There are various types of financial statements that will give you insights on a company’s financial status. The numbers may put you off, but they are the key to understanding how the company has been operating, and how well they have been handling different aspects of their finances.
If you are an absolute beginner at accounting and this is your first time reading this accounting series, please read our previous article on understanding accounting terms.
Read Also: Understanding Accounting Terms In 10 Minutes (Part 1)
In this article, we will look at different financial statements such as the Statement of Financial Position, Statement of Changes in Equity, Statement of Comprehensive Income, Statement of Cash Flows. Each financial statement tells you different things you need to know before you invest in the company.
Statement of Comprehensive Income (also known as Income Statement)
Three types of accounts appear in the income statement: revenues, costs, and expenses. It vertically tells you:
Revenues – Costs – Expenses = Profit or Loss
Other common names for the income statement include: statement of profit and loss, report of earnings or verbally, P & L. The period covered in the statement must be reflected in terms of month, quarter or year.
For example, the income statement of BreadTalk shows us that their profits have fallen in 2015.
Statement of Financial Position (also known as Balance Sheet)
The balance sheet is like a snapshot of the business at a point in time. It contains the assets, liabilities, and equity. When you look at it, you will see how much the company owes, and your revised equity share.
The balance sheet is useful in helping investors derive ratios.
These ratios include:
- Current ratio
- Quick ratio
- Accounts receivable turnover
- Inventory turnover
- Debt to equity ratio
We will be covering these ratios in part 3 of our accounting series.
Statement of Changes In Equity
The statement of changes in equity breaks down how equity changes over the reporting period. This statement shows beginning share capital, events that increase it, and events that decrease it. Cumulative net income not distributed to shareholders is known as retained earnings. The ending equity is calculated here, and carried over to the statement of financial position (balance sheet).
Statement of Cash Flows
We often hear of the phrase, “Cash is King”. Value investors like to determine if a company is worth investing by judging how well they handle their cash. Investors look favorably to companies who finance their expenditures with cash generated from operations, and not cash from selling their assets because it is not sustainable to do so.
Statement of cash flows has three main sections: operating, investing, and financing activities. Supplies expected to be used up in the short-term operations (usually within a year) fall under operating activity. Long-term asset investments by the company will be categorised under investing activities. Financing activities can include long-term borrowing and repaying of cash from lenders.
Unlike the income statement, which records non-cash expense, the statement of cash flows does not. For example, depreciation is a non-cash expense that we will not see in the statement of cash flows. Instead, it allows investors to see where the company generates and spends their cash.
Cash Flow From Operating Activities
Examples:
- Collection from clients (cash inflow)
- Payment for supplies (cash outflow)
- Payment to employees (cash outflow)
It is important for cash flow from operating activities to be positive. Cash from this area is generated by the firm’s business activities. If a net cash outflow (derived after tabulating all cash inflows and outflows) occurs here, it means that the business is not earning revenue from its operations and suggests that it may fail.
Cash Flow From Investing Activities
Cash spent or generated from property, plant, and equipment are recorded here. When a company buys or sells an asset, the cash spent or generated will be reflected in the statement. Unlike a negative cash flow from operating activities, when there is a negative cash flow from investing activities, it isn’t always a bad sign. Often, when a company is growing, there is a net cash outflow in this area because the company is investing in assets (e.g. building, factory, machinery) that will help them generate profits in future.
Examples:
- Purchase of equipment (cash outflow)
- Purchase of investment securities (cash outflow)
Cash Flow From Financing Activities
Cash flow from financing activities are usually cash paid or received from investors outside the company. The shares of the company are a financing activity and not an investing activity because the firm itself is not investing in it. It is just a method for the company to raise funds for its operations or expansion.
Examples:
- Interest paid (cash outflow)
- Issuance of shares (cash inflow)
- Dividends paid (cash outflow)
- Repayment of (long or short term) loans (cash outflow)
Summary
Read Also: How You Can Use Fundamental Analysis And Technical Analysis Together
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