How to Read Financial Statements
A simplified guide to understanding the Balance Sheet, P&L, and Cash Flow Statement.
A Simplified Overview
Financial statements can be complex. This guide simplifies the core concepts for educational purposes and is not investment advice. Always consult with a financial advisor and conduct thorough research.
The Three Key Statements
Think of a company's financial statements as its report card. They tell you how the company is performing and where it stands financially. There are three main statements to understand:
- The Balance Sheet: A snapshot of what a company owns and owes at a single point in time.
- The Profit & Loss (P&L) Statement: A video of a company's performance over a period (like a quarter or a year).
- The Cash Flow Statement: Tracks the movement of actual cash in and out of the company.
1. The Balance Sheet
The Fundamental Equation: Assets = Liabilities + Equity
The balance sheet must always balance. It shows what a company owns (Assets) and how it paid for them (through debt/Liabilities or with its own money/Equity).
| Component | What it Means | Examples |
|---|---|---|
| Assets | Resources the company owns. | Cash, inventory, machinery, buildings. |
| Liabilities | What the company owes to others. | Bank loans, money owed to suppliers. |
| Equity | The owners' stake in the company. | Share capital, retained earnings. |
What to look for: Is the company's debt increasing much faster than its assets? A healthy company typically grows its equity over time.
2. The Profit & Loss (P&L) Statement
Also called the Income Statement. It shows profitability.
The P&L statement tells a story over a period. It starts with total sales and subtracts various costs to arrive at the final profit.
- Revenue (Sales): The total money generated from sales.
- Cost of Goods Sold (COGS): Direct costs to produce the goods sold.
- Gross Profit: Revenue - COGS.
- Operating Expenses: Costs like salaries, marketing, and rent.
- Operating Profit (EBITDA): Gross Profit - Operating Expenses. Shows profit from core business operations.
- Net Profit (PAT): The final profit after deducting interest, taxes, and other expenses. This is the "bottom line."
What to look for: Is revenue growing consistently? Is the company's net profit margin improving over time? Consistent growth is a positive sign.
3. The Cash Flow Statement
Profit is an opinion, cash is a fact.
A company can be profitable on paper but have no cash in the bank. The cash flow statement tracks the actual cash moving through the company from three activities:
- Cash Flow from Operations (CFO): Cash generated from the company's main business activities. A consistently positive CFO is a very healthy sign.
- Cash Flow from Investing (CFI): Cash used for or generated from investments, like buying new machinery (a cash outflow) or selling assets (a cash inflow).
- Cash Flow from Financing (CFF): Cash from financing activities, like taking a new loan (inflow) or repaying debt and paying dividends (outflow).
What to look for: A healthy, growing company typically has a strong positive cash flow from operations, which it uses to invest for the future (negative CFI) and repay its debts (negative CFF).