THE FUNDAMENTALS OF FINANCIAL STATEMENTS

Accounting is the language of business. And it is critical to understand the moving parts in the financial statement.

The problem is most investors overlook changing ratios, the returns on equity and simple forecasts. Sometimes the smallest impact will have a ripple effect compounding better or worse overtime.

• balance sheets, explain the accounting equation

  • assets

    • Assets are resources that a company owns or controls with the expectation of future economic benefit. They can be tangible, such as buildings, land, equipment, or inventory, or intangible, such as patents, trademarks, or copyrights. Assets are listed on a company's balance sheet, which provides a snapshot of its financial position at a specific point in time. The value of an asset is equal to its cost minus any accumulated depreciation. Assets are important because they provide a company with the means to produce income and pay expenses.

    • Here are a few key things to keep in mind when looking at balance sheet assets:

      • Liquidity: Assets can be classified into those that are liquid (easily converted to cash) and those that are not. Liquid assets, such as cash or marketable securities, are important to a company because they can be quickly converted to cash to meet unexpected expenses or opportunities.

      • Current assets: Assets that are expected to be converted to cash or used in the business within one year are considered current assets. These assets are important because they help to ensure a company's short-term financial stability.

      • Fixed assets: Fixed assets, such as property, plant, and equipment, have a longer useful life and are expected to provide economic benefits to a company over a longer period of time.

      • Intangible assets: Intangible assets, such as patents or trademarks, are difficult to value and can be a source of significant economic value to a company.

      • Depreciation: Depreciation is a method of allocating the cost of a long-lived asset over its useful life. Depreciation reduces the value of an asset and is reflected in a company's income statement.

    • It is important to consider the composition of a company's assets and how they are managed, as it can provide valuable insights into its financial strength and risk profile.

  • liabilities

    • Liabilities in a balance sheet are the debts and obligations of a company that are due to be paid to creditors and lenders. Liabilities are classified as either current liabilities, which are expected to be settled within one year, or long-term liabilities, which are due beyond one year. Some common examples of liabilities include loans, accounts payable, mortgages, bonds payable, and pension obligations. Liabilities are important to monitor as they reflect the amount of debt a company has and its financial obligations, which can impact its ability to pay its bills and maintain solvency.

    • When analyzing a company's balance sheet, there are several things to consider about liabilities:

      • Composition: Understanding the types of liabilities a company has is important. For example, short-term debt is typically less risky than long-term debt.

      • Trends: Changes in the level of liabilities over time can indicate the company's financial health. A sudden increase in liabilities could be a red flag.

      • Coverage: The company's assets should be sufficient to cover its liabilities. This is often measured by comparing the company's current assets to its current liabilities.

      • Maturity: It's important to know when the liabilities are due and whether the company has the ability to pay them on time.

      • Interest costs: Interest costs are an important factor to consider when evaluating liabilities, as they represent an ongoing expense that reduces the company's profitability.

    • Overall, a comprehensive understanding of a company's liabilities is important in order to assess its financial health and the potential risks associated with investing in it.

  • equity

    • Equity in a balance sheet refers to a company's residual ownership interest in its assets after deducting liabilities. It represents the portion of a company's assets that are financed through capital contributions from the owners, such as common and preferred stock, retained earnings, and other reserves. Equity is an important measure of a company's financial strength and stability, and is used to calculate important financial ratios such as the debt-to-equity ratio and return on equity.

    • Here are some key things to keep in mind when evaluating equity on a balance sheet:

      • Capital Structure: Equity is a crucial component of a company's capital structure, which is the way it finances its operations and growth. By comparing the amounts of equity and liabilities, investors can gauge the risk involved in a company.

      • Retained Earnings: Retained earnings represent a company's accumulated net income that has not been paid out as dividends. This is a key component of equity and can provide a company with the ability to invest in growth opportunities or fund operations during challenging times.

      • Equity Classes: A company's equity can be comprised of multiple classes of shares, such as common and preferred stock. Each class may have different voting rights, dividend rights, and other financial benefits.

      • Owner's Equity: Equity is often referred to as owner's equity, as it represents the residual ownership interest of the shareholders. Understanding equity is important for determining a company's valuation and its ability to generate returns for its owners.

      • Changes in Equity: It's important to track changes in equity over time to assess the company's financial performance and to identify trends in earnings, dividends, and other equity transactions.

    • A balance sheet is a financial statement that provides a snapshot of a company's financial position at a specific point in time. It lists the company's assets, liabilities, and equity. Here are some key things to understand about balance sheets:

      • Assets: Assets are the resources owned by a company that have monetary value. Common assets include cash, investments, inventory, property, and equipment. Assets are listed in order of their liquidity, meaning the ease with which they can be converted into cash.

      • Liabilities: Liabilities are the debts and obligations owed by a company. Common liabilities include loans, accounts payable, and taxes owed.

      • Equity: Equity represents the residual interest in the assets of a company after deducting liabilities. It represents the value of the company that is owned by shareholders.

      • The relationship between assets, liabilities, and equity: The balance sheet must balance, meaning that assets must equal the sum of liabilities and equity. This is represented by the equation: Assets = Liabilities + Equity.

      • Changes over time: Balance sheets are a snapshot of a company's financial position at a specific point in time, so it's important to compare balance sheets from different periods to see how a company's financial position has changed over time.

      • Importance for investors: Balance sheets are an important tool for investors to assess the financial health of a company. By understanding a company's assets, liabilities, and equity, investors can get a better understanding of its financial strength and its ability to meet its obligations.

    • By understanding these key elements of a balance sheet, you can get a better understanding of a company's financial position and make more informed investment decisions.

• cash flow statements

  • operating 

    • Operating cash flows refer to the cash generated by a company's main business activities. Understanding operating cash flows is important because it provides information about a company's ability to generate cash from its core operations. Here are some key things to keep in mind when considering operating cash flows:

      • Sources of cash: Operating cash flows can come from the sale of goods or services, collections from customers, and other revenue-generating activities.

      • Uses of cash: Operating cash flows can also be used for expenses related to the company's core business activities, such as employee salaries, rent, utilities, and other operating expenses.

      • Trends: By comparing operating cash flows from different periods, you can see trends in the company's ability to generate cash from its core operations and assess its overall financial health.

      • Comparison with peers: Comparing a company's operating cash flows with those of its peers can give you a better understanding of how it compares in terms of cash generation from core operations.

      • Impact of non-recurring items: It's important to keep in mind that operating cash flows can be impacted by non-recurring items, such as one-time expenses or gains.

      • Quality of earnings: Operating cash flows can also provide insight into the quality of a company's earnings. If a company's operating cash flows are consistently lower than its net income, it may indicate that the company is using aggressive accounting practices or has a weak operating performance.

    • By understanding operating cash flows, you can get a better sense of a company's ability to generate cash from its core operations, which is an important factor in making investment decisions.

  • investing

    • Investing cash flows refer to the cash a company generates or uses in its investing activities, such as buying or selling fixed assets, acquiring or investing in other companies, or buying and selling securities. Here are some key things to know about investing cash flows:

      • Significance: Understanding a company's investing cash flows is important because it provides information about how the company is using its cash for growth and expansion.

      • Capital expenditures: Investing cash flows can include capital expenditures, which are funds used to purchase or upgrade fixed assets such as property, plant, and equipment.

      • Mergers and Acquisitions: Investing cash flows can also include funds used for mergers and acquisitions, which are transactions in which one company is absorbed by another.

      • Securities transactions: Investing cash flows can also include funds generated or used from the sale or purchase of securities, such as stocks or bonds.

      • Financial health: A company's ability to generate positive investing cash flows can indicate its financial health and its ability to fund growth and expansion.

      • Future prospects: A company's investing cash flows can also provide insight into its future prospects. For example, if a company is consistently generating positive investing cash flows, it may indicate that the company is positioning itself for growth in the future.

      • Comparison with peers: Comparing a company's investing cash flows with those of its peers can give you a better understanding of how it compares in terms of its investments and its overall financial health.

    • By understanding investing cash flows, you can get a better sense of how a company is using its cash for growth and expansion, which is an important factor in making investment decisions.

  • financing

    • Financing cash flows refer to the cash a company generates or uses in its financing activities, such as issuing or repaying debt, issuing or buying back stock, or paying dividends. Here are some key things to know about financing cash flows:

      • Significance: Understanding a company's financing cash flows is important because it provides information about how the company is financing its operations, growth, and expansion.

      • Debt financing: Financing cash flows can include funds generated or used from the issuance or repayment of debt, such as bonds or loans.

      • Equity financing: Financing cash flows can also include funds generated or used from the issuance or repurchase of stock, such as common or preferred shares.

      • Dividends: Financing cash flows can also include funds used to pay dividends to shareholders.

      • Financial health: A company's ability to generate positive financing cash flows, such as issuing new debt or issuing new stock, can indicate its financial health and its ability to fund growth and expansion.

      • Future prospects: A company's financing cash flows can also provide insight into its future prospects. For example, if a company is consistently generating positive financing cash flows, it may indicate that the company is well positioned for growth in the future.

      • Comparison with peers: Comparing a company's financing cash flows with those of its peers can give you a better understanding of how it compares in terms of its funding sources and its overall financial health.

    • By understanding financing cash flows, you can get a better sense of how a company is financing its operations, growth, and expansion, which is an important factor in making investment decisions.

  • working capital changes

    • Working capital is the difference between a company's current assets and its current liabilities. A change in working capital can have a significant impact on a company's cash flows.

      • Positive change: If a company's working capital increases, it means that it has more current assets or less current liabilities, which can result in a positive impact on its cash flows. For example, if a company collects more accounts receivable or pays off short-term debt, it will increase its working capital and generate positive cash flows.

      • Negative change: On the other hand, if a company's working capital decreases, it means that it has less current assets or more current liabilities, which can result in a negative impact on its cash flows. For example, if a company has to purchase more inventory or takes on more short-term debt, it will decrease its working capital and result in negative cash flows.

      • Financing: Changes in working capital can also impact a company's financing decisions. For example, if a company has positive working capital, it may not need to raise additional financing. However, if its working capital decreases, it may need to seek additional financing to meet its obligations.

      • Cash management: Effective management of working capital is important for a company's cash flow and financial stability. A company that can effectively manage its working capital can improve its cash flows, reduce its financing costs, and maintain its financial stability.

    • Overall, the change in working capital can have a significant impact on a company's cash flows, and understanding this relationship is important for effective financial management and investment analysis.

    • A cash flow statement is a financial statement that shows the inflow and outflow of cash over a specified period of time, typically a quarter or a year. The purpose of a cash flow statement is to provide information about a company's liquidity and its ability to generate cash. Here are some key things to keep in mind when reading a cash flow statement:

      • Operating activities: This section of the cash flow statement shows the cash generated from the company's main business activities, such as sales of goods or services. It also shows the cash used for operating expenses, such as employee salaries and rent.

      • Investing activities: This section shows the cash used for investments in long-term assets, such as property, plant, and equipment, and the cash generated from the sale of these assets.

      • Financing activities: This section shows the cash generated from the sale of securities, such as stock or bonds, and the cash used to repay debt.

      • Net increase or decrease in cash: This section shows the net change in cash over the period, which is calculated by subtracting the beginning cash balance from the ending cash balance.

      • Changes in non-cash working capital: This section shows the changes in items that affect cash, such as accounts receivable and accounts payable, but are not reflected in the cash flow statement.

      • Trends: By comparing cash flow statements from different periods, you can see trends in the company's cash inflows and outflows and assess its liquidity over time.

      • Comparison with peer companies: By comparing a company's cash flow statement with that of its peers, you can get a better understanding of how it compares in terms of liquidity and cash generation.

    • By understanding these key elements of a cash flow statement, you can get a better understanding of a company's ability to generate cash and assess its liquidity, which is an important factor in making investment decisions.

  • what does the statement of cash flows tell me that the balance sheet and income statement do not?

    • The statement of cash flows provides information about a company's cash inflows and outflows that is not readily apparent from its balance sheet and income statement. It provides insight into a company's liquidity, solvency, and ability to generate cash.

      • Liquidity: The statement of cash flows provides information about a company's ability to generate cash, which is important for assessing its short-term liquidity. It includes cash inflows from operating activities, such as accounts receivable, as well as cash outflows, such as accounts payable and short-term debt. This information is useful for determining a company's ability to meet its short-term obligations.

      • Solvency: The statement of cash flows also provides information about a company's long-term solvency, including cash flows from financing activities such as issuing or repaying long-term debt. This information is useful for assessing a company's ability to repay its long-term debt and finance its long-term growth.

      • Capital expenditures: The statement of cash flows also provides information about a company's capital expenditures, which are investments in long-term assets such as property, plant, and equipment. This information is useful for assessing a company's ability to generate cash from operations and invest in its future growth.

      • Changes in net working capital: The statement of cash flows also provides information about changes in a company's net working capital, which is the difference between its current assets and current liabilities. This information is useful for assessing a company's ability to generate cash from its operations and manage its current assets and liabilities.

    • Overall, the statement of cash flows provides important information about a company's liquidity, solvency, and ability to generate cash that is not readily apparent from its balance sheet and income statement. This information is valuable for investors, lenders, and other stakeholders who want to understand a company's financial health and future prospects.

• income statements

  • revenue

    • Revenue in an income statement shows the total amount of money a company earned from its sales of goods or services over a specific period of time. It is typically presented at the top of the income statement, and is considered to be the "top line" of the company's financial performance. The revenue figure is a key indicator of a company's overall health and growth, and is used to calculate various financial ratios and metrics that help investors and analysts understand the company's financial performance.

    • discuss the importance and how it matches up with sales

  • expenses

    • An income statement typically shows various types of expenses incurred by a company in order to generate its revenue. These expenses can include:

      • Cost of goods sold (COGS): This is the cost of the goods or products that were sold during the period.

      • Operating expenses: These are the ongoing expenses incurred in the normal course of business, such as salaries and wages, rent, utilities, marketing, and research and development.

      • Depreciation and amortization: These are non-cash charges that reflect the reduction in value of a company's long-lived assets, such as buildings, equipment, and patents.

      • Interest expense: This is the cost of borrowing money, such as interest paid on loans or bonds.

      • Taxes: This includes all federal, state, and local taxes that the company must pay.

    • The total of all these expenses is subtracted from the company's revenue to calculate its net income or loss for the period.

  • Profit

    • In an income statement, there are several profit line items that are important to pay attention to:

      • Gross profit: This is the difference between revenue and the cost of goods sold (COGS). It shows how much profit the company made before other expenses are taken into account.

      • Operating profit (or EBITDA): This is the profit made after deducting all operating expenses, but before deducting interest, taxes, depreciation, and amortization. It provides a measure of a company's operating performance.

      • Net income: This is the final profit figure, calculated by subtracting all expenses, including taxes, from the company's revenue. This is the profit that the company can use to pay dividends, buy back stock, or reinvest in the business.

      • Earnings per share (EPS): This is the net income divided by the number of outstanding shares of stock. It provides a measure of how much profit each share of stock generates.

      • Gross margin: This is the gross profit divided by revenue, and is expressed as a percentage. It shows the company's profitability before taking into account operating expenses.

    • By paying attention to these profit line items in the income statement, you can gain a better understanding of a company's financial performance and its ability to generate profits.

    • What else do i need to know about profit margins?

      • Gross profit, operating profit, and net profit are different measures of a company's profitability:

        • Gross profit: This is the difference between revenue and the cost of goods sold (COGS). It shows how much profit the company made before other expenses are taken into account.

        • Operating profit (or EBITDA): This is the profit made after deducting all operating expenses, but before deducting interest, taxes, depreciation, and amortization. It provides a measure of a company's operating performance.

        • Net profit: This is the final profit figure, calculated by subtracting all expenses, including taxes, from the company's revenue. This is the profit that the company can use to pay dividends, buy back stock, or reinvest in the business.

      • In summary, gross profit measures the company's profitability from its core business activities, operating profit measures the company's overall operational efficiency, and net profit is the final measure of a company's profitability after accounting for all expenses.

    • > what about earnings per share?

      • Earnings per share (EPS) is a commonly used financial metric that represents the portion of a company's profit that is allocated to each outstanding share of its stock. It is calculated by dividing the company's net income by its number of outstanding shares of common stock.

      • EPS is considered important for several reasons:

        • Valuation: EPS is used as a key factor in valuing a company's stock. It provides an indication of the profitability of the company and helps investors compare the relative performance of different companies.

        • Dividends: EPS is a key factor in determining a company's dividend policy. Companies that have higher earnings are more likely to pay higher dividends.

        • Investment Decisions: EPS is used by investors to determine the potential return on their investment. A company with a high EPS is considered more attractive to investors, as it indicates that the company is generating more profits and is more likely to grow in the future.

        • Management Performance: EPS is used to measure the performance of a company's management. A consistently increasing EPS can be a sign that management is effectively managing the company's operations and financial performance.

      • In conclusion, EPS is an important financial metric that provides insight into a company's profitability and is used by investors, analysts, and management to make informed decisions about the company.

    • An income statement, also known as a profit and loss statement or P&L, is a financial document that shows a company's revenue, expenses, and net income over a specific period of time, typically a quarter or a year. The purpose of the income statement is to provide information about a company's financial performance and help investors, lenders, and other stakeholders understand how it is generating and using its revenue.

    • The income statement is organized as follows:

      • Revenue: The first item on the income statement is revenue, which represents the amount of money a company earns from its products or services. This is the top-line number and is a key measure of a company's performance.

      • Cost of Goods Sold (COGS): COGS represents the cost of producing and delivering a company's products or services. This includes direct costs such as raw materials, labor, and manufacturing overhead.

      • Gross Profit: Gross profit is calculated as revenue minus COGS. It represents the amount of money a company earns before considering other expenses.

      • Operating Expenses: Operating expenses are the costs associated with running a business, such as sales and marketing, general and administrative expenses, and research and development.

      • Operating Income: Operating income is calculated as gross profit minus operating expenses. It represents a company's earnings from its core operations.

      • Non-Operating Income and Expenses: Non-operating items are income or expenses that are not related to a company's core operations. This may include gains or losses from investments, interest income or expense, and foreign exchange gains or losses.

      • Net Income: Net income is calculated as operating income plus non-operating income and expenses. It represents a company's final profit or loss for the period.

    • The income statement is an important tool for investors, lenders, and other stakeholders as it provides a comprehensive view of a company's revenue, expenses, and net income over a specific period of time. This information helps to determine a company's financial performance and its ability to generate profits, which are key factors in making investment and lending decisions.