How to Read Financial Statements

How to Read Financial Statements

The Three Main Statements

Every public company publishes three key financial statements quarterly:

1. Income Statement (Profit & Loss)

Shows profitability over a period.

Key Lines:

• Revenue: Total sales
• Cost of Goods Sold: Direct costs
• Gross Profit: Revenue - COGS
• Operating Expenses: Running the business
• Operating Income: Gross Profit - Operating Expenses
• Net Income: Bottom line profit

What to Look For:

• Growing revenue (top line growth)
• Improving margins (profit/revenue)
• Consistent profitability

2. Balance Sheet

Snapshot of assets, liabilities, and equity.

Formula:

`

Assets = Liabilities + Shareholders' Equity

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Key Sections:

• Assets: What company owns (cash, inventory, equipment)
• Liabilities: What company owes (debt, accounts payable)
• Equity: Owners' stake

What to Look For:

• Strong cash position
• Manageable debt levels
• Growing equity over time

3. Cash Flow Statement

Where cash comes from and goes to.

Three Sections:

• Operating: Cash from business operations
• Investing: Capital expenditures, acquisitions
• Financing: Debt, dividends, stock buybacks

What to Look For:

• Positive operating cash flow
• Reasonable cap ex spending
• Sustainable dividend payments

Key Metrics to Calculate

Profitability

• Gross Margin = Gross Profit / Revenue
• Net Margin = Net Income / Revenue
• ROE = Net Income / Shareholders' Equity

Liquidity

• Current Ratio = Current Assets / Current Liabilities
• Quick Ratio = (Current Assets - Inventory) / Current Liabilities

Leverage

• Debt-to-Equity = Total Debt / Shareholders' Equity
• Interest Coverage = Operating Income / Interest Expense

Red Flags to Watch

1. Declining Revenue: Losing market share
2. Negative Cash Flow: Burning through cash
3. High Debt: Leveraged and risky
4. Inconsistent Earnings: Unpredictable
5. Revenue vs Cash Mismatch: Accounting games

How to Access Statements

• Company investor relations website
• SEC EDGAR database (10-Q, 10-K filings)
• Financial websites (Yahoo Finance, etc.)
• Stock analysis platforms

Practice Exercise

Find a company you're interested in:

1. Download latest 10-Q filing
2. Calculate P/E, ROE, Debt-to-Equity
3. Compare to competitors
4. Track trends over 3-5 years

Understanding financial statements is fundamental to stock analysis!