How to Analyze Financial Statements
Original post by Mike Parker of Demand Media
Banks run a credit check on loan applicants to help determine whether the borrower has the ability to repay the loan. A real estate investor typically engages the services of a building inspector to determine the structural soundness of a property before she buys it. You should also be concerned about the financial health of a company before you invest in that company's stocks or bonds. You can learn a great deal about a company's financial health by analyzing its financial statements.
Contact the investor relations department of the company in which you are interested in investing, and request an annual report. There are a number of different types of financial statements. Annual reports typically include at least the company's balance sheet and income statement. The annual report may also include a cash flow statement and a shareholder's equity statement. Each of these financial statements contains pertinent information. Annual reports include additional information in their footnotes and a section commonly referred to as Management’s Discussion and Analysis. These are not technically financial statements, but the information in these sections can shed additional light on the company's financial condition. Read the annual report and identify each type of financial statement. You also often can find annual reports on company websites in the investor relations section.
Determine the company's net worth by analyzing its balance sheet and statement of shareholder equity. A balance sheet may appear complex, but at its heart it has only two sections; one for assets and one for liabilities. A company's assets include everything of value that the company owns. This includes cash on hand, securities and investments, tangible property such as real estate, vehicles, equipment and buildings, and intangible property such as patents and trademarks and goodwill. A company's liabilities include all amounts the company owes. Liabilities may include borrowed funds, outstanding corporate bonds, taxes due and other legal obligations. You can determine the company's net worth by subtracting its total liabilities from its current assets. If the result is a positive number, the company has a positive net worth. If the result is a negative number, the company has a negative net worth. A company's net worth is sometimes referred to as shareholder equity. This amount is also detailed on the company's statement of shareholder's equity.
Determine a company's operating results by analyzing its income statements and cash flow statements. The company's income statement reveals the profits and losses resulting from operations and special circumstances during a specified period of time, typically quarterly and annually. The income statement lists all income received and expenses paid by the company during the specified time frame. The income statement usually includes the earnings per share, which is derived by subtracting expenses from income and dividing the remainder by the total number of outstanding shares of stock. The company cash flow statement provides a fluid accounting of how much cash the company has available at any given time to meet its obligations.
Don't neglect the footnotes and management’s discussion and analysis. The footnotes can provide important information regarding company income taxes, pensions and profit sharing plan obligations, stock option policies and accounting methods. The Securities and Exchange Commission requires company management to inform company shareholders about events, trends and other situations that may impact the financial information supplied in the annual report. This information is designed to provide context to the company's financial reports, and can help you to understand certain decisions and policies implemented by management.
Tips & Warnings
- (pdf) Austin Community College: How to Assess Nonprofit Financial Performance
- IBM: Guide to Financial Statements
- U.S. Securities and Exchange Commission: Beginners' Guide to Financial Statements
- U.S. Small Business Administration:Financial Statements
- Merrill Lynch: Understanding Financial Reports (pdf)
About the Author
Mike Parker has been writing professionally for more than 15 years. His work has appeared in various print and online publications, including "Grassroots Music Magazine," "Christian Single Magazine," BuddyHollywood.com and Lifeway.com. He earned a Bachelor of Arts degree in bible from Hardin-Simmons University.