How to Analyze a Company's Financial Statements

Start with the balance sheet.

The financial statements of a company can tell you a great deal about its history and future plans. The balance sheet tells you the value of all assets owned by the company. It also tells you how much the company owes.The income statement walks you through the company's expenses, from sales to net income. The cash flow statement tells you where the company's cash is coming from and going to. Each financial statement provides the investor or analyst with a well rounded story of how the company operates.

Instructions

1. Turn to the balance sheet. The balance sheet is a listing of the company's assets and liabilities. Specifically, it's used to gauge the company's degree of financial leverage or borrowing.

2. Calculate the debt to asset ratio. This ratio divides total liabilities by total assets. Compare this against the debt to asset ratios of other companies in the same industry for a deeper level of analysis.

3. Turn to the income statement. The income statement is a statement of earnings. It starts with revenues or sales and works down to net income. One analysis tool used in financial statement analysis is margin. Margin is the percent of sales in financial terms. Gross margin is the gross profit percentage of sales. In general, the higher the gross profit margin, the better the business model. Gross profit margin is gross profit (sales minus the cost of goods sold) divided by total sales.

4. Look at the company's cash flow statement. This statement provides details on the sources and uses of company funds. Just because a company is profitable does not mean the profit is coming from operations. In fact, a company can have positive cash flow and negative earnings. Cash flow can originate or flow into activities from operations, financing or investing.

5. Locate the three main sections of the cash flow statement. In a company, cash can come from operations, financing or investing. These are the three main sections of a cash flow statement. A healthy company generates cash flow from operations rather than from financing activities.

References

• Securities and Exchange Commission: Beginner's Guide To Financial Statements