The Power of Financial Statements: How to Analyze and Interpret

Today we're going to discuss about financial statements what they are how to read them and how to actually get value from them for making real business decisions let's start with the definition financial statements are reports that summarize important financial information about your business there are three main types of financial statements the balance sheet income statement and cash flow statement we’ll look at what each of these three statements do and how they work together to give you a full picture of your company’s financial health.

how to read a balancesheet: When it comes to understanding a business, few financial statements are more important than the Balance Sheet. It offers critical insight in to a company's financial health. It can be used by investors when deciding whether to provide funding, executives when crafting strategy, and employees when working toward organizational goals. The balance sheet is often organized according to the accounting equation, assets equals liabilities plus owner's equity.

No matter how the Balance Sheet is organized, it should always balance. Assets should always equal liabilities plus owner's equity. If it doesn't balance, it was likely prepared incorrectly. Here's a closer look at the balance sheet's key components. An asset is anything a company owns that holds inherent, quantifiable value. Assets are typically tallied as positives and broken down into current and non-current assets.

Current assets are anything a company expects to be converted into cash within a year, such as inventory, accounts receivable, and cash and cash equivalents. Non-current assets include long term investments not expected to be converted into cash in the short term, such as patents, goodwill, and buildings and land. A liability is the opposite of an asset. While an asset is something a company owns, a liability is something it owes. Liabilities are financial and legal obligations to pay a debtor, that is why they're typically tallied as negatives. Like assets, liabilities are categorized as current or non-current. Current liabilities within one year, including payroll expenses, rent and utility payments, and accounts payable.

Non-current liabilities are longer term obligations, including provisions for pensions, leases, and deferred tax liabilities. Lastly, owner's equity also known as shareholders' equity, is anything belonging to the owners of a business after liabilities are accounted for. If you add up all the resources a business owns, its assets, and subtract all third party claims, its liabilities, the residual left over is owner's equity. Owner's equity includes two key elements. The first is money, which is contributed to a business as an investment in exchange for a degree of ownership, typically represented by shares. The second is earnings a company generates over time and retains. To see these components in context, here's a balancesheet example or balancesheet format for a fictional company.

So how can business professionals use this information? While the balance sheet serves different purposes, depending on who reviews it, when reviewed internally, it gives insight into whether a company is succeeding or failing. Stakeholders can use that knowledge to double down on successes, correct failures, or pivot toward new opportunities. When reviewed externally, it conveys what resources are available to a business and how they're financed, which helps investors decide whether it's wise to support it financially.

External auditors can also use the balance sheet to ensure a company complies with the reporting laws it's subject to. It's important to remember the balance sheet is always based on past data and communicates information as of a specific date. While you can use it to predict performance, past results don't guarantee what will happen in the future.

As you know it can be really helpful to understand the financial health of a company when creating an algorithm, the easiest way to do this is by looking at a company's three main financial statements. We're going to talk about the first one the income statement unlike the balance sheet which is point in time the income statement covers a period of time often an entire year or just a quarter the statement contains information about a company's net income in addition to information about both revenue and expenses

Now let's jump into how to read an income statement the income statement is often split into two sections an operating section and a non-operating section let's start with the operating section of the income statement the operating section of the income statement contains information on the primary business lines of a company for example if a company produces laptops information relevant to its sale of laptops will show up in the operating section of the income statement the actual revenue associated with the sale of laptops would be the very first line in our income statement following that would be cost of goods sold often abbreviated COGS these are the costs associated with the production of laptops but does not include things like sales costs or administrative costs

COGS is truly the cost of the materials that go into producing these laptops one subtracting  from revenue we get gross margin gross margin is our profit before deducting non product operating expenses which we'll get to next one of these non-products operating expenses is selling general and administrative which is abbreviated as SGA are costs associated with producing laptops but not the cost of the actual materials that go into the final product for example something like office rent or the cost of an HR employee would be things in SGA as you can see those are costs associated with producing laptops but not the cost of the actual material that goes into the good

Another one of these non-product operating expenses is depreciation and amortization these are expenses associated with using fixed assets over the period of our income statement for example if a company built a 40 Million Dollar laptop manufacturing plant that was supposed to last 20 years each year of our income statement we would deduct 2 million dollars in expenses to account for using that plant over its 20-year useful lifetime

Now let's jump into the non-operating section of the income statement the non-operating section of the income statement contains information that is not related to a company's primary business for example if a company rented out an unused portion of its manufacturing plant to another company that would show up in the non-operating section of the income-statement additionally things like interest expenses or other unusual or infrequent expenses which show up in the non-operating section of the income statement this is helpful to the reader because it helps you isolate the performance of a company's primary business line for many other unrelated activities that's still ultimately effect net income

The company’s earnings both before and after taxes and at the very bottom of the income statement is earnings per share which is a company's net income divided by the total number of outstanding shares this lets the shareholder know what their portion of net income is. So how is the income statement actually used in finance well the total net income of a company is used to evaluate its performance investors and analysts will look at profitability and how profit levels have changed over time in order to do this in particular the earnings per share metric is used to compare companies within the same industry

Another thing that’s interesting about the income statement is that it can be used to assess where a company is spending its money and how that has changed over time investors will often make estimates or predictions about the earnings that a company ultimately will report these predictions affect the markets view of a company before it officially releases earnings at the end of a quarter or a year on the income statement can be used in a bunch of ways the fact that fundamentals dataset contains a number of fields derived from the incomes such as earnings per share additionally the fact that estimates data set contains information on analyst estimates using these two data sets you could seek to create a strategy that predicts a company's earnings before they actually report them

Now let's discuss about the third one the cash flow statement through which you get clear understanding between cash flow statement vs income statement. Cash flow statement definition :- Cash flow statement analysis gives important information about a company's actual cash flows because the income statements prepared to unknown crewel basis income and expenses in the income statement are not necessarily cash transactions for example if a customer promises to pay for a product in the future and it's already received that product that would show up as income on the income statement but because you have not actually received cash for the product it would not be considered cash on the cash flow statement because of this difference between accrual income and expenses and then cash transactions the cash flow statement can provide important information and insight about a company

Now let's jump into how to actually read the sections of the cash flow statement the cash flow statements broken up into three sections cash flow from operating activities, investing activities and financing activities let's start with the first one cash flow from operating activities which is all cash flow related to the day-to-day business operations of a company for example for a restaurant cash related to paying wages or buying food ingredients or cash actually received from customers would all show up in the cash flow from operating activities section this section of the cash flow statement can be derived in two ways the direct method and the indirect method

In the direct method each category of operating receipts and disbursements is listed separately in the indirect method you start with operating income from the income statement and then make adjustments to get to the operating income equivalent on a cash flow basis for example you would start with operating income and then make adjustments for things like changes in accounts payable or accounts receivable to get to cash flow from operating activities no matter which one of these two methods is used direct or indirect the cash flow from operating activities section always ends with the actual amount of cash spent or received by a company from its day-to-day business operations

the second section of the cash flow statement is the cash flow from investing activities section this section of the cash flow statement shows all cash related capital expenditures of business on things like buying fixing or maintaining fixed assets like property plants and equipment it can also showcase related to acquisitions such as the acquisition of another company or the purchase of stocks or bonds for a restaurant entity this section of the cash flow statement which show cash spent on things like the purchase of real estate for a new location or the purchase of new kitchen equipment for an existing location it is important to note that in this section of the cash flow statement it does not always show cash disbursements and it can include cash proceeds from things like sale of equipment just like the cash flow from operating activities section this section of the cash flow statement ends with the total amount of cash spent or received from investing activities

the final section of the cash flow statement is the cash flow from financing activities section which is all cash related to how a company actually finances itself this can include issuance or a payment of debt or equity payment of dividends and cash associated with certain leases for a restaurant this would include cash from an equity investment or cash from a loan that the company takes out for itself after calculating the net cash received or dispersed from a company's financing activities the cash flow statement ends with the total amount of cash received or dispersed for the company as a whole

it also shows the change in the company’s cash balance from the prior year end to the current year end there are many ways that the information in the cash flow statement can be useful to investors many investors believe that cash is king and data in the cash flow statement shows whether or not a company is converting sales into cash earnings that are based primarily on near-term cash collections are often viewed as higher-quality by investors because they show that a company is consistently converting operating income into cash additionally the a flow statement shows how a company is managing its cash flow such as by acquiring other businesses investing in fixed assets or by paying dividends to shareholders for companies that are not generating positive