Many investors have heard the terms “income statement”, “balance sheet statement” and “cash flow statement” but have no idea what each of them are and how they could use them. to their advantage. These three statements make up what are known as the “financial statements” of a business. Each publicly traded company is required to disclose these financial statements at least quarterly (every three months) to ensure transparency and insight into the operations of the company. This article aims to dig deeper into the first two statements to help the average investor discover how financial professionals use them to make smarter investment decisions.
The income statement is the best known of the three financial statements. The purpose of this statement is to examine the profitability of a business over a period of time. From a basic outline, the statement begins with the sales of a business and narrows those sales through the expenses of the business to arrive at income. To break it down even further, the expenses are divided into categories of operating expenses, interest expenses, and taxes. Operating expenses include the cost of goods sold; Selling expenses, general and administrative expenses; and depreciation. “Costs of goods sold” are the costs associated with the physical production of the product sold. “Selling, general and administrative expenses” refers to the costs of marketing, labor, overhead and other costs associated with the operations but not with the production of the product. Reviewing a basic income statement online is a great way to familiarize yourself with the layout. This statement is typically used in the valuation process of a business to determine the appropriate price that an investor is willing to invest.
The balance sheet statement is the next financial statement that is also getting a lot of attention from investors. Generally, the balance sheet is used to assess the financial position of a business at a certain date and allocates the assets and liabilities of a business. The difference between assets and liabilities is the net worth of a business, also known as equity. Assets are broken down into current assets (items either in cash or easily convertible into cash) and fixed assets (investments, real estate). Liabilities are divided into current liabilities (items that must be paid within one year) and long-term debt. Equity can be complicated for the average investor to understand, and often unimportant for a financial professional. The balance sheet statement is generally used to assess a company’s ability to pay its debts using its assets.
These two statements are generally used to assess the investment value of a business at a basic level. As a reminder, the income statement shows the profit / loss generated by a business, and what the investor is willing to pay to invest in the business. The balance sheet shows the assets and liabilities of a business. Most investors will assess multiple quarters / years of income and balance sheets, and participate in analyst calls, investor meetings, and sometimes even personal meetings with a company’s management to better understand the business. before investing. This article only scratches the surface of what financial analysts and other financial professionals do on a daily basis to assess an investment for their clients.
Hunter Larson joined DA Davidson in 2015 as a research associate before accepting a position as financial advisor in Aberdeen.