PDF : The Ultimate Guide in Understanding Financial Statements of a Company
Financial Statements What Does It Mean?
Financial statements (or financial report) is a formal record of the financial activities and position of a business, person, or other entity. They are tools widely used by stakeholders to assess the economic decisions. The main Financial Statements are:
Income Statement
Balance Sheet
Cash Flow Statement
Statement of Changes in Equity The statement records the changes in equity over a given period e.
Income Statement
Income Statement: The Income Statement, also referred to as the Profit and Loss Statement, provides a company’s revenues and expenses over a period. This illustrates the conversion of revenues into net income (or net profit). The key components include:
Revenue: The aggregate amount of money received for goods or services.
Cost of Goods Sold (COGS): The direct costs attributable to the production of the goods sold by a company.
Gross Profit: Revenue – COGS
Operating Expenses – These are the expenses of the enterprise that are incurred in connection with normal operations, this includes salaries/wages, rent/mortgage payments, and utilities.
Operating Income: Gross profit less operating expenses.
A company’s earnings net of all expenses, taxes and interest.
Balance Sheet
Balance Sheet — Balance Sheet is a point of time snapshot of the company, which will hold its financial position. This includes everything from the assets to liabilities of the company as well as shareholders’ equity. The key components are:
Assets – things that company owns (eg cash, inventory, property etc.)
Current Assets: Liquid assets (like accounts receivable, inventory) to be converted into cash within one year.
Noncurrent assets: The company’s long-term investments, those which it does not plan on selling for at least a year – such as property, plant and equipment.
Liabilities: What company owes others (hence they are written on the right-hand side of the balance sheet)- these could be loans or accounts to be paid.
Short-term liabilities: All of the liabilities that need to be paid within a year from now. for example, short term debt and accounts payable.
Liabilities, Non-Current – long-term debts(eg long-term debt, pension liabilities)
Shareholders’ Equity: The residual interest in the assets of the company after deducting liabilities. It includes:
Common Stock: The portion of the company that represents ownership in the company.
Retained Earnings – The sum of each year’s Net Income that was not paid out as dividends;
Cash Flow Statement
Cash Flow Statement: This indicates the cash inflows and outflows of a company for a particular period. It provides with information of the company liquidity and functionality to generate cash. The key sections include:
Operating Activities – Cash flows from primary business activities (e.g., cash received from sold goods and services, cash paid to suppliers, employees)
Simple An example might be buying (investing in) equipment cash out and an opposing activity of sale of investments.
FINANCING ACTIVITIES: Cash flows between a company and its shareholders and creditors,including the following transactions, issued stock, paying dividends;repayment of borrowed amounts;
Changes in Equity
The Statement of Changes in Equity details how the equity changed during the period. It includes:
Additional Items Share Capital: Modification to the amount of received capital from shareholders.
Retained Earnings: Flow-through of the changes in total income that were produced, but not paid directly to the shareholders.
Other Comprehensive Income: Gains or losses that are not part of the income statement, but directly affect the Equity Transaction Institutional Markets and Policies Page equity.
Interpreting Financial Statements
Proper analysis of financial statements requires the knowledge of different financial ratios and metrics through which one can estimate a company´s performance and financial health. Some key ratios include:
Profitability Ratios: Like the name implies, these ratios measure how effective a company can generate profit considering revenue, assets and equity.
No Loss Margin: Gross income / Sales
Net profit (nett) margin =net income / revenue
Return on Assets: Net income / Total assets
ROE – Net income / Shareholders equity
Liquidity ratios (what the business has to pay what it owes in the short-term).
Current Ratio: Current assets/ Current liabilities
Quick Ratio = Quick Assets/ Current Liabilities
Solvency Ratios: These focus on the company’s ability to repay its long-term obligations.
Debt to Equity Ratio = Total liabilities/Shareholder equity
Interest Coverage Ratio: Operating income Interest expense
Asset and Liability Ratios: Shows time in days it takes for a company to turns its current assets into cash.
Inventory Turnover Ratio = COGS / Average inventory
Receivables Turnover Ratio: (Revenue / Average accounts receivable)
Why are Financial Statements Important?
For Investment Decisions: Financial statements help Investors to learn about the profit earning capacity and sustainability of doing investment in the company or not.
Predicting Creditworthiness – Creditors use financial statements for making credit decisions.
Decision Making by Management: Managers use these statements to make managerial decisions and enhance the operational efficiency of the business.
Regulatory Compliance: Financial statements also provide companies with a gauge of their compliance to regulations and transparency to stakeholders.
Conclusion
For those of you in business, finance or investing, studying and understanding financial statements is extremely important. Using the income statement, balance sheet, cash flow statement and statement of changes in equity, stakeholders can get a full picture of a company’s financial health and act accordingly. This is why downloading and reviewing financial statement PDFs can give you more detailed look at how well and on what companies are doing, which in turn allows YOU more availability to navigate through the confusing and often times anxiety ridden world of finance.
