Whether you want to buy a company’s stocks or analyze its finances, it is equally important to read its financial statements thoroughly.
This article will teach you how to read a company’s financial statement with ease.
So let’s get straight into it.
What are Financial Statements?
Financial statements are documents that describe a company’s operations and financial performance. Government organizations, accounting companies, etc., frequently audit financial statements to guarantee accuracy and for tax, financing, or investing purposes.
The line items in a financial statement might vary depending on the organization.
But the most typical ones include cash, marketable securities, inventories, short-term debt, long-term debt, accounts receivable, accounts payable, and cash flows from investing, operating, and financing operations.
Importance Of Financial Statements
Financial statements provide insight into how a company runs in terms of its finances. It offers insight into the size and method of a company’s revenue generation, the cost of conducting business, the effectiveness with which it handles cash, and the nature of its assets and liabilities.
Moreover, they contain all the information necessary to assess how effectively or poorly a company can spot any patterns.
The company’s results should be compared to those of its competitors in the same industry when evaluating financial statements to look for trends. You should also compare multiple periods for the company.
Moreover, reading financial statements can be incredibly beneficial for small business owners. You can choose how to expand your business and spend resources by knowing where your company’s finances stand.
Let’s examine how to quickly and easily comprehend financial statements.
- The income statement displays the revenue and costs of your company over time.
- The cash flow statement displays the company’s cash flow position or cash inflow and outflow.
- Your company’s assets, liabilities, and equity are displayed on the balance sheet. The Document communicates a corporation’s “book worth.” You can imagine the available resources and how they have been supported on a specific date.
Taking the time to read and understand your financial statements can help you run your business more effectively and make better decisions about your business’s future.
So, let’s start with the different financial statements and how we can read them precisely.
This statement helps to know the company’s assets, liabilities, and equity at a specific time. The balance sheet can give a snapshot of a company’s financial health and help you assess its solvency.
Here is the accounting equation: Assets = Liabilities + Owners’ Equity.
- Assets are units that a corporation owns with a quantitative price.
- Liabilities sit down with the cash a corporation owes to debtors. This includes outstanding payroll expenses, debt payments, rent and utility, bonds owed, and taxes.
- Owners’ equity refers to the net value of a corporation. The quantity of cash will be left if all assets are oversubscribed and all the liabilities are paid. This cash belongs to the shareholders, who could also be personal house owners or public investors.
The record doesn’t alone offer info on trends, which is why we should also look at alternative money statements, together with financial gain and income statements, to comprehend a company’s money position completely.
The income statement includes a company’s revenues, expenses, and net income for a specific period. The income statement can help you assess a company’s financial performance and identify trends. To understand the profit or loss situation of a company, you need to understand the following terms and their meanings that come under the income statement.
- Revenue– The amount of money a business makes.
- Expenses– The sum of money a company spends on its operations.
- COGS or Costs of Goods Sold– The price of the individual elements required to manufacture whatever a business sells.
- Gross profit– Total revenue after deducting the COGS.
- Profit before taxes – It refers to Operating profit deducting the non-operating costs.
- Gross income– It refers to the total income of a company without deducting any expenses or taxes.
- EPS(Earnings per share)– It is calculated by Net income divided by the total number of shares outstanding.
- Depreciation refers to how much an asset, like outdated equipment, has depreciated over time.
- Profit before interest, taxes, depreciation, and: amortization, or EBITDA
Having good knowledge of these components would help you understand the financial stability of a company.
Cash Flow Statement
A cash flow statement shows a company’s cash inflows and outflows for a specific period. The cash flow statement can help you assess a company’s liquidity and ability to pay its bills.
Cash flows have three activities:
- Operating activities – It refers to the inflow and outflow of money resulting from managing the company and making sales of goods or services. Any adjustments to cash, accounts receivable, depreciation, inventory, and accounts payable are included in cash from operations. This list of transactions includes wages, tax payments on income, interest payments, rent payments, and cash earnings from the sale of goods or services.
- Investing Activities – It refers to the cash inflow and outflow from a corporation’s investments into the company’s long-term success. This group includes any payments connected to a merger or acquisition, the acquisition or sale of an asset, loans given to or received from suppliers, and customer loans. Additionally, this part includes purchases of permanent assets like property, plants, and equipment (PPE). In other words, changes to investments, equipment, or assets are related to cash from investments.
- Financial Operations– Funds used for financing comprises payments made to shareholders and cash obtained from banks or investors. Loans, dividend payments, stock repurchases, equity issuance, debt repayments, and loans are all examples of financing activities.
Three significant company activities are included in this category, and the cash flow statement reconciles the income statement and balance sheet for each.
Following the company’s standard goods or services, operating activities describe the cash flow, including revenue and expenses. Investing activity is the cash flow from buying or selling assets using free cash instead of debt. Assets such as real estate, cars, or patents might be physical or intangible—cash flow from debt and equity financing.
A company’s ability to expand its operations and maintain its financial stability is reflected in a positive cash flow, which is why it is ideal for the company to exceed net income frequently.
The analysis of balance sheets and income statements is also necessary because a company’s positive cash flow does not always imply that it is profitable. It’s crucial to understand that cash flow and profit are two different things.
Besides, knowing the three components of financial statements. Understanding how to read a company’s annual report is essential.
Public firms must publish an annual report to shareholders that details their operational and financial status.
Annual reports frequently use editorial and narrative to illustrate company operations, benchmarks, and accomplishments through pictures, infographics, and a letter from the CEO. Compared to individual financial statements, they give shareholders, investors, and employees more understanding of a company’s vision and objectives.
A company’s income statement, balance sheet, and cash flow statement are all included in an annual report and the editorial. Additionally, it offers insights into various sectors and management’s discussion and analysis (MD&A), accounting principles, and supplementary investor data.
Financial Statement’s Restrictions
Although financial statements offer a wealth of data about a company, they have some restrictions. Investors frequently come to diverse conclusions about a company’s financial success due to the statements’ interpretive openness.
For instance, some investors could favor stock repurchases, while others might like to see that money put toward long-term investments. One investor may see a company’s debt level as acceptable, while another may find the company’s debt level to be concerning.
Reviewing and comprehending these financial records can give you essential information about a company, such as:
- Debts incurred and repayment capacity.
- Earnings or losses for a specific quarter or year.
- If profit has risen or fallen compared to comparable accounting periods in the past.
- Operational costs, particularly when contrasted to the income produced by such expenses.
- Employees can gain from studying balance sheets, income statements, cash flow statements, and annual reports. But accountants, investors, shareholders, and company leadership must be acutely aware of an organization’s financial health.
This is an excellent opportunity for you to start reading your financial accounts. It can give you invaluable insights into your financial health.
Now that you know the basics, you can start reading financial statements confidently. With a bit of practice, you’ll be able to glean valuable insights that will help you make better investment decisions.