How to Read Financial Statements

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How to Read Financial Statements

Understanding financial statements is key to fundamental share analysis and overall investment research. Financial statements provide an account of a company’s past performance, a picture of its current financial strength and a glimpse into the future potential of a firm. Understanding financial statements empowers current and prospective investors to making more informed decisions about their portfolios. The summary below provides a breakdown of the major components of each financial statement and its relevance. Several financial statements are reported by companies. The most important three, and the three used most often by investors, are: Income Statement, Balance Sheet, and the Cash Flow Statement.

  • Income Statement
    The income statement reports how much revenue the company generated during a period of time, the expenses it incurred and the resulting profits or losses. The basic equation underlying the income statement is: (revenue – expenses = income).  Investors use the Income Statement to monitor revenues, expenses and profits and their trends over time, which impacts the valuation of the firm. Earnings per share is simply the earnings the company generated per share of outstanding company stock. This is the figure used in the denominator of the price-earnings ratio, a key ratio used frequently in investment analysis.

  • Balance Sheet
    Although the income statement may be the most popular financial statement, the balance sheet provides vital information on a company’s financial position. In contrast to the income statement, which provides revenue and earnings data over a period of time, the data contained in the balance sheet is a snapshot for a specific date. The balance sheet provides information on what a company owns (assets), what it owes (liabilities), and the shareholder ownership interest (equity). The equation underlying the balance sheet is: assets = liabilities + equity. Analysts use balance sheets to determine trends in assets and liabilities and to ascertain how adequately the firm is financed. In addition, the balance sheet shows changes in a firm’s debt and provides clues as to whether the firm is becoming too highly leveraged. The shareholder’s equity determines the valuation of a firm by providing the book value (which is used as the denominator in the price-to-book ratio), or theoretical value left for the shareholders in event of liquidation.

  • Cash Flow Statement
    The cash flow statement is the third major financial statement provided by companies. This financial report tabulates how much cash is coming in and going out of the firm. When it comes to financial statements, cash is entirely different from profits. A firm can easily generate healthy profits without generating sufficient cash. There are three major elements in the cash flow statement: cash flow from operating activities, cash flow from investing activities and, cash flow from financing activities.

    Cash flow from operating activities encompasses cash generated from a company’s day-to-day operations. Cash flow from investing activities pertains to the purchasing and selling of investments. Cash flow from financing activities covers obtaining or repaying capital. Cash inflows from financing activities include the sale of stock and issuance of debt. Cash outflows include stock repurchases, the issuance of dividends, and the repayment of bonds or other long-term debt. Net cash flow is the total sum of cash flow from operations, cash flow from investing, and cash flow from financing. This figure is the basis of numerous cash flow valuation models; analysts often use cash flow as a basis to develop target prices for the company’s stock.

  • Where Can I Find Financial Statements?
    All listed companies on Bahrain Bourse are obliged to abide by the CBB’s Disclosure Standards. Quarterly, bi-annual, and year end audited financial statements of listed companies are available on Bahrain Bourse’s website.

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