Basically, there are four main financial statements:
1. Balance Sheets
2. Income Statements
3. Cash Flow Statements
4. Statements of Shareholders’ Equity
1. BALANCE SHEETS
A balance sheet will provide detailed information about a company’s assets, liabilities and shareholders’ equity. A balance sheet (also called the statement of financial condition) is a snapshot of the financial condition of the business or organization.
Assets are things that the company owns that has value and is usually a product or service that can be sold. Assets include equipment, vehicles, inventory, buildings, trademarks, patents, cash as well as investments. “Assets have to equal or balance the sum of its liabilities and shareholder’s equity.” Assets are divided into three categories: Current, noncurrent or fixed assets.
- Current assets – things a company expects to convert to cash within one year.
- Noncurrent assets – things a company does not expect to convert to cash within one year or that may take longer than a year to sell.
- Fixed assets – things a company uses to operate the business but that are not available to sell like equipment, the building, vehicles, office furniture, etc.
Liabilities are debts or money that a company owes to other businesses or people. This can include rent for a building, payroll to pay their employees, taxes, borrowed money from a bank, supplies, equipment orders, regulatory fees, credit cards and any obligations to provide goods or services to customers in the future. Liabilities are based on their due dates, example rent due the first of the month. Liabilities are either current or long-term (also called non-current liabilities).
- Current liabilities – are obligations a company expects to pay off within the year.
- Long-term liabilities (also called non-current liabilities) – are obligations that are due more than one year away. Examples are: Bonds payable, loans payable, deferred tax liability, pensions payable, financial lease payable, and post-retirement healthcare obligations.
The classification of liabilities into current and long-term is important because it can help the users of the financial statements assess the financial strength of a business in both short-term and long-term and are critical for assessment of its long-term solvency. A long-term investor will want to know the noncurrent liabilities of a company in order to gauge how well that company will do in the future. Banks are more interested in the current liabilities and short-term liquidity of a company to pay back its loans.
Shareholders equity is sometimes called net worth or capital. It is the money left over after all of the debts have been paid and if the company sold all of its assets. This leftover money belongs to the shareholders, or the owners, of the company.
2. INCOME STATEMENTS
An Income Statement (also known as a Profit and Loss Statement or P&L) shows you how the company makes its money and allows you to judge whether a company is spending too much money on a particular expense and whether the company is turning a profit or not.
The three most important parts of an income statement are the Gross Profit, Operating Expenses and the Net Earnings. The bottom line is that an Income Statement will show you how much the company has earned or lost over the period.
Gross Profit (also called Gross Margin) – what a business earns in total revenue subtracted by the costs of generating that revenue, or sales minus the cost of goods sold. This is considered “gross’ because there are certain expenses that have not been deducted from it yet. To calculate Gross Profit Margin, you would divide the Gross Profit by the Total Revenue. Be sure to watch a company’s gross profit over time, as it should remain stable. Significant fluctuations can be a sign of fraud, mismanagement, accounting irregularities, secular declines in the business itself, or if positive can signal a turnaround, expansion, or a shift in product demand that has rewarded its owners.
Operating Expenses – go towards operating a business such as salaries, benefits, advertising, rent, utilities, depreciation, costs of researching new products, etc. Some items listed are fixed and others may be seasonable or variable. Operating expenses are different from “costs of sales,” which are deducted in figuring the gross profit. If operating expenses are rising greater than gross profits, the business should check to see which areas it can cut back on or which may actually be driving more sales.
Net Earnings (also called Net Income or Net Profit) – are the bottom line for the reporting period and shows how much profit or loss a business achieved.
Most Income Statements report earnings per share (or “EPS”). It tells you how much money the shareholders would receive for each share of stock they owned if the company distributed all of its net income for the period. (Companies almost never distribute all of their earnings and usually reinvest them in the business.) The EPS is normally the net income divided by the total of outstanding shares.
3. CASH FLOW STATEMENTS
Cash Flow Statements (or Statement of Cash Flows) report a company’s inflows and outflows of cash and answers where the money came from and where the money went or was spent. Cash Flow Statements are used for budgeting and business planning. Cash Flow Statements have three main sections: Operating Activities, Investing Activities and Financing Activities.
Operating Activities – Tells you how much cash the company generated from its core business such as the sales of its goods or services for example. This is the area a stockholder should focus most of his/her attention on, as it will paint a picture of how well a firm’s business is producing cash that will benefit shareholders.
Examples of Cash Flows relating to Operating Activities are cash receipts and collections from sales of goods or services, cash receipts from earnings on investments in securities (interest and dividends), payments to suppliers, employees, for interest or for taxes.
Investing Activities – are the sale or purchase of something.
Examples of Cash Flows relating to Investing Activities are cash receipts from the sales of securities and other companies, cash receipts from the sales of productive assets, payments for the purchase of securities of other companies, payments at the time of purchase for the acquisition of productive assets.
Financing Activities – are the borrowing or sale of a common stock. Paying back a bank loan would also show up as a use of cash flow.
Examples of Cash Flows relating to Financing Activities are proceeds from issuing capital stock or other equity securities, proceeds from issuing debt securities or obtaining loans (other than trade credit), payments for reacquisition of capital stock or other equity securities of the entity, payments for the retirement of debt securities (excluding interest), payments of principal on loans (other than trade payables) and payments of dividends.
Shortcuts to make financial statements analysis easier to understand:
If the balance of an asset increases, then cash flow from operations will decrease.
If the balance of an asset decreases, then cash flow from operations will increase.
If the balance of a liability increases, then cash flow from operations will increase.
If the balance of a liability decreases, then cash flow from operations will decrease.
4. STATEMENTS OF SHAREHOLDERS’ EQUITY
The Statements of Shareholders’ Equity is a financial document a company issues as part of its balance sheet as stated above. The shareholders’ equity is determined by calculating the difference between a company’s total assets and its total liabilities and highlights whether a shareholder’s equity goes up or down. The statement of shareholders’ equity enables shareholders to see how their investments are doing and whether they should buy more, sell what they have on hand, or just sit on the stocks they are holding. The Statement of Shareholders’ Equity typically includes the following components: Preferred Stock, Common Stock, Treasury Stock, Additional Paid-Up Capital, Retained Earnings, Unrealized Gains and Losses.
Preferred Stock – is a class of ownership in a corporation that has a higher claim on its assets and earnings than common stock. Preferred stockholders will be entitled to dividends before holders of common stock can receive theirs. Preferred shares usually do not carry voting rights, although under some agreements may revert to shareholders that have not received their dividends. Preferred shares have less potential to appreciate in price than common stock.
Common Stock – is a class of ownership stake in a company that comes with voting rights. However, if a company liquidates then the common stockholder goes to the bottom of the ladder and only will get paid after the preferred stockholders and bond stockholders.
Treasury Stocks – are shares that were once part of the float and shares outstanding but were subsequently repurchased by the company and decommissioned. These stocks do not have voting rights and do not pay distributions. With Treasury Stocks, a company can decide to hold on these stocks indefinitely, reissue them to the public or even cancel them.
Additional Paid-Up Capital (also known as Contributed Capital) – is a term that encompasses both common stock and preferred stock, it is the excess amount investors pay over the par value of a company’s stock. Some states require a par value for common stock, other states do not. If there is no par value, some states will require a “stated value.” You may see the word, “stated” in place of “par” in this case.
Retained Earnings also called Retained Capital – are the total earnings a company has brought in that has not yet been distributed to shareholders. Savvy investors should look closely look at how a company puts retained earnings to use and generates a return on it.
Unrealized Gains and Losses – an unrealized loss occurs when a stock decreases after an investor buys it, but has yet to sell it. An unrealized gain is if the stock rose back above the original stock price but has not yet been cashed in.
To see an example of an Apple Inc. Earnings Statement: https://www.bamsec.com/filing/32019317000009?cik=320193
To see an example of Unrealized Gains and Losses: http://accountinginfo.com/study/investment/holding-gain-ex01.pdf