To understand a company’s financial position—both on its own and within its industry—the evaluator will need to review and analyze several financial statements: balance sheets, income statements, cash flow statements, and annual reports. The value of these documents lies in the story they tell when reviewed together.
1. How to Read a Balance Sheet
A balance sheet conveys the “book value” of a company. It allows you to see what resources it has available and how they were financed as of a specific date. It shows its assets, liabilities, and owners’ equity (essentially, what it owes, owns, and the amount invested by shareholders).
The balance sheet also provides information that can be leveraged to compute rates of return and evaluate the capital structure, using the accounting equation: Assets = Liabilities + Owners’ Equity.
Assets are anything a company owns with quantifiable value.
Liabilities refer to money a company owes to a debtor, such as outstanding payroll expenses, debt payments, rent and utility, bonds payable, and taxes.
Owners’ equity refers to the net worth of a company. It’s the amount of money that would be left if all assets were sold and all liabilities paid. This money belongs to the shareholders, who may be private owners or public investors.
Alone, the balance sheet doesn’t provide information on trends, which is why you need to examine other financial statements, including income and cash flow statements, to fully comprehend a company’s financial position.
This article will teach you more about how to read a balance sheet.
2. How to Read an Income Statement
An income statement, also known as a profit and loss (P&L) statement, summarizes the cumulative impact of revenue, gain, expense, and loss transactions for a given period. The document is often shared as part of quarterly and annual reports, and shows financial trends, business activities (revenue and expenses), and comparisons over set periods.
Income statements typically include the following information:
- Revenue: The amount of money a business takes in
- Expenses: The amount of money a business spends
- Costs of goods sold (COGS): The cost of component parts of what it takes to make whatever a business sells
- Gross profit: Total revenue less COGS
- Operating income: Gross profit less operating expenses
- Income before taxes: Operating income less non-operating expenses
- Net income: Income before taxes less taxes
- Earnings per share (EPS): Division of net income by the total number of outstanding shares
- Depreciation: The extent to which assets (for example, aging equipment) have lost value over time
- EBITDA: Earnings before interest, taxes, depreciation, and amortization
Accountants, investors, and other business professionals regularly review income statements.
This is another important aspect of understanding a company’s financials. The ratio defines the level of different parameters. how much cash exist, how assets are performing, the ratio of loan to equity and so on