Financial statements are written records that convey a company’s business activities and financial performance.
The financial statements are often issued quarterly and annually.
A Financial Statement is broken down into 3 important financial documents: The income statement, the Balance Sheet, and the Cash Flow.
To properly analyze the financial health of a business we need to pay attention to each of these three documents and focus on some key points that will unveil if the business is profitable and in good standing or not.
You can access any Quarterly Financial Statement or 10-K of a publicly listed company. Many websites aside from the company’s own website will provide the info. The easiest way to access a Cash Flow Statement of a company is through Yahoo Finance. Once on the company’s page click financials, or trading view which again you click financials once you have picked the company. There are a plethora of investment related websites where you can get this info, and of course you can visit the website of the company and find them there.
In general If you decide to look for an original 10-K form , or income statement on the company’s website you will not have the luxury of looking at the numbers over the years, or other stats, thus we use third party websites like TradingView which gives us a better insight as well as 7 years of data, so rather searching for them we get them easy.
Income Statement
The first financial document that you will find reading an quarterly or annual report is the income statement.
An Income Statement will show you the profit or loss a company generated over a certain period of time. It focuses on four key areas: Revenue, Expenses, Gains and Losses. It is by far the most populated part of any financial statement and you could get overwhelmed just by looking at it, but after we break it down to parts and point out the sections you need to focus on it will seem much easier.
All Income Statements start with the Total Revenue of the company, which is also called top line, since it’s the first number on the income statement, and is the money the company made from selling its goods and services.
Now let’s turn our attention to Gross profit, what it is and how it is calculated. Gross Profit is the profit a business makes after subtracting all the costs that are related to manufacturing and selling its services or products.
Moving down the statement we have the operating expenses which as you can guess are expenses associated with running business operations, like paying salaries, advertising,rents office supplies and so on. These expenses are not taken into account in the cost of goods sold and need to be further deduced from the gross profit, in order to get the operating income.
Adding operating income with non operating income will give you the Pretax Income which is the company’s revenue after we deduct all operating and non operating taxes, which is considered a more accurate measure of business performance and health.
Now that we went through the Income statements lets focus on the key metrics that determine if the company is strong or weak financially.
First the Total Revenue which as we mentioned is the money the company made after selling goods and services. A solid business will have its total revenue increase over the years.
Second the Total Operating Expenses which are the total expenses that are incurred over a given period of time as a result of normal business activities. This number needs to always be lower than the Total Revenue, if it is not is a huge red flag for the health of the business.
Third, the Gross Profit which is the profit a business makes after subtracting all the costs that are related to manufacturing and selling its services or products. We want to see a positive and growing number here as well.
Fourth is the operating income which is measuring the amount of profit generated from business operations, after deducting operating expenses, such as wages, depreciation and cost of goods sold. We want to always see a positive and growing number over the years here, as this means the company is making profit, a negative number here means that the company is operating at a loss.
Fifth is the net income. As we mentioned above the most important metric in the income statement is the Net income, solid companies will always have a positive and a growing number in this section.
Last two metrics that are highly advisable to calculate and are good indicators to analyze a company’s income statement are the Gross Margin and the Operating Margin.
Gross Margin shows whether the company’s sales are enough to cover their costs. To calculate the gross margin you need to divide Gross Profit with Gross Revenue.
The other metric to calculate is the Operating Margin, which measures how much profit a company makes on a dollar of sales after paying for variable costs of production, such as wages and raw materials, but before paying interest or tax.To calculate that you need to divide the operating income with the Total Revenue.
Balance Sheet
The second financial document that you will find reading a quarterly or annual report is the Balance Sheet.
A balance sheet reports the company’s assets, Liabilities and shareholder equity.
It gives investors a very strong insight in the company’s financial position, what the company owns and what it owes.
Balance sheets are separated into three main sectors: Assets / Liabilities/ and shareholder Equity.
Every balance sheet starts with the total assets, which basically reveals the value of everything the company owns and can be liquidated into cash within 12 months time, that can be inventory, accounts receivable, equipment, copyrights , patents and obviously cash on hand.
Liabilities on the other hand are the legal debts a company owes to third party creditors, these can be employee salaries, mortgage payments, loan payments, sales taxes and so on.
Last, we find the equity or shareholders equity which is basically what the company is worth after the company is liquidated and all the debts are paid off. Thus the shareholders equity equals Assets minus Liabilities.
Cash Flow
The third and longest financial document that you will find reading a quarterly or annual report is the Cash Flow.
The Cash Flow Statement summarizes the movement of cash and cash equivalents that come in and go out of a company. It measures how well a company manages its cash position, meaning how well the company generates cash to pay its debt obligations and fund its operating expenses.
There are three main components to be found on every Cash Flow Statement, those are:
Cash flow from operating Activities, which is the amount of cash flow the business generates from daily operations, such funds received from the sale of goods and services, interest payments, income tax payments, rent payments, and so on.
Second, Cash Flow from Investing Activities which is the amount of cash flow the business generates from investments, such as buying or selling assets for the company, loans made to vendors or received from customers, payments related to mergers and acquisitions and so on. Typically the number in this section is negative as the company has to spend money to invest on itself or acquire other companies.
And last, Cash flow from Financing Activities Which is the amount of cash flow the business generates from taking new debt or raising new debt, as well as paying dividends and buy back stock. Typically this number is negative as well , however you will notice that in Amazon’s case this number is positive some times, like in 2017, and 2021 which is normal. That usually happens if the company is taking on debt or doing dilution to raise money.
Another key component to take note of is the Free Cash Flow, which is the cash left after a company pays for its operating expenses and capital expensure. This metric is very important, and it serves as a measure of profitability, thus is a key indicator of the Financial Health of the company.
In this video, we will teach you how to read and analyze a Financial Statement Report sheet and help you understand the basic information contained in this document.
Also read:
How to Read and Analyze an Income Statement For Beginners (2022)
How To Read And Analyze A Balance Sheet For Beginners (2022)
How To Read And Analyze A Cash Flow Statement For Beginners (2022)
For More Videos Subscribe here.
