Brief of Financial Statements
A company's financial statements are a window into its financial health.
No wonder studying them is an integral part of fundamental analysis.
While analysts dig deeper into financial statements and try to unearth
the not-so-obvious aspects of a company's financials, understanding
basic financial statements should suffice for an investor in most cases.
Infyture, Investment For Your Future
A company's financial statements are a window into its financial health.
No wonder studying them is an integral part of fundamental analysis.
While analysts dig deeper into financial statements and try to unearth
the not-so-obvious aspects of a company's financials, understanding
basic financial statements should suffice for an investor in most cases.
There are three major financial statements: the balance sheet,
profit-and-loss statement and cash-flow statement. The balance sheet
tells you about the assets and liabilities of a company. The
profit-and-loss statement tells you about a company's profitability. And
the cash-flow statement is about the flow of cash into and out of a
company.
Balance sheet
The balance sheet is so called because it always balances according to this relation:
Assets = Liabilities + Owners' equity.
A
balance sheet that doesn't balance is simply wrong. The balance sheet
shows the assets that a business owns, the liabilities that it owes and
the funds contributed by its shareholders.
Assets include land,
equipment, inventory, goodwill, patents, brand value, etc. Liabilities
include debt (long-term and short-term) and any other payables that a
business has. Shareholder funds are in the form of equity and reserves.
A
weak balance sheet is one that is saddled with debt. When a business
has a strong balance sheet, it has more assets and equity than
liabilities. In order to know the balance-sheet strength, you need not
actually see the balance sheet; you can just look at the debt-equity ratio.
Profit-and-loss statement
As its name suggests, the
P&L statement tells you about the profitability of a company. The
simple formula to calculate profits is
Profit (loss) = Revenue -
Expenses.
The head 'revenue' generally has two entries: revenue
from sales and other income. Other income is the revenue from sources
other than the core area of the company's operations. For instance, it
could be income from investments, dividends, royalties, etc.
The
head 'expenses' constitutes the categories of expenditure such as cost
of raw materials, employee costs, etc. On subtracting the total costs
from the total revenues, we get the 'operating profit', which is nothing
but a company's profit from its core operations.
In order to
arrive at the final profit figure, any miscellaneous income or loss is
to be added to or subtracted from the operating profit. Finally, net
profit is obtained after deducting the tax applicable.
Cash-flow statement
The cash-flow statement shows the movement of cash in a business. While
businesses can misstate their profits through accounting jugglery, they
can't fudge the movement of hard cash. Hence, a cash-flow statement
provides a true picture of a company's financial health. However, for
banks and finance companies, the cash-flow statement is of limited use
as they follow a different business model than other types of
businesses.
The cash-flow statement has three components: cash
flows from operating activities, from financing activities and from
investing activities. The statement also mentions the current cash
holding of the business.
What you need to check in the data is
whether flows from operating activities are positive or not. If they are
positive, it means that the company is able to generate cash from its
operations. If they are negative, it means that the company is losing
money. While it may show profits in its P&L statement, negative
flows from operations should ring an alarm.
Cash flows from
financing activities show the money raised for the company's operations
or the money paid towards debt repayment. The former will be a positive
number on the statement, while the latter will be a negative number.
Cash
flows from investing activities capture the cash used in investments.
For instance, a business that has generated surplus cash may park it in a
bank fixed deposit. Next year it may withdraw cash from that FD. The
former will be a negative number on the statement, while the latter will
be a positive number.
The balance sheet, profit-and-loss
statement, as well as the cash-flow statement contain the data necessary
to guide investors looking to invest in a company. Ratios used in
analysing stocks also require figures and data contained in these
statements, without which a thorough analysis is impossible.
Sources:
Various publications
Disclaimer: The
information provided herein is based on publicly available information and
other sources believed to be reliable, but involve uncertainties that could
cause actual events to differ materially from those expressed or implied in
such statements. The document is given for general and information purpose and
is neither an investment advice nor an offer to sell nor a solicitation. While
due care has been exercised while preparing this document, we do not warrant
the completeness or accuracy of the information. We will not accept any
liability arising from the use of this material. The recipient of this material
should rely on their investigations and take their own professional advice.
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