Familiar with terms such as “balance sheet” and “income statement”? These are definitely concepts you should familiarise yourself with before registering for a brokerage account! They offer a window into the health of a company, which can be especially helpful if you are interested in investing in the particular company!
Also known by its more formal name, the Statement of Financial Position, the balance sheet aims to provide the “book value” of a company. Information such as the amount of resources (or assets) owned and how they were financed (liabilities) up till a particular point in time are shown in the balance sheet as well.
Click here to read about understanding a balance sheet in more detail!
The three main branches of a balance sheet are: assets, liabilities, and owners’ equity.
- Assets: Anything owned by the company with value, such as cash, equipment, etc.
- Liabilities: Money owed to a debtor, such as debt payments, bonds payable, and taxes.
- Owners’ Equity: Net worth of the company. This money belongs to the shareholders.
The golden equation is as follows:
Assets = Liabilities + Owners’ Equity
If this is hard to remember, try remembering ALOE (vera)…
A balance sheet by itself will not be able to tell you much, which is why other financial statements such as the income and cash flow statements have to be read in tandem in order to fully understand the financial standings of a company.
Better known as a Profit and Loss (P&L) statement, the income statement is a summary of all revenue, expense, and other gains and losses for a given period. This statement is often shared in reports (annual or quarterly) and helps investors identify potential trends, as well as business activities.
Click here to read about understanding an income statement in more detail!
The following are the main components:
- Revenue: The amount of money the business brings in
- Expenses: The amount of money the business spends
- Cost of Goods Sold (COGS): The cost of components parts of the product sold by the business
- Gross Profit: Total Revenue – COGS
- Operating Income: Gross Profit – Operating Expenses
*Operating expenses refer to any expense incurred for daily operations
- Income before Taxes: Operating Income – Non-Operating Expenses
- Net Income: Income before Taxes – Taxes
- Earnings Per Share (EPS): Net Income / Total Number of Outstanding Shares
- Depreciation: The value of assets lost due to time (aging equipment, wear and tear)
- EBITDA: Earnings Before Interest, Tax, Depreciation and Amortisation
Yes, there may be a few terms which may be new to you, but most of these items on the income statement speaks for itself.
The income statement is often used to understand the profitability of the business, together with more in-depth information such as:
- How much does it cost to produce a single product?
- Is there any excess cash at the end to plow back into the business?
With this information, investors and business owners can take it a step further to determine financial trends, such as when costs are highest, and when they are at the lowest, in order to make investment or business operations decisions respectively.
Cash Flow Statement
With cash flow statements, information regarding the movement of a business’ cash during a specified period or duration of time can be understood. It exhibits the business’ ability to operate in the short and long term, based on the information inside the statement.
The cash flow statement can be broken down into three sections:
- Cash Flows from Operating Activities: Transactions related to company’s business operations, including both revenue and expenses paid in cash
- Cash Flows from Investing Activities: Transactions from the purchasing or selling of assets
- Cash Flows from Financing Activities: Transactions from debt and equity financing
It is important to note that the difference between a cash flow statement and an income statement is that the former only deals with cash that’s flowing in and out of the company, while the latter deals with both cash, as well as payables and receivables. Payables and receivables stand for cash to be paid or received in the future, respectively.
The purpose of a cash flow statement is to aid in making financial decisions, based on how liquid (how cash rich) the company is. Businesses can make operating decisions based on the information as well.
It is important that all these statements are read in tandem in order to get a better glimpse of the company’s financial standings. Coupled with other methods of obtaining information such as financial ratios, this will help you get a more holistic understanding of what the company is up to, allowing for an informed decision before you purchase the company’s shares.