How to Read and Interpret Financial Statements?
A financial statement is one of the most essential parts when assessing the business's stability and health. The financial statement is a complete statement of the year through which the owners and the shareholders can determine how well the company works and what is going well.
Reading and understanding a financial statement is a complex thing. There are a lot of different terminologies, calculations, and measurements that need to be done to know about the stability of the business. If you want to know how they can read and interpret financial statements, this article is just for you. So, let's jump right into the article and look at it.
What is a Financial Statement?
Before learning to read and interpret a financial statement, you should know what it is and why it is essential. A financial statement is a summary of a company's financial situation. It allows the owners to understand whether the company works in a stable condition.
With the help of financial statements, the owners and shareholders can make the right decisions for the company; this is also a way to plan the venture and the upcoming projects and understand how the company will work in the forthcoming months.
Hence, a financial statement is one of the most important documents for a company as it helps with understanding its condition and how it works.
How to Read Financial Statement?
Now, we are going to the central part, which is how to read the financial statement. A company has three main types of financial statements: the balance sheet, the cash flow statement, and the income statement. You must follow the following steps to read and interpret all these statements correctly.
1. Reading the Balance Sheet:
The balance sheet is the first thing you must understand regarding financial statements. A balance sheet allows you to see the assets and liabilities of the company. It also shows the company's resources, when it is purchased, the amount for purchasing, and even the amount it owes to other companies.
The balance sheet gives you a clear picture of the investment, the debts, and the company's equity. There are different formulas that you have to use to understand this sheet.
· Current Ratio = Current Assets / Current Liabilities
· Quick Ratio = (Cash Equivalents + Marketable Securities + Accounts Receivable) / Current Liabilities
· Debt to Equity Ratio = Total Debt / Owner or Shareholders' Equity
The Current Ratio should dip at most 2:1; otherwise, it will indicate that you need more existing assets. If the quick Ratio is 1:1 or higher, then this means that your company is doing well. Lastly, the debt-to-equity ratio should be 4:1 to ensure your company works appropriately.
2. Reading the Income Statement:
The next part of the financial statement is the income statement. With the help of this statement, you can see how much money the business is spending. It also shows the amount the business has earned and other things related to the capital that the company is making.
The income statement is the net profit of the business. You will find many things you need to know to read correctly in the balance sheet.
· Sales Revenue:
It is the total amount of money the company has made in the month without detecting any expenses.
· Operating Earnings:
After subtracting the company expenses, the operating earnings are the amount you will have, but it does not include any taxes or interests.
· Income Tax Expense:
It is the amount the company needs to keep for the taxes, the debits, and other similar things.
· Net Profit:
Lastly, you will have the business's net profit; this is the amount left after taking out the income tax, the operating earnings, and all the other things.
3. Reading Cash Flow Statement:
Only some companies might have a cash flow statement, but many companies do have it; this is why you need to know how to read it. The cash flow statement provides a detailed picture of what is happening to the business's cash over the period or the accounting time.
There are different sections when it comes to the cash flow statement. There is the cash flow from the operating system, cash flow from the investing activities, and cash flow from the financial department.
Operating system means the cash flow from delivering goods and services to the customers. The cash flow includes the expenses that go into the system and the profit made. Most companies use their revenue for investment, so the money from buying and selling the assets will be considered the cash flow from investing activities.
Lastly, we have the financial activities, which means the money made from the debt and equity. All of this is combined to make a complete cash flow statement.
A cash flow statement is essential in a financial statement because it is a quick summary of the economic costs and allows the owners and the management to look at how they use the money and how it can be enhanced.
Final Words:
The financial statement is an essential aspect of the business as it has a lot of important information you need to know. However, reading and understanding this statement can be challenging because it has many different things. Therefore, this article was helpful for you in learning more about this and how you can easily read it.
