Understanding Financial Statements For Better Investing

Understanding financial statement can help you a lot in stock investing. It can help you in choosing the right stock. There are three main financial statement: balance sheet, income statement, and statement of cash flow.

Balance sheet shows the financial position of a firm at a particular point of time. Balance sheet shows the firms asset, which are resources used in its operation like cash, office equipment, and building. The balance sheet also shows liabilities (claims of creditor to assets) and stockholders’ equity (claims of owner to assets). The company gets their resources (assets) from borrowing (liabilities) and from their investor (equity). Thus assets = liability + equity.

So how do you know a company is good or not from its balance sheet? A good company will always grow their assets, means that they are expanding. Increasing liability could be good or bad. Too much debt / liability is not good for the company, because it will have more risk. The company might not able to pay all their debt. When reading balance sheet, always check the change of asset, and liability from the same period last year. For example, compare the first three months asset this year with the first three months asset last year. Also, check balance sheet with other company’s balance sheet in the similar industry, preferably the same size. Younger company will grow more then mature company. If company A’s asset grows 10 percent, and company B’s asset grows 20 percent, then it means that company B is better.

Income statement reports the revenue, expenses, and profit (or loss) for a company over a specific interval of time. The most important thing to look for is Net Income, which is the difference between total revenue and total expense during a period. Increasing Net Income is what we look for. Also checks for increasing sales, and decreasing expense.

Another important number is the Earning Per Share (EPS) or how much earning which represents a stock. Increasing EPS is also good, but you must also watch out for outstanding stock. The number of outstanding stock can give you false impression of EPS. So you should cross check with Net Income. Look for growing EPS and Net Income.

Statement cash flow indicates how the cash position of the firm has changed during the period covered by the income statement. The statement of cash flows breaks down the sources and uses of cash into three components: operating, investing, and financing activities. From this, you can know how the company uses and gets its money, like:

o Are they using their money for expanding the business (investing activities) or not.
o How much money do they get from their operation (net income).
o How much money do they pay for their debt.
o How much money do they pay dividend.

By answering to those questions and understanding the company’s balance sheet and income statement, we should know how the company is doing. Are they going to the right direction or not. If you think they are heading to the right direction, you might consider buying their stock.