Decoding Financial Reports

January 18, 2022

Financial statements are documents provided by a company to give investors a closer look at how the business has performed over some time. These documents answer every investor's important questions before executing a trade. At first glance, these forms can be horrifying with no prior experience in reading such documents.

Still, with our help, you'll be able to read through financial statements decoding what you're looking for.

Investors seek three main types of financial statements when researching a stock.

Income Statement

An income statement shows you the company's profit and loss over a given period. Its core function is to provide the net income by subtracting the expenses and losses from the overall yields. The net income results from your company's total money and is located in one large number and EPS.

Income statements typically include the following information:

- Revenue: The amount of money a business takes in

- Expenses: The amount of money a company spends

- Costs of goods sold (COGS): The cost of parts of what it takes to make whatever a business sell

- Gross profit: Total revenue fewer COGS

- Operating income: Gross profit fewer operating expenses

- Income before taxes: Operating income less non-operating expenses

- Net income: Income before taxes fewer taxes

- Earnings per share (EPS): Division of net income by the total number of outstanding shares

- Depreciation: The extent to which assets (for example, aging equipment) have lost value over time

- EBITDA: Earnings before interest, taxes, depreciation, and amortization

Investors have formatted two main methods of reading and analyzing income statements that reduce the time needed to review the document while thoroughly providing all the required information.

Vertical Analysis

The process of reading down a column of data in a financial statement, determining how individual line items relate to each other. It also helps you analyze whether performance metrics are improving.

Horizontal Analysis reviews and compares changes in the dollar amounts in a company's financial statements over multiple reporting periods. It's frequently used in absolute comparisons but can be used as percentages, too. By conducting a horizontal analysis, you can tell what's been driving an organization's financial performance over the years and spot trends and growth patterns, line item by line item. Ultimately, horizontal analysis identifies trends over time.

Balance Sheet provides insight into a company's financial standing at that given time. Typically balance sheets are released every quarter comparing economic changes since their previous report.

This document consists of three sections.

- Assets: What the company owns of value. Current assets include liquid assets and assets that can become liquid within a year. Examples include cash, short-term Treasuries, accounts receivable, and inventory. Non-current assets include long-term investments, real estate, and equipment used in manufacturing, to name a few.

- Liabilities: The debt of the company. These divide into current and non-current. Current liabilities include payments a company will have to make within a year, such as accounts payable and short-term debt. Concurrent disadvantages include things like long-term debts.

- Shareholder Equity: Think of shareholder's equity as what the company would have if it shut down, sold everything, then paid your debts. Shareholder's equity is the difference between assets and liabilities and is the company's net worth.

Cash flow Statement

Shows the amount of money flowing in and out of the company by breaking financial documents into a few categories.

- Operating activities: Net income from the company's business, stock compensation, receivables, accounts payable that were paid, and other business-related items.

- Investing activities: If a business buys or sells stocks or bonds, this activity is in this part of the cash flow statement. The same is true if the company buys or sells real estate or equipment.

- Financing activities: If a company issues new common stock, it is in this part of the cash flow statement. In this section, dividend payments are an expected outflow, as are stock buybacks. And if a company repays debt, that will appear as a line item here.

All these categories combined produce the company's total cash flow. If the sum is positive, the company has more cash than the previous report showing growth and profit. If the sum is negative, that indicates a cash decrease.

Where to find financial statements?

With more and more platforms becoming available to the public, it has never been easier to access a company's financial documents. You can get a company's financial statements straight from the source—the company itself. Go to its investor relations (IR) page and look for its most recent quarterly earnings report. Usually under a "news," "press releases," or "financials" tab at the top of the page. Many companies keep their latest results as a focal point on their main IR page. For example, Spotify has a dedicated webpage that appears when you google Spotify investors.

There are a few platforms available for traders researching multiple companies and prefer having a centralized source of information for all companies. You can go directly to the SEC's website and look up the company's latest quarterly report. Atom is also a platform built by investment professionals that created a stock research application that allows users to access all financial documents and upcoming events.

The bottom line is that for all publicly traded companies listed on major U.S. exchanges, financial statements are full of information, updated quarterly, and readily available. Once you learn to decode them, you'll feel much more comfortable in your investments and ready to learn more about executing trades.

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