How to Read a Financial Statement
People's eyes tend to glaze over when they have to read financial statements. That's because most people simply don't know how to do it. The fact is, if you spend a few minutes learning how to approach the task, a financial statement can reveal more than you realize. There are only three pieces to the puzzle: balance sheet, income statement and cash flow statement. Learn the basics of each, and you'll open up a world you never realized existed.
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Instructions
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Find out about what a company owns, owes and the value of the shareholders' interests by looking at the balance sheet. The first portion of the balance sheet tells you about what the company owns. It includes real estate, equipment, inventory, cash, and other assets. It also includes intangible assets like trademarks, patents and goodwill. A company's balance sheet also shows liabilities like money the company owes, money it has borrowed and taxes owed. Finally, it shows "shareholders' equity," which is what the company has left after it pays its debts. That's the money that belongs to the shareholders.
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See how much revenue has been generated by the company over various periods of time on its income statement. It also shows what the company spent to make its products or how it provided its services. From this information, you can determine how much profit or loss the company generated for the period. In addition, you will see a line, earnings per share. This is the amount per share that the company earned for that period.
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Turn to the company's cash flow statement to see how it managed its cash. A company must have sufficient cash to pay its expenses and to buy inventory and other assets. You'll learn if the company made a profit by looking at the income statement, but you'll need to look at the cash flow statement to see if the company generated cash.
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Read the footnotes to get the whole story. For example, you will learn about the company's tax liability and how it affects its operations. The footnotes also include information about the company's pension plans, as well as stock options that may be granted to its senior officers.
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Curl up with the company's "Management's Discussion and Analysis of Financial Condition." Do this because it is management's opportunity to explain the company's health--as well as its financial performance. It's your opportunity to see the company through the eyes of its managers. It's a great supplement to the hard numbers contained elsewhere.
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Tips & Warnings
You can learn to be adept at reading financial statements, but there is no substitute for talking with someone with the company. For example, a company's future plans cannot be found in the financial statements, but they bear directly on the value of the company in the future.
