ratios computed using fundamental analysis will draw pieces of data from places found on different statements. For instance, ROE uses information from both the income statement and balance sheet.

What Do Financial Statements Tell You?

A company’s financial statements provide insights into a company’s financial position, profitability, and growth potential. Taken together, financial statements allow analysts to conduct fundamental analysis to evaluate a stock’s value and growth prospects. Financial statements also can signal red flags about financial instability or accounting improprieties.

Are All Shareholders Entitled to a Company’s Financial Statements?

Publicly traded companies are required by the SEC to release their financial statements for public consumption. Investors and non-investors alike are able to access these documents online and for free, from a company’s own website or through the SEC’s EDGAR database.

The Bottom Line

There is no one indicator that can adequately assess a company’s financial position and potential growth. That is why financial statements are so important for shareholders and market analysts alike. These metrics (along with many others) can be calculated using the figures released by a company on its financial statements.