Are you an entrepreneur of a business? Or are you managing someone else’s business? Either way you will need to know how to read financial statements. But what if you do not have any financial background? Don’t worry, these five tips will help you to read financial statements easily.
What are Financial Statements?
First of all, financial statements are written reports that convey the business activities and the financial performance of a company.
Who read financial statements? It is a report that are usually read by investors, top management, and government authorities. But sometimes employees may be asked to read those reports. This is especially true if the employees have a certain proportion in the company’s ownership.
What are the objectives of reading financial statements? Those who need to read financial statements will be able to have views on the performance of the company. Financial statements can also give ability for the reader to make predictions about the future of the company reported.
Who make financial statements? Accountants make financial statements based on transaction proofs that the company has and make. Accountants may be employed by the company. If the company is relatively small, it usually outsources the service to freelance accountants or the company that provides the service.
Financial statements comprise of 4 essential reports. They are balance sheet, income statement, cash flow statement, and statement of shareholders’ equity. They present different views on the company.
Tips 1: Read Balance Sheet to Get a Glimpse on the Company’s Assets
Balance sheet is a snapshot of the company's assets, liabilities and shareholders' equity as of the date of publication. This is the balance in the Balance Sheet:
Assets= Liabilities + Shareholders’ Equity
The formula is intuitive. You can see that assets are financed by either borrowing money (liabilities) or your own (equity). For example, if the company has an asset of IDR 1 billion, and liabilities of IDR 200 million. Then the equity has to be IDR 800 million. If not, then the balance sheet is not balanced and has to be corrected.
What can we see from the balance sheet? The easiest thing is to look at the company’s size. Scroll immediately to the Total Assets, and look at the number. What you see there give you the ideas of how large is the company. Compare it to other companies that you see around you to get the idea of how much the size matters.
In the asset side, first look for Cash and Cash Equivalent. It gives you idea how much cash the company holds. The larger the number the better positioned the company is. Then find Receivables. It gives you idea how much other companies owe the reporting company. Receivables means there will be cash in the future for the company, given the company is able to collect them.
Next important thing in asset side is inventories. It gives you idea the worth of inventories that have not been sold as of the date of publication. It is also can be sold and converted into cash. Below you will see Current Assets. Current Assets are assets that can be sold or converted into cash in less than a year, theoretically in normal situation.
Fixed assets and Non Current Assets are illiquid assets. Illiquid assets are assets that cannot be easily converted into cash. This account includes land, buildings, vehicle and equipment.
In the liabilities side you need to see the Total Liabilities. The number will give you idea how much the company will have to pay other parties in the future.
In the Total Equity you can get the idea of the size of the money attributable to a business' owners. It is also called net assets since it is equivalent to the total assets of a company minus its liabilities.
Tips 2: Read Income Statement to See the Productivity of the Company
An income statement is also called profit and loss statement. By the name, you can understand the most important number you need to look for. Yes... find the net profit or sometimes recorded as earnings after taxes (EAT). If the number is positive you get profit, otherwise, it is a loss.
If you want to know the sales of the company, you should look at the first account in the statement. Below it are costs or expenses. Costs of sales or costs of goods sold are costs associated directly to the revenues generation. Operating costs are costs incurred to operate the company but not directly related to sales. For example, if the company produces bread, then purchases of flour, sugar and eggs will go to cost of goods sold. But office rental and vehicles expenses can be found in operating costs.
Tips 3: See Cash Flow Statements to Find Out How Much Cash You Are Going to Have
Having a huge profit does not necessary your company will have huge cash. Why? Because in income statement, sales that are still to be collected have been recorded as revenues.
Cash inflow means that how much cash that you are actually receiving. Cash outflow is the actual amount of money that you are paying. So if you need to find out how much cash that you are actually receiving or disbursed over a period, then you should find the Net Increase/ Decrease in Cash and Cash Equivalents.
Tips 4: Check Out your Equity in the Statements of Shareholders’ Equity
As an investor you want to know how much your equity has grown (or shrink, God forbids). Then you should find it fast in the Statements of Shareholders’ Equity. You can find your beginning balance and compare it directly to the ending balance. You will see whether the change was due to profit and loss of the company or because someone or yourself has put more capital to it.
Tips 5: Use Financial Ratios to Get the Idea How Good The Company Is Doing
But read the financial statements, meaning the number by itself is not giving you ideas how the company is actually doing. You need to calculate financial ratios, a topic for other times.