The four most essential statements of a company are: balance sheet, cash flow statement, income statement and statement showing stockholders’ equity. These statements illustrate the financial health of a company, its incoming and outgoing cash, profit and loss and shift in equity of stockholders. Companies make available their periodic financial statements to stockholders. On analyzing the four financial statements of a company, you come to know its financial health and performance on the whole. Therefore it is very important for investors to know how to read a financial statement. Comparison of consecutive financial statements over different years helps measuring the progress of companies. This is how you can proceed to know how worthwhile it will be to invest in a company
1. Analyze the balance sheet of the company and statement showing stockholders’ equity. Find out its total liabilities and compare the same to the total amount of stockholders’ equity. The total of all the liabilities signifies company’s total debt whereas equity of stockholders indicates the financial investments made by investors. Try to find a financially strong company having liabilities less than stockholders equity. For instance, a company having total liabilities of $100,000 against $ 300,000 as total equity of stockholders means the company is conformist in using debt.
2. From the income statement of a company you can know its total expenses and total revenue. If revenue is more than the expenses it incurred, its income statement will show net income, which equals revenue minus expense. On the other hand if its expenses are more than the revenue earned, it the statement will show net loss. A thriving company should have more revenue, compared to expenses. For example, when a company shows $100,000 as total revenues and $70,000 as total expenses, it will show $30,000 as net income, in the income statement, suggesting that the company produced moderately good profit.
3. Make out the net decrease or increase of cash as noted at the end of the cash flow statement. This is the amount of cash that the company finally created or consumed for the period of accounting. Search for a financially healthy company that can create an increase in its net cash. For example, a company showing a net increase of $90,000 in its cash means that its cash account grew up by $90,000 for that period of time.
4. Watch the opening and closing balance of total equity of stockholders in the record of stockholders equity and the financial amounts which caused changes in the balance. In the statement, the amounts that reduce equity of stockholders are shown in parentheses while the amounts which augment equity of stockholders are shown without parentheses. An increase in closing balance, compared to the opening balance, shows that the equity of company increased, and signifies that the company is growing. Choose a thriving company wherein total equity of shareholders shows growth and net income primarily contributes to its growth.
5. Make a comparative study of the financial statements for the past few years recognize any negative or positive trends. You should understand that an efficiently managed company would continue maintaining its debt to a conservative level. It will show a steady increase in its net income over the years, showing a progressive addition to its cash and a consistent growth in the equity of its shareholders.