Financial statements are everywhere. Sometimes reading them and understanding them seem impossible. Does it ever seem like financial statements are in a foreign language? If you said yes, well, you are right. Financial statements are in a foreign language and that language is the language of business called accounting. Everyone needs help to understand them.
So, why do you want to learn to understand financial statements? Accounting was developed to provide useful financial information for people that make decisions. From a one-person entrepreneur to the largest multinational corporation, every business has financial information that gets reported on financials. Understanding these can unlock lots of information about the company.
Maybe you want to be a better:
- Decision maker
- Board member
Or maybe you just want to learn more about financial statements because you want to know more about a particular business. Whatever your reason, you can learn to read a financial statement. Yes, you can do it!
Financial statements tell a story
Financial statements tell a story about the company. This is important because every financial story is unique. Each company is unique and each year is unique. This financial story can be good, bad, boring, or great. The story is in the financial statements. You just have to know where to find it.
Financial statements tell a story, but you have to know how to read that story.
Business is competitive and each business competes for customers and sales and profits. The company’s financial statements can give you an idea of how well the company is competing. The financials how well the company is doing and how much debt the company has.
When you read financial statements you need to always ask, “How well is the company doing?” You are learning to read financial statements not just to check off a bucket list item, but to know information about a company. So, a good question is always, “What does this mean?” and “Are these results good or bad, improving or getting worse?”
Financial statements are to a company what medical records are to an individual. Medical records tell a lot about a person’s medical history and their current health. Financial statements tell about a company’s financial history and its financial health. So, financial statements are the financial health records for a company. So, if you want to know the health of a company, you need to understand financial statements.
Financial statements to a company are like a person’s medical records because they show the company’s financial health.
Every financial statement has 3 major parts:
Income Statement: Is the company profitable?
The income statement shows how profitable a company is for the period. The income statement shows the results of the company’s operations always for a period of time, either for a quarter or a year.
The income statement shows how profitable, or not profitable, a company is. The income statement format is revenues minus expenses. If the revenues are higher, the company would report a net profit. If the expenses are higher, the company would show a net loss. The income statement is sometimes called the profit & loss statement. Net profit is also called net income or net earnings.
Balance Sheet: What does the company own and owe?
The balance sheet shows what the company owns, what it owes, and its net worth. The company owns assets. Assets are all the valuable stuff that the company controls. Subtract the company’s debts that it owes from its assets that it owns and you will figure out the company’s net worth. The net worth is what is left over after all the debts have been paid.
Cash Flow Statement: Cash in and cash out
The Cash Flow Statement shows the company’s cash in and out of the business. It is useful for seeing how much cash is received by the company through operations and how much through stock and bond sales. It is also useful to see how much cash is spent on large asset purchases and the amount of stock and bond repurchases.
Learning to read financial statements is an important skill. Warren Buffett, the legendary investor, recommends accounting for everyone that invests in stocks. It is also important for people that want to know more about a company or to make better decisions.
You have to understand accounting and you have to understand the nuances of accounting. It’s the language of business and it’s an imperfect language, but unless you are willing to put in the effort to learn accounting— how to read and interpret financial statements—you really shouldn’t select stocks yourself. — Warren Buffett