SINGAPORE (Jan 29): Before investing your money into any company, you should do your research to determine whether the investment is worth it or not. And one of the first few things you should be looking at is the company’s financial statements, which provide an important source of information.
This is especially essential when you are looking to identify stocks with sustainable dividends and a steady growth outlook.
After all, by exploring investment options, we can safely assume that you are looking to grow your wealth exponentially on top of your existing savings.
It sounds easy enough to buy stocks that will generate money for you. But how do you as an investor go about doing this? Why, you study the financial statements of companies you want to invest in, of course.
What is a financial statement?
A financial statement is like a report card that provides a detailed summary of a company’s overall performance, as well as its profits and losses, performance outlook, and stability.
It is prepared by the company’s management team. An external and independent auditor then looks over the statements to verify that they are factually accurate.
The report is then released to various stakeholders – including the company’s management team, employees, investors, government agencies, and vendors – who rely heavily on these statements.
Where can I find them?
They usually appear in the company’s annual report, which you can request for at no charge. A quick search online should also lead you to the report on the company’s website.
Locally-listed companies also report their financial results regularly on the Singapore Exchange (SGX).
Alternatively, financial statements are available at the Accounting and Corporate Regulatory Authority (ACRA)’s website.
What is it used for?
Savvy investors will know that it is imperative to study financial statements closely in order to identify whether the company will do well in the long run. Keep in mind, that this does not ensure any definite profits, but it helps minimise the possibility of loss, if you play your cards right.
How do I read or analyse a financial statement?
For starters, do not be afraid of the numbers. They are there to help you make sense of the company’s business decisions and performance outlook.
To further break it down, there are three main areas of a financial statement that you need to pay closer attention to: the income statement, balance sheet, and cash flow statement, all of which are interrelated.
a. The income statement
Also known as the profit and loss statement, this is where you will find the company’s revenue earned, expenses incurred, as well as the depreciation value during the time period that the statement is focused on.
Take care not to oversimplify them into positive and negative figures though. You will have to refer to any notes and supporting documents to see what the company spent on, and how they dealt with the profits. You should also keep in mind the economic conditions that took place during that time period.
The income statement usually starts with the revenue on top, expenses, and then other income to arrive at net profits or earnings.
b. Balance sheet
The balance sheet is where you make sense of the company’s financial health.
This is also where you will find the value of the company’s assets, liabilities, and equity that was held by the company during the period of reporting (which takes into account the entire time from which the company was established).
Assets refer to any property or item that is of value; they also include any monies that are still owed to the company. Liabilities are areas that lose money for the company, as well as any debts that the company might owe others. Current assets refer to those that can be converted into cash within one fiscal or financial year; current liabilities include short-term debts, taxes, and other payments due within the year.
A company is funded by equity and debt; the former sells shares in exchange for a percentage of ownership of the company whereas the latter funds the company through debt instruments such as credit lines, loans or bonds. Equity also refers to the positive difference in the amount of assets and liabilities such as retained earnings, which are profits a company has not reinvested, or distributed in the form of dividends.
c. Cash flow statement
As its name suggests, this statement shows the inflow and outflow of cash in a company for a period of time. It is also a more precise method of calculating the company’s cash (or net) profits.
While the cash flow statement takes most of its information from the income statement by deriving information using its net income (strictly cash transactions); unlike the income statement, the cash flow statement does not take into account factors such as depreciation.
A company with healthy finances means it has a steady inflow of cash in the long run that outweighs the outflow, which leads to a positive cash flow.
You should always refer to the income statement when reading the cash flow statement, as positive cash flow does not always equate to profit.
However, prolonged and recurring negative operating cash flow is a red flag in financial analysis as there is constant cash outflow from the fundamental business.
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Click here for a more detailed breakdown, including a guide to calculating financial ratios that indicate the demand for the company’s inventory.
