Understanding a company’s financial health is one of the most important abilities for aspiring investors, entrepreneurs, and managers to master. With this knowledge, investors will be able to find more viable prospects while avoiding unnecessary risk, and professionals at all levels will be able to make more strategic business decisions.
Financial statements provide a window into a company’s health, which might be difficult to assess through other means. Many company professionals are not qualified to read and interpret these documents, unlike accountants and financial specialists. As a result, crucial information is obscured.
If you’re unfamiliar with what a financial statement, and the meaning of financial statements, then this beginners guide to financial statements can help you read and comprehend the information included inside them.
What Is Financial Statement?
The meaning of financial statements is to understand a company’s financial position, both on its own and within its industry, several financial statements must be reviewed and analyzed: balance sheets, income statements, cash flow statements, and annual reports. The worth of these financial statements is found in the story they convey when read together.
1. Understanding a Balance Sheet
A balance sheet indicates a company’s “book worth.” It enables you to view what resources are available and how they were funded as of a certain date. It displays the company’s assets, liabilities, and owner’s equity (essentially, what it owes, owns, and the amount invested by shareholders).
Using the accounting equation, the balance sheet also provides information that can be used to compute rates of return and evaluate the capital structure. Liabilities + Owners’ Equity = Assets . To understand the meaning of financial statements it is important to understand what assets and liabilities are.
Assets are anything a corporation owns that has a monetary value. While, Liabilities are sums of money owed to a debtor by a corporation, such as overdue payroll expenses, debt payments, rent and utilities, bonds payable, and taxes.
The balance sheet does not provide information on trends on its own, which is why it is necessary to review other financial statements, such as income and cash flow statements, to completely understand a company’s financial status.
2. How to Interpret an Income Statement
A profit and loss (P&L) statement, often known as an income statement, describes the cumulative impact of revenue, gain, expense, and loss transactions for a particular period. The document, which is frequently distributed as part of quarterly and yearly reports, depicts financial trends, company operations (revenue and expenses), and comparisons across specified time periods.
Accountants, investors, and other company professionals evaluate income statements on a regular basis:
To determine how well their company is performing: Is it financially viable? How much money is spent on the production of a product? Is there money to put back into the business? To evaluate financial trends, consider the following: When are costs highest? When do they reach their lowest point?
3. Understanding a Cash Flow Statement
A cash flow statement’s objective is to provide a complete picture of what happened to a company’s cash during a particular time period known as the accounting period. It displays an organization’s ability to operate in both the short and long term based on the amount of cash coming in and out of it.
Cash flow statements are divided into three sections: cash flow from operations, cash flow from investing, and cash flow from borrowing.
Operating operations describe the cash flow generated after a company delivers its regular goods or services, which includes both revenue and expenses. Investing activity is defined as the cash flow generated by the purchase or sale of assets—typically in the form of physical property such as real estate or vehicles, but also non-physical property such as patents—using free cash rather than debt. Financing operations describe the cash flow generated by loan and equity financing.
It’s critical to understand the distinction between cash flow and profit. While cash flow refers to the amount of money that flows into and out of a business, profit is what remains after all of a company’s expenses have been removed from its revenues. Both are critical figures to understand.
A cash flow statement allows you to identify what activities create cash and use that knowledge to make financial decisions.
Ideally, cash from operating income should frequently surpass net income since positive cash flow reflects a company’s financial health and potential to expand operations. However, good cash flow does not always imply a company is profitable, which is why you must also examine balance sheets and income statements.
This beginners guide to financial statements teaches one the meaning of financial statements and their relevance. Financial statements are maintained by all businesses and people who intend on investing in them should know what a financial statement is as this will help them make a sound decision.
Through this beginners guide to financial statements, one can easily analyze and interpret the financial statements of any company and would easily answer the question to what is financial statement.