Understanding Financial Statements
Financial statements are the primary source of information for external parties interested in understanding a company's financial position.
This article reviews what comprises a financial statement, how to read one and provides links to online resources.
Then you have the three 'primary' statements:
1) an income statement (sometimes called an 'earnings statement'), which shows revenue, expenses and net income/loss;
2)
a balance sheet, which lists assets and liabilities; and 2) a cash flow statement, which summarizes cash inflows and outflows during a specified time period. There are also many other types of supplementary financial statements that help someone understand the performance of a company or corporation.
You can also turn to a professional, who will provide a more advanced evaluation that is usually available in the form of an audit report.
Note that some of these links are to external sites, as they are hosted on the Internet. The links are from external sites, so do not expect that they will continue to be available after you read them or search them for updates.
A complete discussion about financial statements and their characteristics can be found in the Financial Accounting Standards Board's statement number 157, "Financial Reporting Principles." This document provides additional information about preparing and presenting financial statements.
A very good resource for explanations is the IS-13C Formats page maintained by CCH Financial Services (formerly Milliman).
After a company generates its financial statements, it can then use them as the basis for further analysis. This is done through ratios, which are simply ways of expressing one statement in terms of another. Ratios are usually presented with an industry average and a range, often expressed as "where X is the number or percent." The range aspect means you cannot rely solely on ratios to determine if a company has problems. You must also look at other factors such as cash flow, operating history and management competence.
Ratio discussions often include other non-financial information such as payment and collection issues. Non-financial information can be presented in several formats called corporate governance reports (available from the Corporate Library).
The following table provides a list of ratios with definitions, where they come from, and the sources that provide ratios and other information. An archive of the IS-13C form is available here: http://www.cch.com/foundation/is13cform.cfm
There are also industry-specific proxy statements which include all of the above information, including board members' descriptions of their qualifications, as well as comparisons to historical averages for peer companies in a given industry sector.
Companies will generally provide a description of each report, but in order to find the information, you will have to hunt down the individual documents.
The reports are also sometimes published by the Securities and Exchange Commission (SEC), usually as an "Investor Alert" or a "Proxy Report".
A full explanation of corporate statements can be found in an article on Wikipedia.
For a more technical view of financial statements from a computer science perspective, see: http://cs401.stanford.edu/notes/financial-reporting-formats-jeff-pike/. This is part of Stanford University's CS 401 course notes on Financial Reporting Formats.
For a detailed discussion on fundamental analysis from which the above chart was taken, see http://www.investopedia.com/university/fundamentalanalysis/.
There is also a discussion about the usefulness of financial statements for the non-professional investor.
The CFO's report is given in the annual report and is considered an "Earnings Guidance". It provides some details about why a company's earnings and revenue appear to be different from last year, why sales results were better or worse than expected (which can influence share price), and what it expects to happen in the future so that investors can make better decisions when buying shares of stock.
A discussion of the most important financial statements can be found at Investopedia.com
The U.S. Securities and Exchange Commission (SEC) provides a site for investors to access the information about publicly traded companies: http://www.secinfo.com/. This site includes corporate filings, financials and company news on U.S.-based public companies. The SEC is also responsible for protecting investors from market fraud or abuse through its enforcement of extensive federal securities laws, by encouraging market professionals to help monitor compliance with these laws and through targeted outreach programs.
The Federal Reserve Bank of New York provides additional information about the largest financial institutions in the United States: http://www.newyorkfed.org/
The CIA World Fact Book provides information about countries where public companies are not traded: https://www.cia.gov/library/publications/the-world-factbook/. The World Fact Book offers fact-based information for 265 world entities in a snapshot format, making it easy to use and flexible for users to access updated country data on a regular basis as these are continually changing.
Analysts and investors have several tools they can use to research a company. One of the most important tools is a "risk rating". This helps you get an idea of the overall financial stability of the company, so you know whether it's a good investment or not. The risk rating measures three major factors: 1) size 2) profitability and 3) growth rate. These factors complement each other and allow an analyst to rank the financial stability of companies in terms of quality or riskiness.
A list of some common risk ratings is as follows:
DV01/GAAP (http://tinyurl.com/7jtlhpz) reports the company's results based on total enterprise value. This number is based on the company's market capitalization, any stock sales and any debt the company may have to cover shortfalls.
DV01/EBITDA (http://tinyurl.com/6r5r7vf) tells you what a company's income would be if it operated only according to its own book values and was free from external business obligations.
DV01/EBITDA LT (http://tinyurl.
Conclusion
There are a lot of different things you can do, from looking up the company's financial statements online, to searching for an analyst report or looking at an industry specific report to determine if it's a good investment. Most of these reports are free online (although a few require a fee), so it may take you some time to find what you're looking for, but if you want reliable information about the company or industry in general, it may be worth your time.
References
http://www.investopedia.com/university/fundamentalanalysis/financialratios.asp#axzz2QmWxCY5V
http://www.fool.