How to analyze a company using the financial statements
When you analyze a company the first place you should start with your research would definitely be the financial statements.
There are three very important Financial Statements to look at when you analyze a company.
- Income Statement
- Balance Sheet
- Cash flow Statement
These statements are very important for you to select the best stocks.
When you decide to buy stocks it is vital to know how the companies are performing internally. The first financial statement you should look at would be the income statement.
Analyzing an income statement
Identify profits or losses of the company during a time frame
The Income Statement is important because it shows the investor whether there was a profit or loss during a selected time frame (yearly/quarterly).
Identify what causes to reduce the profit of the company
The income statement also allows the investor to see what is eating away at the profits, which are located under the operating expenses. The most important factor when looking at the operating expenses lies in the fluctuation of what the company is spending. For example, if a company is selling its products, the general and administrative expense is changing drastically, this could be that there are competitive issues in the same industry.
Determining the competitive advantage of a company within its industry
The Income Statement is a great place to start when determining the competitive advantage of a company within its industry. It is the place where the investor can determine the companies overall profitability. This makes sense because why would a sensible investor waste money and time with a company that is turning a loss. The investor would be taking on high risk and money losses on a company that is losing in terms of revenue.
The next important financial statement is the balance sheet.
Analyzing a balance sheet
What are the things available in a balance sheet ?
The Balance sheet is the next important financial statement to analyze. A balance sheet is important because it shows what are the company assets, liabilities, and equity(assets - liability).
Why do investors need to analyze the balance sheet of a company ?
The balance sheet is a financial statement that reports the company assets, liabilities, and equity at a specific point in time. This financial statement is mainly used to calculate some ratios and determine things like whether the company is receiving cash from services rendered or not.
Identify how much debt the company is having during a time frame
The balance sheet also shows how much debt the company is holding at different time frames. Debt becomes an issue because companies need to pay it back with interest. This accumulation of debt leads to more interest and an increased loss in profits.
Lastly, you want to take a look at the cash flow statement.
Analyzing a cash flow statement
The Cash Flow Statement is the last very important financial statement to look at when you analyze a company. Here you will be able to find out where the cash is being generated, which is the inflow.
Identify where the cash is coming from
It is important to know where the cash is coming from because it makes no sense to invest money in something where money magically appears and there is no idea as to when where and how much cash will actually come into the business.
Identify where the cash is being spent
The next important aspect of the cash flow statement is where the cash is being spent. It is the outflow of cash from the company. The outflow of cash is important to this financial statement because it shows where the company is putting the cash coming in and whether or not it would be useful to the growth of the company.
Identify the trend of free cash flow
When you analyze a company using a cash flow statement, it is also a good idea to pay attention to the free cash flow the company has and whether or not it is increasing or decreasing. You can calculate free cash flow by reducing capital expenditures from the cash a company produces though out its operations (cash a company produces - capital expenditures). A good performing company will have an increasing amount of free cash to be ready if ever needed for unexpected things in the future.
Summary of how to analyze a company using the financial statements
The income statement, balance sheet, and cash flow statement as you can see, are vital when you analyze a company. Because they show us whether the company is generating a profit, the financial health of the company, and how much money the company can keep. These factors play a very major role in whether or not you will select the absolute best stocks with a competitive advantage on your journey with investing.
Check out below, for the comprehensive articles about analyzing each type of financial statements.