Reading financial statement forms like balance sheet, income statement and cash flow statement gives you an in-depth view of company's business performance.
Financial statement forms are an important source of information for stock fundamental analysis. Off course, you have to know how to read them and many investors are scared of this topic, since they lack the basis economical knowledge. But if you will continue to read this article, you will find out that reading financial statements isn't as hard as it looks like at all.
Let's first make it clear, what exactly are financial statement forms? This is the way of how a company reports its performance to the public. The most important financial statements are balance sheet, income statement and cash flow statement. Investors analyze financial statements, which are the quantitative part of fundamental analysis by the way, and form their investment decisions based on the research findings.
The Most Important Financial Statement Forms
The balance sheet simply shows what the company owns and what it owes at the exact point of time. In other words, you can read figures like company assets, shareholders equity and liabilities out of balance sheet. The three mentioned figures are related with the following simple formula:
Company Assets = Liabilities + Shareholder Equity
Like said, assets are something that company owns, like buildings, machinery, inventory and cash for example. On the other side of equitation you can see how the assets are financed - with owners equity, who invested their cash in company stocks together with all the retained earnings out of profits made in the previous years, or with debt, which must be sooner or later paid back.
Income statement reports company performance over specific period of time, most often in one year, half year or in a quarter. At this point i would like to mention, that company business year is not always the same as the calendar year; some companies for example start their business year on 1st Of July and finish it on 30th of June. You can read figures like revenues, expenses and profit out of income statement.
Cash Flow Statement
Cash flow statement records every in and outflow of a company's cash in a specific period of time. In cash flow statement you can read information regarding operating cash flow (OCF) from daily business activities, cash from investing (CFI) or terminating investments in assets, and cash from financing (CFC) for given or borrowed funds.
Cash flow statement is a very important part of financial statement forms, since it cannot be manipulated like income statement for example, where innovative accountants can manipulate profit in several ways.
Management Discussion and Analysis (MD&A)
Management usually explains the recent business performance and current situations in the industry as a preface to mentioned financial statements. They also present their discrete vision of things running up in the future; the key business details are not revealed off course.
This is a very important part of researching financial statement forms for investors. You should look for how clear and accurate are management's comments and be especially careful about negatives, like potential risks or any other uncertainties. Management should be disclosing price sensitive information upfront and honestly.
Independent Auditor's Report
Independent auditors express their opinion about integrity of the financial statements, if they provide adequate and accurate enough information, thus giving the statements the credibility. Every publicly traded company has to provide to investors auditor's report by law. In the auditor report you can read about which parts of financial statements were audited and what is the auditor responsibility, how the accounting standards were applied and an auditor's opinion about the statements.
Notes to the financial statements are connecting balance sheet, income statement and cash flow statement with some additional information in an easy to read/understand document. Reading notes shouldn't be ignored by investors.
You can find some additional information in the notes, like maturity dates of outstanding debt for example, which cannot be put in the financial statements.
You will also find in the notes information regarding used accounting methods. Be especially careful if the accounting methods have changed; it could be a sign of the management trying to hide bad results with innovative accounting.
Where Can You Find Company's Financial Statement Forms?
In developed countries it is very common that publicly traded companies have to submit their financial statement every quarter (10-Q) and at the end of business year (10-K) to exchange supervisory body, which is the Securities and Exchange Commission (SEC) in case of U.S. It is also usual that independent auditor report and management insights into the future business are appended. Beside SEC fillings companies also release so called annual reports, which in nothing else than boring 10-K form in a much fancier marketing format.
All the reports are normally accessible over the internet for free (SEC EDGAR database or company's websites), so you shouldn't worry too much about getting them when needed.
Prepare for Research
Once you will start analyzing financial statement forms, get yourself the historical data as well, so that you will be able to perform some comparisons, calculate the dynamics of certain ratios, and so on. Researching management future plans and estimating the probability of their realization is also extremely important part of quantitative fundamental analysis.
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