Understanding the financial statement before investing in a company

INTRODUCTION

What comes into your mind when I say match a word with finance? Let me guess “Financial statement” right? From the time we have chosen commerce as our field in school this word has been with us.

We all must know what they are right ? Financial statements are the documents created by management to offer a regular evaluation or report on the state of the company’s operations. The statements are referred to as financial statements since they include financial information. Financial reports are another term for financial statements.

For the financial statements to be beneficial to the users, relevant info must be included. Any information that aids these users in making investment decisions is beneficial knowledge. Their evaluation of past, present, or even future occurrences should be aided by this information.

A crucial tool for managing a firm is a set of financial statements. They provide vital information on the performance of the firm and provide a snapshot of its financial situation. “A business’s financial  statements are a measure of its decisions and actions”. Stakeholders, shareholders, and management are informed about an entity’s performance and financial health through its financial statements. The legislation requires that a Chartered Accountant (an auditor) review the financial statements and any relevant disclosures made by management to determine whether they reflect the true and fair view in order to increase the level of confidence in the financial statements.

Before we begin studying the three types of financial statements(income statement, cash flow statement and balance sheet)  we should understand a major role of the trial balance that helps in the preparation of these financial statements.

TRIAL BALANCE

A trial balance is an accounting worksheet where the balances of all ledgers are totaled into equal amounts in the columns for the debit and credit accounts.

Trial balance sheets include all of a company’s accounts that incur debits or credits during a given reporting period, the sums of all debits and credits recorded during that period, the account numbers associated with each account, the dates of the reporting period, and the total amounts credited and debited to each account.

Trial balances can provide an overview of individual account balances and account performance.

Now since you have got an idea of trial balance. Lets see how trial balance plays a role in the making of the financial statements.

1. When creating a financial statement, accountants start with the trial balance worksheet.
2. In  accordance with the double-entry accounting principle, a trial balance is created. This means that a corresponding credit entry will be recorded in the credit column for each entry made in the debit column. Errors can be found and fixed because it includes entering all the entries from the organization’s ledgers in this manner.
3. One can also make sure that the account balances are correctly extrapolated from accounting ledgers with the use of the trial balance.
4. Because a trial balance gives accountants tallied columns, adjustments may be made quickly even after it has been created.

TYPES OF FINANCIAL STATEMENTS

1) Income statement/ Statement of operations/Profit and loss statement

The company’s profit and loss for the entire fiscal year are detailed in the income statement. The total revenue is subtracted from all operating and non-operating expenses to arrive at the company’s net profit/net loss.

Revenue, cost of sales, sales, general, and administrative expenses, other operating expenses, non-operating income and expenses, gains and losses, non-recurring items, net income, and EPS are the elements of the income statement.

The following are some ways in which the income statement is significant to the investing guide:

• Income statements are often prepared either monthly or quarterly; this enables investors to regularly monitor the success of the company.
• The income statement’s vertical analysis might be helpful for comparisons with other businesses in the sector.
• Net profit, which reveals how much the business actually made (or lost) over the reporting period. Investors value net profit because it indicates whether or not a company truly turned a profit.
• The income statement helps in answering 3 vital questions of the investors that are
  • How much revenue did the business generate?
  • How was that cash used?
  • Did the business turn a profit?

• Several line items of income statements help in calculating financial ratios that lay a major role in performing the financial analysis of a company.

2) Cash Flow statement

A financial statement called a cash flow statement gives total information about all cash inflows a business makes from continuing activities and outside investment sources. Additionally, it consists of all financial outlays made over a specific time period to cover investments and business expenses. A cash flow statement divides into three activities those are operating activities,investing activities and financing activities.

The following are some ways in which the cash flow statement  is significant to the investing guide:

• While making an investment decisions investors will always keep at priority the quality of earnings , cash flow statement comparison helps the investors to do this
• Cash flow statements help in giving the investors a breakdown which shows how the cash is moving at their places.
• Cash flow statement shows the investors the financial soundness of the entity , it acts as a vital indicator for the financial health of the company.
• The operating activities section of the cash flow statement helps to show the investors how much money the company is making from its core operations and how much is spending to conduct these operations.
• It provides answers to a variety of difficult problems that management frequently has, such as: Why is the company unable to pay dividends despite producing adequate profit? Why is there such a large cash balance sitting idle despite the loss? Where have the fixed asset sale revenues gone? etc.
• The investing activities section of the cash flow statement shows the investors the assets in which the company has invested in.
• In the financing activities section of the cash flow statement, investors may see how much money is moving between the company’s owners, creditors, and employees in this area. Numbers pertaining to capital brought into the company during the pertinent period, debts paid off, dividends paid to directors, and capital borrowed during that period can all be found there.
• Several line items of cash flow statements help in calculating financial ratios that lay a major role in performing the financial analysis of a company.
• If the business has long-term financial obligations, a cash flow statement can help owners and investors assess the likelihood of payback. It makes it simple to forecast the time, size, and uncertainty of upcoming cash flows.

3) Balance Sheet

A balance sheet is a financial statement that lists the assets and liabilities of a corporation at a certain point in time. It is one of the three primary financial statements—the other two being the income statement and cash flow statement—that are used to assess a company’s performance.

A balance sheet must be maintained at all times. This is so because balance sheets adhere to the fundamental accounting  equation that states  assets equal liabilities plus capital. Every transaction has an equal and opposing impact on both sides of the equation.

The following are some ways in which the cash flow statement  is significant to the investing guide:

• Equity is the amount that the company’s shareholders are truly entitled to, and it is equal to assets less liabilities. Retained earnings and paid-in capital are two items in the equity section to which investors should pay close attention.
• Understanding a company’s situation both now and in the future requires knowledge of its balance sheet. It aids in determining if a company has borrowed more money than it can manage or whether it has enough cash on hand to meet its needs.
• Several line items of the balance sheet help in calculating financial ratios that lay a major role in performing the financial analysis of a company.
• The liabilities section of the balance sheet helps to evaluate the amount of debt the company owes, Investors often benefit more from a lower amount of debt .
• The amount of money to which the firm’s owners would be entitled if the corporation were to settle all of its liabilities will be examined in the shareholders’ equity section. For investors, a higher percentage of shareholders’ equity is usually preferable.
• Most investors examine the company’s balance sheet before selecting a company for investment in order to assess its financial position. Additionally, they blend it with a number of other indicators to determine the likelihood of future growth for the company.

(Also Read – Top Financial Literacy Platforms for A Successful Financial Planning)

CONCLUSION

The process of examining a company’s financial statements in order to make decisions is known as financial statement analysis. It is used by external stakeholders to assess an organization’s general health as well as its financial performance and market value. It serves as a monitoring tool for handling finances for internal stakeholders.

There are various ways to read financial statements. To better comprehend changes throughout time, financial statements can first be compared to those from earlier times. Comparative income statements, for instance, show the income for a company both last year and this year. The users of financial statements are informed of the health of a company by noting the year-over-year change.

Financial statements can also be interpreted by contrasting their performance with that of rivals or other market players. Analysts can better understand which businesses are outperforming the rest of the industry by comparing their financial statements to those of other businesses.