The capability of understanding a firm’s financial health is a core skill for aspiring learners, entrepreneurs, investors, and managers to develop. Equipped with this specific knowledge or information, the investors may better determine the unique opportunities while also avoiding risk, and professionals of every level may make highly strategic business decisions.
Understanding the Financial Statements
To properly understand the financial position of an organization – both within its sector – you must analyze and review different financial statements: cash flow statements, income statements, balance sheets, and annual reports. The core value of such documents tend to lie in the story they are telling when reviewed together.
- Reading a Balance Sheet
A balance sheet focuses on conveying the firm’s book value. It further enables you to evaluate what specific resources it has and how they have been financed as of a particular date. It showcases its liabilities, assets, and the equity of owners.
The balance sheet further delivers sufficient information, which may be leveraged for computing the capital structure and rates of return, using the accounting equation:
Assets = Liabilities + Equity
Assets are elements a firm owns having quantifiable value.
Liabilities are the finances or money a firm owes to the debtor, like the payroll expenses (outstanding), bonds payable, debt payments, and taxes.
Equity is a firm’s net worth. It is also the money, which will be left if every asset was sold and every liability was paid. This money belongs to the shareholders, who can be the public investors or private owners.
The balance sheet, alone, does not deliver quality information regarding trends that is why you must evaluate other financial statements, including the cash flow and income statements, for comprehending the financial position of an organization.
- Reading an Income Statement
The income statement, also called ‘profit and loss (P&L) statement’, summarizes the cumulative influence of gain, revenue, loss, and expense transactions for the provided time period. The document is shared often as the core aspect of annual and quarterly reports, and demonstrates the business activities, financial trends, and comparisons over the set periods.
Income statements specifically includes the expenses, revenues, gross profit, cost of goods sold (COGS), income before taxes, operating income, depreciation, and earnings per share (EPS).
- Reading an Cash Flow Statement
The cash flow’s core objective involves delivering a detailed and in-depth picture of what happened to the cash of a business in the specified time, called the accounting period. It further demonstrates the capability of a firm to operate in the long and short term, based on how much cash flows into and out of it.
- Reading an Annual Report
The annual report refers to a publication, which the public firms are needed to annually publish to share holders to define their financial and operational conditions.
Annual reports integrate the storytelling and editorial in the form of infographics, images, and letter from the CEO to describe benchmarks, corporate activities, and achievements. They further deliver the staff, shareholders, and investors with sufficient insight into the goals and missions of a firm, compared to the individual financial statements.
Beyond the editorial, the annual report focuses on summarizing the financial information and involves the income statement, cash flow statement, and balance sheet of a firm. It delivers the industry insights, accounting policies, discussion and analysis, and extra investor information.