Best Things You Need to Know About Financial Statements

Best Things You Need to Know About Financial Statements

If you want to know about the financial health of a company, then have a look at its financial statements. Studying these financial statements is a very significant part of fundamental analysis. The function of an analyst is to dig deeper and evaluate the financial statements very well. This allows them to discover the hidden aspects of the financial status of a company. But in the case of an investor, it is enough to understand the basic financial statements.

An investor should focus on the three most significant financial statements. These are profit and loss statement, cash flow statement and the balance sheet. If you go through the profit and loss statement, you will get to know about the profitability of a company. The cash flow statement tells you about the cash flow of a company. It will give you an idea about the amount of cash flowing out as well as into the company. Having a look at the balance sheet of a company gives you an idea of the liabilities and assets of a company.

  • Profit and loss statement: As told earlier, the profit and loss statement of a company lets an investor know about the profitability of a company.

Profit = Revenue-Expenses. This is the simplest formula to calculate the profit of a company. Under the heading of "Revenue", there are basically two categories; one is revenue from sales and the second is revenue from other income sources. If you are wondering what other income sources are, then its meaning is the income that a company acquires from sources other than its core operational area. It can either be income from royalties, or investments, dividends and so on.

If you want to calculate the final profit figure, then you need to add or subtract any miscellaneous income or loss respectively from the operating profit.

In the end, you will be able to obtain the net profit by deducting the applicable tax.

  • Cash flow statement: The cash flow statement gives you an idea of the flow of cash in and out of a company. It is possible that a company may misstate its profits by using clever tricks. However, it is not possible for a company to involve in some trickery regarding the flow of hard cash. Thus, if you go through the cash flow statement of a company, you will get the true picture of the financial status of that company.

There are three major components in a cash flow statement – the flow of cash from investment-related activities, from finances related activities and from operating activities. You will also get to know about the present cash holding of a company from this statement. 

While going through the cash flow statement, you need to check whether the cash flow from operating activities is positive or negative. If the statement is negative, then this shows that the company is losing money. If it is positive, then this means that the company is capable of generating cash from business operations.

The cash flows related to the financial activities gives you an insight into the company’s operations or money spent for the purpose of debt repayment. The latter will be negative, while the former will be positive.

Cash flows related to investment activities tells you about the cash used for the purpose of investments. A company that has surplus cash generation may turn it into a fixed deposit. The following year. The company is free to withdraw cash from that fixed deposit. The former will reflect a negative impact on the statement while the latter will reflect a positive impact.

  • Balance sheet: The relation is quite simple- Assets= Liabilities + Owner’s Equity. If a balance sheet is not balancing at the end, then it is absolutely wrong. The balance sheet of a company gives you an idea of the assets of a company, the liabilities of the company as well as the funds contributed by the shareholders.

If you are wondering what all are included in the asses of a company, then let us tell you that the assets of a company include equipment, land, goodwill, brand value, patents and so on. Liabilities mean the short term as well as long term debts, and any other payables of the company.

A balance sheet that is weak will be saddled with debts. A strong balance sheet will have more equity and assets as compared to the liabilities. If you want to have an idea of the strength of a balance sheet, then you just need to know the debt-equity ratio.

If you are an investor and you want to invest in a company, then it is necessary that you go through all the above-mentioned financial statements. A thorough analysis is incomplete without the data and information present in these statements. You will get these statements online or in the annual reports of a company.