Demystifying Financial Statements

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In order to determine a stocks value, analysts pour over company financial statements in order to find trends, strengths and weaknesses. They break down the data and present it to investors through different ratios designed to help them make quick comparisons and make predictions about where a stock is headed.

These financial statements include the balance sheet, income statement and cash flow statement. They reveal information about the financial health of the company including efficiency, profitability, liquidity, and numerous other details.

Let’s take a closer at each financial statement and see what kind of information we can find.

The Balance Sheet

This statement contains details on a company’s assets, liabilities and shareholder’s equity. It will tell you what kind of assets it owns and what types of debt the company owes. The numbers on the balance sheet will always add up according to the following equation: assets = liabilities + shareholder equity.

This relationship means that assets (what the company owns) must be paid for using either debt financing (liabilities) or investor money (shareholder equity). Key things to note on the balance sheet include the following:

Cash and cash equivalents: This is most liquid money a company has and is beneficial for paying off unforeseen expenses.

Total assets: The total of all assets listed on the balance sheet. This number should be higher than total liabilities – ideally with room to spare.

Current liabilities: Debt or expenses that is due within 12 months. A good thing to watch for is how cash and cash equivalents compares to current liabilities.

Long term debt: The interest and principal on issued bonds.

Total liabilities: All the debts and expanses of a company. This figure should be lower than total assets.

The Income Statement

The income statement is also known as the profit and loss statement and generally contains information about the company on a quarterly basis. It tells you what kind pf profits the company makes, the profit margin and the expenses being paid – either on a regular basis or a one-time charge.

The income statement is vital for figuring out the company’s earnings-per-share and can be used to place target prices on a stock. Comparisons made to prior time frames give analysts the ability to see how a company is performing quarter-over quarter or year-over-year.

The Cash Flow Statement

The most often overlooked statement is the cash flow statement which tells investors how a company is spending its money on a quarterly and annual basis. Cash flows can be broken own by where its being generated: from operations, from investment activity and from financing.

This statement is critical for determining a company’s free cash flow – a statistic used to calculate how much money a company has accounted for capital expenditures. Put another way, free cash flow shows investors how much excess money a company can generate to make new acquisitions or invest in new opportunities.

Final Thoughts

Many financial ratios are calculated using a mix of all three financial statements. Once you understand how to read them, you can make historical comparisons on your own and make predictions about where a company is heading. Knowing what the financial statements mean for a company gives you the ability to make smarter investment decisions and avoid costly mistakes.