A company’s financial statements consist of the balance sheet, income statement, and statement of cash flows. Describe what each statement tells us and their limitations.
First off we will look at the balance sheet. A balance sheet is defined as “shows a firm’s assets, liabilities, and shareholder equity at a given point in time” (Keown, Martin, & Petty, 2014). These terms make up what is known as a company’s “financial position”. This is probably the most important thing when looking at a company in terms of projecting stability of operations and drawing up projections for profit over the long term. This represents the company’s overall health. The overall picture of the balance sheet shows the total assets the company has and puts them up against the total liability’s the company has outstanding as well as the stockholder equity, as it is also a form of liability a company caries, and gets a total projection in either the positive or the negative that will give you a very clear picture of company financial health. The weakness of this document is that it does not specifically look at yearly income like the income statement, which we will discuss next. Again, I feel the balance sheet is the most important of these documents, but what it represents in overall company financial health, it lacks in specificity and intricate detail.
Next on the agenda, is the income statement. The income statement, also known as the profit and loss statement, is defined as “a basic accounting statement that measures the results of a firm’s operations over a specified period” (Keown, Martin, & Petty, 2014). This “measurement” is taken from a few different data points that the firm gains in the course of one fiscal year. Those data points are; profit from sales or activities against the cost of the sales or goods sold which gets you your gross profit which is the profit after you subtract the cost. Next, total operating expenses are subtracted from your gross profit which gets you your profit while operating, also known in the stick world as EBIT, or earnings before interest and taxes. This is not the first thing I look at, but it is always a deciding factor and a must look at when I look at a company in the market, as it will tell me how they have done over the past year and if they are reflecting a positive trend towards profitability. However, the weakness of this document is that it does not show you the company’s outstanding liabilities. The company could have millions in liabilities and only turned a profit of thousands. When you count in the loan balloon payments they will have to make down the road, this could be a large red flag, so it definitely only paints part of the picture for you.
Statement of Cash Flow
Lastly, is the statement of cash flows. The statement of cash flows is key for “identifying the sources and uses of cash that explain the change in a firm’s cash balance reported in the balance sheet” (Keown, Martin, & Petty, 2014). This is considered one of the big three to stockholders for a reason, the ability to pinpoint why a company is taking on debt, or why a company has so much operating capital is vastly important to a shareholder. With this, you can see if the company is building for future success and making moves to maximize future profitability, or if they are simply resting on their laurels or frivolously spending their money on unneeded assets. The weakness of this document is that while it gives you a story, it lacks both an overall view which can be provided by the balance sheet, and an intricate view which is provided in the income statement. While I still consider this document less important than the balance sheet, in the end I always take a deep look at all three financial documents.