Financial Statements

Overview

Financial statements are documents that present the financial information of a company or organization in a structured and standardized format. They provide a snapshot of a company’s financial position at a specific point in time and can be used to assess the company’s performance, liquidity, solvency, and cash flow.

There are three main types of financial statements:

1. The balance sheet: This statement shows a company’s assets, liabilities, and equity at a specific point in time. It is used to assess the company’s financial position and its ability to pay its debts.
2. The income statement: This statement shows a company’s revenues, expenses, and profit or loss over a specific period of time, usually one year. It is used to assess the company’s financial performance and profitability.
3. The statement of cash flows: This statement shows a company’s inflows and outflows of cash during a specific period of time, usually one year. It is used to assess the company’s liquidity and cash management.

Financial statements are typically prepared by a company’s management and audited by an independent third party, such as a certified public accountant (CPA). They are typically presented in a standardized format and are used by a variety of stakeholders, including investors, creditors, regulators, and analysts.

How to read a balance sheet?

A balance sheet is a financial statement that presents a company’s financial position at a specific point in time. It provides a snapshot of a company’s assets, liabilities, and equity.

To read a balance sheet, you will need to understand the following concepts:

1. Assets: Assets are resources that a company owns or controls, such as cash, investments, property, and inventory. They are listed on the balance sheet in order of liquidity, which means the assets that can be converted to cash most easily are listed first.
2. Liabilities: Liabilities are obligations that a company owes to others, such as loans, taxes, and bills that are yet to be paid. They are also listed on the balance sheet in order of liquidity, with the most liquid liabilities listed first.
3. Equity: Equity represents the residual interest in the assets of a company after liabilities are subtracted. It includes capital stock, retained earnings, and any other funds that have been invested in the company.

To read a balance sheet, start by looking at the assets section. This will give you an idea of the company’s financial resources and how they are being used.

Typical assets that may be listed on a balance sheet include:

1. Current assets: These are assets that are expected to be converted into cash within one year or less, such as cash, accounts receivable, and inventory.
2. Fixed assets: These are long-term assets that are not easily converted into cash, such as property, plant, and equipment.
3. Intangible assets: These are non-physical assets that have value, such as patents, trademarks, and copyrights.
4. Investment assets: These are assets that are held for investment purposes, such as stocks, bonds, and real estate.

It is important to note that the types of assets listed on a balance sheet will vary depending on the nature of the business. For example, a manufacturing company may have a large amount of fixed assets, while a service company may have a larger amount of intangible assets.

Next, look at the liabilities section to see what the company owes to others.

Typical liabilities that may be listed on a balance sheet include:

1. Current liabilities: These are short-term obligations that are due within one year or less, such as accounts payable, taxes owed, and short-term debt.
2. Long-term liabilities: These are obligations that are due in more than one year, such as long-term debt and leases.
3. Contingent liabilities: These are potential obligations that may arise in the future, such as lawsuits or guarantees.

It is important to note that the types of liabilities listed on a balance sheet will vary depending on the nature of the business and its financial structure. For example, a company with a large amount of long-term debt may have a higher level of long-term liabilities on its balance sheet.

Finally, review the equity section to see how the company has financed its assets and how much ownership the shareholders have in the company. Equity is the residual interest in the assets of a company after liabilities are paid. It represents the ownership interest of the shareholders in the company.

It’s important to note that a balance sheet is just one piece of a company’s financial puzzle. To get a complete picture of a company’s financial health, you’ll need to also review its income statement and cash flow statement.

How to read an income statement?

An income statement, also known as a profit and loss statement or P&L, is a financial document that shows a company’s revenues, expenses, and profit or loss over a specific period of time, usually one year. It is used to assess a company’s financial performance and profitability.

To read an income statement, you should start by looking at the top of the document, which should show the period of time covered by the statement. Then, you should look at the revenues section, which shows the total amount of money that the company has earned from its operations during the period. This is typically presented as the top line of the income statement.

Typical revenue items that may be listed on an income statement include:

1. Sales: This is the revenue that a company generates from selling goods or services.
2. Interest income: This is the revenue that a company generates from investing its excess cash in interest-bearing instruments, such as bonds or certificates of deposit.
3. Rent income: This is the revenue that a company generates from renting out its property or equipment.
4. Royalties: This is the revenue that a company generates from licensing its intellectual property, such as patents or trademarks.
5. Dividend income: This is the revenue that a company generates from its investments in other companies.

It is important to note that the types of revenue items listed on an income statement will vary depending on the nature of the business. For example, a company that sells physical products will likely have a large portion of its revenue coming from sales, while a company that generates revenue from intellectual property may have a higher proportion of revenue coming from royalties.

Next, you should look at the expenses section, which shows the total amount of money that the company has spent on its operations during the period. This includes the cost of goods sold (COGS), which represents the direct costs of producing the goods or services that the company sells, as well as other expenses, such as marketing, research and development, and general and administrative expenses.

In addition to revenues, an income statement also lists a company’s expenses, which are the costs incurred in the process of generating revenue. Typical expenses that may be listed on an income statement include:

1. Cost of goods sold (COGS): This is the cost of the goods or materials that a company uses to produce the products it sells.
2. Sales and marketing expenses: These are the costs associated with promoting and selling the company’s products or services.
3. General and administrative expenses: These are the overhead costs of running the business, such as rent, utilities, and insurance.
4. Research and development expenses: These are the costs associated with developing new products or improving existing ones.
5. Depreciation and amortization: These are non-cash expenses that reflect the wear and tear on a company’s assets over time.

It is important to note that the types of expenses listed on an income statement will vary depending on the nature of the business. For example, a manufacturing company may have a large portion of its expenses coming from COGS, while a service company may have a larger proportion of expenses related to sales and marketing.

After you have reviewed the revenues and expenses sections, you can calculate the company’s profit or loss by subtracting the expenses from the revenues. If the result is positive, the company has made a profit; if the result is negative, the company has incurred a loss.

It’s also a good idea to review any notes or disclosures that are included with the income statement, as these can provide additional information about the company’s financial performance and its accounting policies.

In addition to reviewing the income statement on its own, you may want to compare it to the company’s financial statements from previous periods or to the financial statements of other companies in the same industry. This can help you get a better understanding of the company’s financial performance over time and how it compares to its peers.

How to read a cash flow statement?

A cash flow statement is a financial report that shows the inflow and outflow of cash for a company over a specific period of time, such as a month or a year. It provides information about a company’s liquidity and how it is generating and using cash.

There are three main sections in a cash flow statement:

1. Operating activities: This section shows the cash flow from the company’s day-to-day business operations, such as selling goods or services and collecting payments from customers.
2. Investing activities: This section shows the cash flow from the company’s investments in long-term assets, such as purchasing or selling property, plant, and equipment.
3. Financing activities: This section shows the cash flow from the company’s financing activities, such as borrowing money or repaying debt.

To read a cash flow statement, start by reviewing the operating activities section. This will give you an idea of the company’s overall financial health and whether it is generating enough cash to cover its operating expenses.

The operating activities section of a cash flow statement shows the cash flow from a company’s day-to-day business operations. This includes the cash generated from selling goods or services and the cash spent on operating expenses, such as salaries, rent, and utilities.

Some specific items you might expect to see under operating activities on a cash flow statement include:

1. Net income: This is the company’s profit or loss from its business operations, as reported on the income statement.
2. Depreciation and amortization: These are non-cash expenses that reflect the wear and tear on a company’s assets over time.
3. Changes in working capital: This is the difference between a company’s current assets and current liabilities. For example, if a company’s accounts receivable increased while its accounts payable decreased, this would result in a positive change in working capital.
4. Other non-cash items: These are items that do not involve a cash outflow or inflow, such as stock-based compensation.

By reviewing the operating activities section of a cash flow statement, you can get a sense of how much cash a company is generating from its business operations and how it is using that cash to fund its operating expenses. Comparing this section to previous periods can also give you an idea of whether the company’s cash flow is improving or worsening over time.

Then, review the investing and financing activities sections to see how the company is using its cash for long-term investments or financing activities.

The investing activities section of a cash flow statement shows the cash flow from a company’s investments in long-term assets, such as property, plant, and equipment. This includes the cash spent on purchasing these assets as well as the cash generated from selling them.

Some specific items you might expect to see under investing activities on a cash flow statement include:

1. Purchases of property, plant, and equipment: These are long-term assets that are used in a company’s business operations.
2. Sales of property, plant, and equipment: This is the cash generated from selling these assets.
3. Investments in stocks, bonds, and other securities: This is the cash spent on purchasing these investments.
4. Sales of stocks, bonds, and other securities: This is the cash generated from selling these investments.

By reviewing the investing activities section of a cash flow statement, you can get a sense of how much cash a company is using to fund its long-term investments and how it is generating cash from these investments. Comparing this section to previous periods can also give you an idea of whether the company’s investing activities are increasing or decreasing over time.

On a cash flow statement, the section labeled “financing activities” includes all the transactions that involve a company’s borrowings and repayments, as well as the issuance and repurchase of its own equity. These activities can have a significant impact on a company’s cash position.

Examples of financing activities that might appear on a cash flow statement include:

• Issuance or repurchase of debt: This includes the sale of new debt instruments, such as bonds, and the repayment of existing debt. It also includes the issuance or repurchase of short-term debt, such as commercial paper.
• Issuance or repurchase of equity: This includes the sale of new shares of stock and the repurchase of existing shares. It also includes the issuance or repurchase of other equity instruments, such as stock options or warrants.
• Dividends: This includes any dividends paid to shareholders during the period covered by the cash flow statement.
• Changes in shareholder equity: This includes any changes in the equity of the company due to the issuance or repurchase of equity, as well as any changes in retained earnings.

It is important to note that financing activities do not include transactions that involve the company’s operating activities, such as the sale of goods or services. These transactions are reported in the “operating activities” section of the cash flow statement.

It is also helpful to compare the cash flow statement to previous periods to see if the company’s cash flow is improving or worsening over time. Additionally, you can compare the cash flow statement to the company’s income statement and balance sheet to get a more comprehensive understanding of its financial performance.