Financial statements are an invaluable tool for analyzing and assessing the financial situation of public companies. It is a set of data and information presenting financial results, operations and the general condition of the company in a given period. The ability to read and understand these documents is crucial in making thoughtful and informed investment decisions.
What is a financial statement?
A financial statement is a document that presents information about the financial situation and results of operations of a given company over a specific period of time. It is an essential tool both for internal decision makers, who use it to monitor a company’s operations and make strategic decisions, and for external stakeholders, who evaluate a company’s ability to meet its obligations and its overall financial condition.
Typical elements of financial statements contains:
It presents the financial situation of the company in a given period of time, and includes:
– Assets: These are the resources that the company has. They can be divided into two main categories: long-term assets (e.g. real estate, machinery, fixed assets) and current assets (e.g. receivables, inventories). Long-term assets represent long-term investments, while current assets are resources that can be turned into cash in a relatively short period of time.
– Liabilities: These are the sources of financing for an organization’s assets. These also fall into two main categories: equity (e.g. shareholders’ equity, retained earnings) and debt (e.g. loans, bonds). Equity shows the contributions made by the company’s owners, and debt shows the liabilities that the company will have to pay off in the past.
The golden rule of accounting – a principle that states that a company’s assets must always equal its liabilities.
- Profit and Loss Statement
Also referred to as the income statement, it compares revenues from various types of activities and related costs. Calculating the difference between these two aspects allows you to obtain the current financial result of a given company, which will be expressed as gross profit or loss. This result should then be modified by mandatory charges such as income tax.
- Cash Flow
It presents all cash flows in a given enterprise, including their sources and use. It allows you to determine whether a company is able to generate sufficient cash to cover its current liabilities and investments. The information contained in this position is divided into three groups:
– Operating cash flow: Cash generated or spent in connection with the day-to-day operations of a company. They include transactions related to a company’s core operations, such as the sale of products and services, and the associated costs.
– Cash flows from investing activities: Investments in long-term assets that are important in connection with the operation of the enterprise. These include transactions related to the purchase and sale of long-term assets, such as real estate, machinery, vehicles and investments in other projects.
– Cash flows from financing activities: Financial transactions that affect a company’s equity and liabilities. They include, among others: financing the company by issuing shares, taking out loans, repaying debts, and paying dividends.
Purpose of financial statements
Financial statements are intended to provide transparent and reliable information that will allow stakeholders to accurately understand the financial condition of a company. This is essential information from the point of view of decision making, risk assessment and monitoring the company’s activities.
- Informing stakeholders: Financial reports are a source of information for both internal and external stakeholders of a company. Owners, management, investors, lenders, analysts and regulators use this data to understand how a company is managing its resources and it performs.
- Basis for decision making: Investors use the information contained in financial statements to evaluate whether an investment in a company is profitable. Based on these documents, they make decisions about buying or selling shares of a given company.
- Control and regulation: These are documents that form the basis for regulatory bodies whose task is to monitor and control the activities of enterprises.
Financial reports contain a number of useful information that can be used to analyze the condition and effectiveness of a company’s operations. Financial indicators such as net profit, profitability or market indicators may be extremely useful in this analysis. With their help, you can better understand how the company is doing on the market and what its development prospects are, which will allow you to assess the attractiveness and risk of a given investment.
- Net profit
This is one of the most important indicators that provides information on the operational efficiency of a given company after taking into account all costs, including operational, financial and tax costs.
- Profitability indicators
Used to measure the efficiency and profitability of an investment or operating activity. It allows you to determine how much profit a company generates in relation to investments or operating costs. There are different types of profitability indicators, each providing different types of information:
– Gross Profit Margin Ratio: Measures a company’s efficiency in generating gross profit on each revenue generated. It is calculated using the formula: Gross profit margin = (Gross profit / Sales revenue) x 100%.
– ROS (Return On Sales): Assesses how much profit a company generates from operating activities compared to sales revenues. It is calculated using the formula: ROS = (Operating profit / Sales revenue) x 100%.
– ROA (Return On Assets): Shows how much profit a company generates in relation to the value of its assets. It measures the effectiveness of using own assets to generate profit. It is calculated using the formula: ROA = (Net Profit / Assets) x 100%.
– ROE (Return On Equity): Assesses how much profit a company generates relative to shareholders’ equity. This is an important indicator for shareholders because it shows how well the company manages shareholders’ capital and generates profits for them. It is calculated using the formula: ROE = (Net profit / Equity) x 100%.
- Market indicators
They help investors understand how the market values a given company’s shares in the context of its profits and development prospects. They allow you to assess whether a given company’s shares are undervalued or overvalued, which is an important step in the investment decision making process.
– Earning Per Share (EPS)
This ratio is used to measure the profitability of a company’s shares and assess how much of the profit per share of the company accrues to the shareholder. EPS is one of the key indicators for analyzing stock fundamentals and provides information on the profitability of investments in shares of a given company. It is also a metric often used by investors to compare different companies to assess which stocks are more attractive.
– Price-to-Earnings (P/E Ratio)
It reflects the ratio of the market price per share to a company’s earnings per share (EPS). A low P/E value (below 15) may suggest that the shares are undervalued, which may constitute an attractive investment opportunity. A high value (above 20) may mean that the shares of a given company are overvalued, which should be a signal for caution.
Publication and availability
The frequency of publication of financial statements depends primarily on the regulatory requirements in force in a given country. For listed companies, the publication of quarterly financial statements is a standard requirement. However, annual financial reports are the most important document in which the company presents its results, balance sheet, cash flows and any additional information.
Timely publication of financial statements is crucial from the point of view of investors and capital market participants. Thanks to these documents, they can assess the company’s financial condition, its operating results, ability to generate profits and development prospects. Transparency in the publication of financial statements also helps build trust in the company and avoid potential inaccuracies and financial fraud.
Some jurisdictions also have financial statement auditing laws, where an independent auditor checks whether financial statements are reliable and compliant. This is an additional layer of control and quality assurance of financial information provided by companies.
Financial statements provide key information about the financial condition of a given company, its operating results and development prospects. It is also worth remembering that, in addition to the information contained in financial statements, investors should take into account the current market and geopolitical situation and other factors affecting the company’s operational capabilities. The combination of financial analysis and a broader understanding of the market is the key to making informed investment decisions.