A Straightforward Guide to Financial Statements
Created on 23 Nov 2023
Wraps up in 9 Min
Read by 1.7k people
Updated on 15 Jan 2024
Allow me to share a personal story with you which helped me really get into the investing sector (and by this, I mean the OG, aka stock market). You see, I wasn’t always a finance-savvy person who regularly kept track of the market’s movements. But, a couple of years back, something changed.
It was 2021, and my younger brother, who was always a step ahead of me in finance, told me that he was debuting his investment journey. He planned to do so by buying shares of Avenue Supermarts, popularly referred to as DMart. So, like a good sibling, I lend my ears to the new thing he found exciting and promising. Truth be told, his ranting went right over my science-filled head. But then jargon like “Annual Report” and “Financial statement” turned my puzzlement into intrigue about this unfamiliar territory. So, I inquired about it.
To this, my brother opened a 200-300 word pdf of DMart’s Report showing all the statements and the numbers. Inquisitive by nature, I started doing my own research, and the result was flabbergasting. I thought: “How can he understand all these numbers and even remember what they mean?”
That’s when I came across the magic that is financial statements. The statements are more or less like a student’s report card demonstrating their abilities, skills, and specialities of the past 2-3 years consecutively.
To save you the exertion of researching and analysing a company I went through during that time, let me introduce you to the A-Z of financial statements. Here, we’ll see what financial statements mean, their types, and their requirements in making your investment journey successful.
Financial Statements & its Types
Most are aware of the three statements most essential in a company’s Annual Report: cash flow, income, and balance sheet. But, apart from these usuals, which we will discuss further, there are two more kinds of financial statements that also play a major role in painting the picture of a business’ finances.
So, get your student mode on as the class on “Everything Financial Statement” is going to begin! 🤓
And since Avenue Supermarts introduced me to investing, I will be referring to its Annual Report 2023 going forward. You can download your copy from Ticker, in addition to all the other engrossing details about the stock, by clicking here. 📑
Let’s begin this ride of finances, revenues, and losses with the…
1. Cash Flow Statement
Also known as CFS, the Cash Flow Statement of a company gives an insight into the amount of cash generated by the operating activities or investments. A CFS tells a story about the money a company has after repairs, assets, and other expenses are taken care of. Simply, it provides a detailed overview of a company's cash inflows and outflows during a specific period.
CFS also acts as a bridge between the income statement and balance sheet, revealing how operating activities, investing activities, and financing activities impact a company's cash position.
If you want to pursue a course on How to Analyse a Cashflow Statement, Quest by Finology provides you with the complete course on that. Just click on the link, and there you go!
Also, Insider provides you with one more article on cash flow, which tells you why analysing Cash Flow Statements Important. Just click this link to access it.
Three Sections of Cash Flow Statement and its components:
- Net income (or loss)
- Depreciation and amortisation
- Changes in accounts receivable, inventory, and payables
- Non-cash expenses
- Proceeds from sales of fixed assets
- Payments for acquisitions of fixed assets
- Investments in other companies
- Payments of dividends
- Proceeds from issuing stock
- Payments of dividends
Insider provides you with an article on Identifying Bad Companies, Cash Flow Statements and Rights Issues. Learn about this crucial topic in cash flow by clicking on the link.
You can see the three sections highlighted in Avenue Supermarts Cash Flow Statement below. 👇
Key Benefits of CFS
- Measures the cash available to invest in growth after meeting operating expenses and debt obligations. Hence, one can calculate a company’s ability to initiate new projects & invest in assets. 🏢
- Assesses how well the company's accrual-based earnings translate into cash flows. Thus clarifying whether the company is following its preset path or not. 🛣️
- Indicates the efficiency of cash generation relative to sales. This portrays a company’s financial health in regards to its operations. 💸
To learn how to calculate cash flow and accurately interpret a CFS, read Cash Flow Statement: Understanding All the Elements.
2. Income Statement
Also known as the Profit and Loss (P&L) statement, the income statement provides a snapshot of a company's financial performance over a specified period. 📸
A company's income statement is very similar to the salary one earns every month (or three, as is the case with a company's quarterly results). This doesn’t necessarily represent the cash amount as CFS does, but it gives the idea about the capital a company generates and the profit or loss it receives from its operations.
In plain terms, an income statement serves as a roadmap, guiding investors and analysts through the maze of a company's revenue, expenses, and profitability. 🛤️
With the income statement, you get to know the following:
- Net sales: The gross revenue minus discounts, returns, and allowances.
- Other income: Revenue from sources other than the core business, such as interest income or rental income.
- Cost of goods sold: The direct expenses associated with producing the goods or services sold.
- Selling, general, and administrative (SG&A) expenses: Costs related to marketing, sales, and general administration.
- Depreciation and amortisation: Non-cash expenses represent the wear and tear of fixed assets and intangible assets over time.
- Gross profit: Revenue minus the cost of goods sold.
- Operating profit: Gross profit minus SG&A expenses.
- Net income (or loss): Operating profit minus interest expenses, income taxes, and other non-operating expenses.
You can check these figures for DMart from the red-squared portion of the image below. ⤵️
Key Positives of Income Statement
- Gross profit margin: Gross profit as a percentage of net sales, indicating the efficiency of converting costs into revenue. This demonstrates the profit a company is making every quarter with ease. 💰
- Expenditure Pattern: With the income statement, sources of expenses are revealed, providing an insight into where the company is using its capital. 🔍
To learn what importance an Income Statement plays in analysing a company’s profitability, read the article Decoding Income Statement.
3. Balance Sheet
Giving a report on a company’s assets, liabilities, and shareholders’ equity is what a balance sheet does. Since a balance sheet represents a company’s financial health, it is also known as a statement of financial position.
The balance sheet can be summed up in the following equation:
Assets = Liabilities + Shareholders’ Equity
A balance sheet comprises these components:
- Current assets: Easily convertible into cash or used within one year, such as cash, accounts receivable, and inventory.
- Non-current assets: Held for more than one year, such as property, plant, and equipment, and investments.
- Current liabilities: Due within one year, such as accounts payable, short-term loans, and accrued expenses.
- Non-current liabilities: Due beyond one year, such as long-term loans and bonds payable.
- Contributed capital: The amount invested by shareholders in exchange for ownership.
- Retained earnings: Profits accumulated over time that have not been distributed to shareholders.
The components from the balance sheet are highlighted in the image below. ⬇️
Key Essentials of a Balance Sheet:
- Current ratio: Measures a company's ability to pay its short-term obligations. This is a good thing, as debt is generally equivalent to a red flag in the finance world. 🚩(Exceptions are industries like financial services and utilities.)
- Debt-to-equity ratio: Assesses the proportion of a company's financing that comes from debt versus equity. Through this metric, one can easily calculate whether a company has debt, and if yes, then how much. 💸
- Working capital: Indicates the difference between a company's current assets and current liabilities, reflecting its ability to meet its short-term obligations. 💰
Learn what other details a balance sheet provides for a company’s finances by reading 5 Components of Balance Sheets that Influence Investment Decisions.
4. Statement of Changes in Equity
Also known as the statement of retained earnings, the statement of changes in equity gives an indication of the changes shareholders’ equity goes through over a specific period.
Similar to CFS, this statement bridges the income and balance sheet statements by revealing the factors contributing to the movement in shareholders' equity.
Statement of changes in equity consists of the following components:
Opening Balance of Shareholders' Equity: This represents the total shareholders' equity at the beginning of the reporting period.
Changes in Shareholders' Equity: This section details the various transactions and events that have affected shareholders' equity during the period. These changes may include:
- Total comprehensive income
- Transfers to retained earnings
- Treasury stock transactions
- Issuance of new shares
Closing Balance of Shareholders' Equity: This represents the total shareholders' equity at the end of the reporting period.
Key Benefits of Reviewing Statement of Changes in Equity
- Equity Changes: This statement gives the changes in shareholders’ equity at the beginning and end of the period mentioned in detail. Hence, making informed investment decisions gets much easier for investors. ✍️
- Sources of financing: It reveals the sources of capital that have contributed to the company's growth, such as retained earnings or new share issuances. This paints the picture of everything earnings for the investors regarding the company in detail. 🖌️
- Changes in ownership: It reflects any changes in the ownership structure of the company due to share issuances or repurchases. Since owners, aka shareholders or board members, play a crucial role in determining the direction a company may take, it is essential to be in touch. 🧑💼
5. Funds Flow Statement
Funds Flow Statement is one such financial document that is not readily available in a company’s Annual Report. This is what makes it unique from the earlier mentioned statements so far. But, just because it is not available doesn’t affect its importance in the slightest.
Funds Flow Statement is a comprehensive detailing of the past two Balance Sheets and the recent Income Statement. It is also called a "Statement of Sources and Application of Funds" as it provides details of the type of cash inflows and outflows in a company.
The following components are involved in the Funds Flow Statement:
- Current Assets: Current investments, trade receivables, inventories, cash and cash equivalents, etc.
- Non-Current Assets: Fixed assets, non-current investments, deferred tax assets, and long-term loans.
- Current Liabilities: Short-term borrowings, trade payables, outstanding expenses, and unpaid dividends.
Check out the format of a Funds Flow Statement and other crucial details by reading Understanding Funds Flow Statement.
The Bottom Line
And that’s how you can know how well or unwell a company is faring without searching for every detail individually. By seeing the figures of the financial statements, you can make sound investment decisions. So, start investing like great investors do and spread this magic recipe with others. Drop a comment about your views and share the article to educate your acquaintances about the financial sector.
*Disclaimer: The stocks and companies discussed above aren't a recommendation from Insider by Finology and shall not be construed as a replacement for professional advice. Consult a professional or conduct the necessary research before making investment decisions.
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