How to Read Financial statements

One sees Financial Statements as a bunch of numbers, another one sees a whole story about a company, its success story or big drama. How to understand the statements and what should you pay attention to?

Public companies provide different financial statements that can be vied and downloaded from Yahoo! Finance or SEC. Statements can be provided Quarterly or Annually. So it depends on you, whether you want to see a big picture or a more detailed and close view on the company. Here you need three main statements: Balance Sheet, Cash Flow Statement and Income Statement. Depending on what is happening in the company they might publish
Press Releases where they tell you about new products they are about to launch, expansion of the company or a new management team. So let's see each Financial Statement separately.

Balance Sheet

Balance sheet shows what a company has and what it owes. It has it's equation:

Assets=Liabilities+Owner's Equity

Assets is everything the company owes: buildings, offices, inventory, work-in-process goods, goodwill and cash. Liabilities is everything the company owes: utilities, employee's salaries, long-term debt and short-term debt and other obligations. Owner's equity is everything the shareholders invested in the company, it represents the total net worth of the company.

From its name we can understand that this financial statement better be in a balance, then the company is doing OK. The company shouldn't have too much debt, which might mean that they have poor sales and have to take more and more debt to pay liabilities. It is also believed that the company shouldn't have too much free cash, which might mean that the management is too short sighted and doesn't know what to do with it and because free cash has its opportunity cost. Also a company that has lots of cash can turn into a careless company that might spend money on wasteful projects and excessive luxury which all together demotivate and demoralize the management. 

To get the idea of whether the company is financially stable or not we can also use financial ratios. From the Balance sheet we can get two Ratios: Debt-to-Equity and Working Capital. Debt-to-Equity ratio shows how much debt the company has compared to its assets. For example it can have 40% Debt and 60% Equity or vice versa. The  ratio also depends on the industry. For some companies it is acceptable to have high ratio and for others it is a bad sign. Working Capital ratio shows how much capital is left for the company if it pays off all its short-term liabilities right now. If this number declines over a period of time it means the company has less and less capital and might eventually file for bankruptcy.

Cash Flow Statement

Cash Flow statement shows all the inflows and outflows of cash in the company. The outflows can be everything that the company is paying for (debt, utilities, salaries) or is buying (purchasing new equipment). The inflows are the revenues that the company gets out of its operations and sales or if the company sells something.

Company can receive cash from different sources: through its operating activities,financing activities and investment activities. You can see how much it bought, how much it sold, how much it got from its sales and how much it distributed to investors as dividends. Some companies do not distribute dividends and reinvest all the earning back into the company. Usually start-up companies do that to boost their growth. So if you see that the company doesn't pay dividends you'd better think if you agree on that because you will not get immediate dividends but will have to wait for a couple of years or maybe more.

You can compare Cash Flow Statements of competitors who sell same products to see who has hire sells. Those who have less might soon be going down unless they have any plan to boost their sales, like new marketing strategy or product's improvement of modification (which you can get from press releases).

 

Income Statement

Income Statement shows all the revenue that the company received in a last quarter or a year. It also shows all the expenses that the company had to deal with. The purpose of the income statement is to show how much the company earns through various operations, how much it spends and what is left. The last number is Net Income- the profit that the company has left after all the expenses.

Mostly as an investor you want to make sure that the company has profits from its operations. Positive income means that the company can reinvest the left over money back into developing its product or business or this money can be later distributed among shareholders as dividends.

 

Press Release

When going through the financial statements a company provides to public you can find press releases among them. Company uses Press Releases to  let the Public know about what is happening in the company. 

For example, the company might hire a new management team which is going to improve the company's structure and performance. Usually this brings a hope that the company's business is going to improve and the price of its shares might go up. 

Another example of a Press Release is when a company is about to launch a new product that is about to come to market. This also drives prices up because it means that the company soon is going to get lots of revenue. Of course it is possible only in case the product is well marketed and has high sales.