Relevance of financial statements in fundamental analysis

Financial statements are the cornerstone of fundamental analysis. It has three key financial documents: the income statement, balance sheet, and statement of cash flows.

Publicly listed companies are required to follow financial reporting rules of the country in which they are listed. Most of these stock exchanges and financial rules in the country require companies to publish quarterly and annual financial report to investors.

In this article we will briefly introduce each financial statements that the management publishes and its function.

Income statement

Income statement will tell you how much a company made or lost during a particular quarter or year in comparison to past data. In a statement, each company publish how much revenue they have generated for the period and how it spent to make that money. You can find out earning per share, net profit, price to earning ratio from this statement.

Balance sheet

Balance sheet of a company shows how much money a company has and how much it owes to others as at a particular date.

It balance based on the below equation:

Assets = Liabilities + Equity

Assets is what company owns and what it owes is called liabilities. The difference between these two is known as equity.

Statement of Cash flows

Please note, net earnings of a company are not necessarily cash income. In accrual accounting, you are recording certain transactions in which cash has not been spent. For instance, depreciation charged to profit and loss account is not a cash expenditure. You are charging depreciation based on the assets used in the company.

For this reason to know the cash position of a company, management prepare and publish statement of cash flow. It will let you know how much cash a company has generated from its core business, and how much cash it generates from financing and investment activities.

In addition to these financial statements, you should also look for auditor’s opinion, management comments, guidance for the future and investor call transcripts.