Being a smart investor means making well-informed decisions. You need to do your due diligence and then put your money into an asset. One of the key sources of information is the financial statement. It is a written document that shows the business activities and reflects on the financial performance of the company. It allows you to understand key financial data like profits, expenses, and losses, and helps decide whether the company is a feasible investment option.
Financial statements include an income statement which shows the revenue, expenditure and earnings per share. It has a balance sheet which lists the assets, liabilities and shareholder equity. And a cash flow statement which shows the operational costs, debt repayments and more. It is one of the most important documents for investors to look at. They allow investors to understand the cash flow of the business and see whether the business is on a sustainable path of growth or not.
How do investors use financial statements?
Financial statements can provide a snapshot of the company’s performance at a specific point in time. The statements can help understand the financial position of the company and the data in them gives a measure of cash flow projections, the revenue generation potential as well as helps conduct a competitive analysis. All these factors can help decide if the business is worth investing in.
An investor considering an investment in the company would be keen to know more about the revenue, net profit and dividends. All the information can be easily found in the financial statements, thus, helping you make the right decision.
Things to know about statements
Here are a few things you need to know about financial statements before you start to read them.
Fiscal year
Before you start reading the statements, you need to understand the basic terms for example, what does fiscal year mean? It is time lasting one year but not necessarily starting at the beginning of a calendar year. The statements are prepared for a fiscal year and it consists of 12 consecutive months in which a business is conducted. When you read the financial statements, you need to see the fiscal year it covers.
Net profit
Financial statements show the net profit of the company. It is the money that a business has left over after it pays all its expenses. This is a good place to see if the business is making sustainable profits.
Sales
A company could have an exceptional product or service but it can only make revenue if people are willing to buy it. The income statement will reflect the sales figure and you will be able to see the sales growth. If it has an upward trend, the product or service is working.
Cash flow
Cash is king in every business and you will see the cash flow statement in the financial statements. Look at the amount of cash generated by the company over a fiscal year. If the cash generated is positive, it shows that it gained more cash than it used and it is a good sign. The statement will show the cash generated through operations, investment and financing activities. Free cash flow is the amount of cash that is left after you meet the expenses and it is a sign of sustainable operations.
Debt
Debt is one thing investors should never overlook. If a company goes out of business, debt holders will get their money back before the equity holders. Any company with heavy debt will carry a certain amount of risk and high debt payments can hinder the ability to meet other expenses in slow business periods. The debt should be in a tolerable range as compared to the assets owned by the company and a high debt is a big red flag.
Dividend yield
The dividend yield of a company is the percentage of returns on the investment through dividends alone. Many investors are looking for dividend-paying companies and in this case, understanding the dividend yield is important. It will show the amount of dividends that a company pays every year on its share price. Any company paying consistent dividends is a good sign.
Investors should compare the financial statement of a company to other companies in the same industry in order to see how well it is performing against its peers. Do not make an investment decision by simply studying the financial statement of one company for one fiscal year. Thorough research can help identify high-growth potential companies to invest in.
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