LEARNING HOW TO READ A COMPANY’S FINANCIAL STATEMENTS

Before you decide whether or not if you should invest in stock market, here are a few questions that would help you make a better decision and push you to think very carefully.

- How much cash does the company already have?

- How much revenue has the company made since it was started?

- How much revenue does the company expect to make in the future?

- Does the company have any debts?

Then, once you have done asking yourself with the above questions, the next step for you to start is by looking at the company’s financial statements. Learning how to read Financial Statements is similar to learning a new language. If you want to order a better dish in a Spanish restaurant, you will probably need to speak Spanish to read the course of menu. This is similar with a company’s business. If you want to find a good stock to invest in, you will need to learn how to speak the language of finance and read their financial statements. Just like learning any new languages other than your mother tongue. It is difficult at first, yet, the more you practice the more fluent you will become.

Broadly speaking, all companies need to keep track of their finance which means that they are keeping track of all the money coming in and going out, as well as other transactions that do not necessarily involve the exchange of money. At the end of each month, quarterly (three months), and year, a company will prepare financial statements which literally are the summary of all its financial transactions in that given period. In the case of a company that is publicly traded where its shares are sold on a stock market, for instance, it is required that the company prepare and file quarterly and annual financial statements so that the government and the public can see how the company is doing.

Actually, there are a lot of parties who will be keen to have a look at the financial statements of a company. First, the company’s management and board of directors will use the financial statements to track performance. The financial statements typically show how the company has done in the past and will help management to make better decisions about the future. Second, Lenders or the so-called creditors such as banks that have provided loans to the company may also want to see its financial statements. Some loans may have certain requirements, such as the company’s debt-to-equity ratio "cannot be more than either 0.3 or 0.4" in order to receive that loan, or the lender may just want to see how much cash the company has in order to estimate how likely it is the company will be able to pay back the loan and interest in a timely manner.

Here’s a quick illustration of a company’s debt-to-equity ratio, and how to calculate it is by "dividing a company's total liabilities with its shareholders’ equity".

On the other hand, investors are very interested in seeing the financial statements. They are making decisions about whether to buy or sell stock in the company and thus they need to know how the company is doing to help inform their decisions. When it comes to a company’s financial statements, there are three types that you need to learn how to read them before you decide to invest or buy its shares.

Firstly, it is a balance sheet. The balance sheet basically shows a snapshot of the company’s assets (its resources that it expects to create value in the future), liabilities (the loans and other obligations due to others), and owners’ equity (also known as shareholders’ equity or stockholders’ equity – the stake that the owners or investors like yourself have in the business).

Secondly, it is an income statement. The income statement practically demonstrates how much revenue the company generated over the year, how much it cost to sell its main products, how much it cost to pay its employees over the year, and how much it owed in interest and taxes for the year. On a very basic level, if the company makes more revenue than it spends in costs, it is a profitable business. However, if the company’s costs are greater than its revenues, then it is not a profitable business.

Thirdly, it is a statement of cash flows. The statement of cash flows technically illustrates how much cash came into the business and how much cash went out of the business. It is important to note here that when we use the term cash in the financial world, we mean not only the currency bills like you normally think of such as dollars or euros, but also checks, electronic transfers, as well as the balance in the bank account. In fact, most businesses will do a lot of their transactions through electronic means (e.g. mobile banking, wire transfers, etc.); yet, they are still considered as the amount of cash which flows in and flows out.