Beginner’s Guide to Understand Financial Statements

Companies around the world prepare financial statements to measure performance for a year or quarter and publish it for stakeholders to tell them where a business stands in financial terms.

Stakeholders such as management, shareholders, creditors, and government agencies have vested interest in a company’s financial statements. These internal and external agencies can easily evaluate the company by comparing it with another company of the same industry.

financial statements profit and loss account balance sheet cash flow and equity

Financial statements are based on the accounting equation. This means assets of the company are financed by liabilities and equity.

Asset = liabilities + owner’s equity

All most all listed companies have published their annual and quarterly reports in their official website. You can check these sites as well.

Financial statements includes following main components;

  1. Income statement – it will tell you how well did the company perform during the accounting year or quarter. It’s also known as profit and loss account.
  2. Balance sheet – it gives a snapshot of company’s asset, liability and owner’s equity position as at the report date, such as the end of the year or quarter.
  3. Statement of retained earning or stockholders equity – it will show you how retained earning changes during the year
  4. Statement of cash flow – it will show how the company generate and spend cash from operating, financing and investing activities during the year.

Independent auditors attest to the fairness of the financial statements by submitting auditor’s report to shareholders. You can find auditor’s report in company’s annual report along with the profit and loss account, balance sheet, cash flows and statement of retained earnings.

These financial statements will relate to a specific date and time period. You can find all of them in company’s annual report or quarterly report filed with stock exchange

You can analyze financial statements of a company to get answer to many of your investment questions such as;

  • Does the company generate sufficient cash flows to serve firm’s borrowings and future requirements.
  • How well the company has performed during the quarter or year.
  • What is the amount of risk you will be taking as a investor for your investments.
  • Does the company has adequate capital to fund its future growth.

Notes to financial statement

Immediately following above four statements, you will find a section in the annual report as “notes to financial statements” or “notes to accounts”.

These notes are an integral part of the financial statements to understand the company better. It’s the responsibility of the management to prepare these statements and notes to accounts.

Notes to accounts gives you lots of information such as

  • Company’s accounting policies
  • Statutory liabilities such as income tax etc
  • Pending legal proceedings if any.
  • Contingencies if any
  • Operating segments wise revenue and profit details.

As an investor you will get lots of information from company’s financial statements and annual report. However, some of the key information such as present economic condition and market fluctuations will not be available for you. You are required to understand company’s growth and relate it to the present situations.