What is financial statement analysis

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Financial statements are a set of documents showing a company’s current financial status. Specifically, these statements indicate:

  • How much money is being made and spent
  • What the company owns and how much it owes
  • Where money came from and where it went
  • The amount of money kept in the company by the owners
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Entrepreneurs need to know what to look for in financial statements and how to properly analyze them so they can make informed decisions about their business. Many insights are available at a glance while others require deeper analysis.

Financiers and investors read and conduct even deeper analyses to determine whether or not to put more money into a business or take it out.

Financial statements convey the results and financial position of a business.

  • We use them to evaluate sales, profitability, cash flow, and other metrics
  • financial statements are prepared on a quarterly and annual basis

Financial Statements Overview

  1. Balance Sheet
  2. Income Statement.
  3. Statement of Cash Flows
  4. Statement of Stockholder’s Equity

Balance Sheet

— The Balance Sheet presents a Company’s assets, liabilities, and shareholder’s equity at a point in time

— Assets represent future economic benefits i.e. office building, patents, or even inventory

— Liabilities represent future economic sacrifices i.e. bank loans, accounts payable to suppliers.

— Equity represents capital contributions to the business + cumulative retained profits (earnings)

 — Under the accounting equation: Assets = Liabilities + Equity

— Current assets/current liabilities ¡ Assets/liabilities that will be consumed (or paid off/settled) within the next year ¡ i.e. accounts receivable, inventory, or accounts payable

 — Non-current assets/non-current liabilities ¡ Assets/liabilities that will not be consumed (or paid off/settled) within the next year ¡ i.e. production equipment, long-term bank obligation

Income Statement

 — The Income Statement summarizes the profit generating activities of a business

 — Most companies report a multiple-step income statement

Statement of Cash Flows

— The Statement of Cash Flows shows how a company’s cash balance changed over a period

 — The statement classifies cash transactions into 3 categories:

¡ Operating Activities

¡ Investing Activities

¡ Financing Activities.

Operating Activities

 — Operating activities represent cash inflows and outflows related to a Company’s main business activities

— Inflows include: cash received from customers for the sale of goods/services, interest income, and dividends from investments

 — Outflows include: inventory, salaries/wages, other operating expenses, interest on debt, and income taxes

Investing Activities

 — Investing activities include cash inflows/outflows related to the purchase and sale of non-current assets

 — Examples: ¡ Purchase/sale of long-lived assets used in the business

¡ Purchase/sale investments in stocks and bonds

¡ Acquisition or disposition of businesses.

Financing Activities

 — Financing activities relate to the external financing of the Company (debt + equity)

 — Inflows:

 (1) shares issued to owners

 (2) borrowing money

Outflows: (1) dividends, (2) acquisition of shares, (3) repayment of debt principal

Earnings-Per-Share (EPS)

 — Shares are units of ownership in a business that provide for an equal distribution of profit or dividends

— All public companies have shares that are traded on stock exchanges

Earnings-Per-Share (EPS)

— Basic shares outstanding = the number of shares outstanding

— Sometimes companies issue stock options or other equity awards to executives as compensation. This represents “dilution” to current shareholders

— Diluted shares outstanding = the number of shares outstanding + any potential claims on common shares

Earnings-Per-Share (EPS)

— Earnings-Per-Share (EPS) = Net Income / Shares Outstanding

 ¡ Represents how much profit the Company generates per share outstanding

— Basic EPS = Net Income / Basic Shares Outstanding

 — Diluted EPS = Net Income / Diluted Shares Outstanding