You need to understand financial statements in two scenarios: investing in or running a business. Financial statements give you a clear picture of a company’s health if you know how to read them. You can think of it as a doctor looking at a patient’s chart.
As an investor, financial statements help you make an informed decision on whether to risk your money on a company or not. As a business owner, they give you directions on what you should do and where you should go in your business. Here is a rundown of key financial statements to get you started.
As defined by ScaleFactor, Inc., the balance sheet is a summary of a company’s assets and liabilities for a given period. Assets are on the left or top part of the sheet. Liabilities and shareholder equity are on the right or bottom part. The idea is to balance the left and right sides (or top and bottom). This should show that money borrowed (liabilities) and put in by the owners (shareholder equity) went into buying materials or equipment (assets) to make goods or perform services for the company. As much as possible, the two sides should always be balanced.
The income statement is a summary of what the company earned and spent in a given period. This may be a quarter or a whole year. It shows all the money coming in from sales (revenue) and all the money going out (expenses). The difference between the two is the net income. The income statement shows you if the company is making money from period to period. It also shows patterns of revenue and expenses over time.
Cash flow statement
The cash flow statement reports the cash going in and out of the till in a given period. The main purpose of a company is to produce cash, so it is important to know exactly where it comes from, where it goes, and how much there is. The cash flow statement classifies transactions in three areas: operations, financing, and investments. It excludes non-cash transactions found in the income statement.
You need to understand financial statements to make better investments and business decisions. Do not let jargon intimidate you. The simple descriptions above are good enough for a start.