Analysing the financial statements of companies is a key element in making informed investment decisions. Financial statements provide detailed information about a company’s financial condition, its revenues and expenses, and its ability to generate profits and manage debt. In this guide, we will look at the key elements of financial statements to look out for when evaluating company stocks.
Basic financial statements
A company’s financial statements typically include three main documents:
- Balance Sheet: Shows the company’s financial condition as of a certain date, including its assets, liabilities, and shareholders’ equity.
- Income Statement: A measure of a company’s financial results for a certain period, including revenues, expenses, and net income.
- Cash Flow Statement: Provides information about a company’s cash flows, including cash flows from operating, investing, and financing activities.
Analysing key financial ratios
To effectively analyse financial statements, it is important to pay attention to the following key indicators:
Profitability metrics
- Return on sales: Expressed as a percentage, it shows how much of the revenue remains as profit after deducting all expenses. It is calculated as (Net Profit / Revenue) × 100%.
- Return on Assets: A measure that shows how efficiently a company uses its assets to generate profits. Calculated as (Net Income / Average Asset Value) × 100%.
- Return on Equity: Measures how efficiently a company uses its equity capital to generate profits. Calculated as (Net income / Average equity) × 100%.
Liquidity ratios
- Current Liquidity Ratio: Measures a company’s ability to cover its short-term liabilities with current assets. Calculated as (Current Assets / Current Liabilities).
- Quick ratio: A more stringent liquidity test that excludes inventory from current assets. Calculated as ((Current Assets – Inventories) / Current Liabilities).
Financial risk indicators
- Debt Ratio: Measures a company’s debt to equityratio. Calculated as (Total Liabilities / Equity).
- Interest Coverage Ratio: Measures a company’s ability to service its debt obligations, calculated as (Operating Income / Interest Expense).
Trend Analysis and Comparison with Competitors
When evaluating a company’s financial statements, it is also important to analyse trends over time and compare key metrics with competitors in the same industry. This will help you understand how the company is coping with changes in the economic environment and its competitiveness.
Evaluate growth prospects
Analysing financial statements is not just limited to current performance. It is also important to assess the company’s growth prospects based on its expansion, innovation and investment plans. Consider the following aspects:
- Growth investments: How the company plans to utilise its resources for growth and expansion.
- Market Analysis: Trends and forecasts in the industry in which the company operates and how they may affect its future.
- Management team: The experience and qualifications of the company’s management team and their ability to achieve strategic goals.
Conclusion
Analysing company financial statements is an important tool for successful stock investing. Pay attention to key financial indicators, trends, compare them with competitors and assess growth prospects. This comprehensive approach will help you make more informed investment decisions and increase the chances of a successful investment.