The Income Statement
The first one is the Income Statement. If you want to find out about a business’s profitability you go to their income statement.
There you can find out how much in sales a business had in a certain period. Which costs, and what was the resulting profit or loss.
There is another name you may hear for the income statement: P&L for profit and loss.
Fundamentals of Financial Analysis
The Balance Sheet
The second main financial statement is the Balance Sheet. The balance sheet shows which assets the company owns, the liabilities it owes to others, and the equity that belongs to the owners.
The Cash Flow Statement
And finally, there is the Cash Flow Statement. This one lets you know if the company generated cash, where that cash came from and what it spent it on.
Generating Business Insights
Based on the data in these reports a financial analyst will try to get insights into several factors that contribute to a company’s overall financial health:
- One of the most important ones is Liquidity: Without sufficient cash generation, the business has very little chance of surviving.
- Next is Profitability: this refers to the ability of a business to generate profits.
- Another one is Efficiency: how well is the company using its assets and liabilities to generate income? For example, how often is inventory turning over or how long are receivables outstanding; how long are we waiting to get paid?
- And finally Leverage. Meaning to which extent is the company depending on borrowing to finance its operation.
A lot in financial analysis comes back to context. For example, if I tell you that the company Office Plus has profits of 1 million dollars, is that good? Or liabilities of 2 million. Is that a lot?
It’s hard to tell without knowing the relation to other numbers like sales or total assets. Or compare them to prior year numbers or the results from competitors.
So, putting the numbers from financial statements into context is important. That’s why financial analysts work a lot with ratios.
And it’s equally important to consider ratios that analyze all factors of a company’s health. Because it’s not enough to just look at profitability. A company can be profitable on paper but not generate much cash. Or the return on equity may look great but it’s highly leveraged which carries a higher risk if there’s a downturn in the economy.
A good financial analyst takes different aspects of a business into consideration when it comes to evaluating the business or making strategic decisions about the future growth of the business.
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