How to Read Company Financial Statements (Basics Explained)

Summary

The video explains the importance of analyzing a company's financial statements for potential investments, highlighting the key components: the balance sheet, income statement, and cash flow statement. It emphasizes how many investors overlook these vital documents due to confusion, yet understanding them is crucial for assessing a company's financial health. The video breaks down each section of these statements, showing how they provide insights into a company's assets, liabilities, earnings, and cash flow. By mastering the basics, investors can make more informed decisions and avoid unnecessary risks.

Takeaways

• 🔍 Understanding a company's financial health is crucial for potential investors.
• 🚫 Many investors overlook financial analysis and focus solely on products and services.
• 📈 Financial statements are often misunderstood but are essential for assessing a company's health.
• 📚 The basics of financial statements are not complicated and can be quite revealing.
• 📋 The main financial statements include the balance sheet, income statement, and cash flow statement.
• 💼 The balance sheet provides a snapshot of assets, liabilities, and equity at a specific point in time.
• 💵 Assets are categorized as current or non-current, and liabilities are current or non-current.
• 📊 The income statement shows a company's earnings and expenses over a period, not just a snapshot.
• 💹 The cash flow statement is critical for understanding a company's liquidity and solvency.
• 🌐 Financial statements may vary slightly by company, industry, or country but generally follow similar formats.
• 💡 Investors are encouraged to read financial statements from various industries to enhance their understanding.

Q & A

What is the importance of analyzing a company's financial statements before investing?

Analyzing a company's financial statements is essential for understanding its past, current, and potential future financial situation. This analysis helps investors make informed decisions rather than taking unnecessary risks based on products or services alone.

Why do many investors avoid analyzing financial statements?

Many investors avoid analyzing financial statements because they find them complex and full of numbers, which can be confusing or intimidating. However, with a basic understanding, financial statements are not as complicated as they might appear.

What are the three main financial statements typically included in a company's financial report?

The three main financial statements are the balance sheet, the income statement, and the cash flow statement. These provide an overview of the company's financial health from different perspectives.

What is the purpose of a balance sheet?

The balance sheet provides a snapshot of a company’s assets, liabilities, and shareholders’ equity at a specific point in time. It helps investors understand the company’s financial position, including its liquidity and overall stability.

How is the balance sheet structured?

The balance sheet is divided into five sections: current assets, non-current (or long-term) assets, current liabilities, non-current (or long-term) liabilities, and equity. These sections show what the company owns, owes, and the shareholders' stake.

What is the difference between current and non-current assets?

Current assets are expected to be used or sold within one year, including items like cash and inventory. Non-current assets, on the other hand, are long-term and not expected to be sold or used within the year, such as property and equipment.

What does the income statement show?

The income statement shows the earnings and expenses of a company over a specific period of time, detailing the company's financial performance. It covers items like gross profit, operating income, and net income after taxes.

How does the income statement differ from the balance sheet?

The balance sheet is a snapshot of the company's financial position at a specific point in time, while the income statement tracks the company's financial performance over a specific period, detailing how much revenue and profit the company generated.

What is the purpose of the cash flow statement?

The cash flow statement provides information about the cash inflows and outflows during a period, showing the company’s liquidity. It helps investors assess whether the company has enough cash to meet its obligations and continue operations.

What are the three main sections of a cash flow statement?

The cash flow statement is divided into three sections: cash flow from operations (day-to-day activities), cash flow from investing (acquisition and disposal of long-term assets), and cash flow from financing (borrowing and equity transactions).

Outlines

00:00

🔍 Importance of Financial Statements in Investment Analysis

The first paragraph highlights the significance of understanding a company's financial health for investment purposes. Many investors skip analyzing financial statements, focusing only on products and services, which leads to unnecessary risks. The complexity of financial statements often deters investors, but once basic knowledge is gained, analyzing them can become an insightful and straightforward process. The video promises to explain the essentials of financial statements to help viewers understand a company's financial health, using Tesla's quarterly results as an example.

05:01

📊 The Balance Sheet: Assets, Liabilities, and Equity

This paragraph introduces the balance sheet, which provides a snapshot of a company’s financial standing by detailing assets, liabilities, and equity. It explains how the balance sheet is structured into five main sections: current assets, non-current assets, current liabilities, non-current liabilities, and shareholders' equity. Each of these sections is defined with examples like cash, inventory, long-term debt, and equity representing the company's net worth. The balance sheet reflects the accounting equation, where assets equal liabilities plus equity.

10:04

📈 The Income Statement: Tracking Performance Over Time

The third paragraph focuses on the income statement, which shows a company's revenue and expenses over a specific period, helping investors assess financial performance. It explains the key components such as gross profit, operating income, and income before and after taxes. The income statement contrasts with the balance sheet by presenting financial activities over time, not just at a single point. Multi-step income statements, often used by listed companies, separate operating from non-operating activities, showing both earnings and costs associated with running the business.

💵 The Cash Flow Statement: Understanding a Company's Liquidity

The fourth paragraph details the cash flow statement, which provides crucial information about a company’s liquidity and solvency. It explains how this statement shows the cash coming in and going out, ensuring a business can meet its obligations. It is divided into three sections: cash from operations, cash from investing activities, and cash from financing activities. Each section tracks different aspects of a company's cash flow, ensuring that investors can understand how much cash is on hand for the company to meet its financial commitments.

📝 Wrapping Up: Understanding Financial Statements

The final paragraph provides a summary of the three major financial statements: the balance sheet, the income statement, and the cash flow statement. It encourages viewers to download and analyze financial statements from various companies to understand how they differ by industry. The video aims to give viewers a solid foundation in reading these documents and offers further resources, like a video on Warren Buffett, for those interested in advancing their financial analysis skills.

Keywords

💡Financial Statements

Financial statements are official records that provide an overview of a company's financial activities and position. In the video, the main focus is on three key financial statements: the balance sheet, income statement, and cash flow statement. These statements are crucial for analyzing a company’s financial health, and the video emphasizes that many investors skip this step despite its importance.

💡Balance Sheet

The balance sheet provides a snapshot of a company’s assets, liabilities, and shareholders’ equity at a specific point in time. In the video, it's described as the first statement that appears in financial reports, detailing how assets equal liabilities plus equity, forming the foundation for assessing a company’s financial stability.

💡Income Statement

An income statement shows the earnings and expenses of a company over a specific period, helping to assess its financial performance. The video explains that it highlights the company’s revenue, gross profit, and expenses, ultimately revealing whether a company is making a profit or incurring a loss. This is key in determining whether a company is successfully operating.

💡Cash Flow Statement

The cash flow statement shows the inflow and outflow of cash in a company over a given period. It helps assess the company’s liquidity, or its ability to pay off short-term obligations. In the video, it's explained as a crucial tool for understanding a company's financial health, as running out of cash can lead to insolvency, one of the major reasons companies fail.

💡Assets

Assets are resources owned by a company that are expected to bring future benefits. The video breaks assets into two categories: current assets, which can be converted into cash within a year, and non-current assets, which are long-term resources like property and equipment. Understanding a company’s assets is critical for evaluating its capacity to generate future profits.

💡Liabilities

Liabilities represent the company's obligations or debts, categorized into current liabilities (due within one year) and non-current liabilities (due after one year). The video emphasizes that liabilities are crucial to understanding the risks a company faces, as excessive debt can threaten its financial stability.

💡Shareholders' Equity

Shareholders' equity is the residual value that would remain for shareholders if all assets were liquidated and liabilities paid off. It provides insight into the net worth of the company. In the video, it's explained as a positive figure if assets exceed liabilities, signaling financial health, while a negative figure indicates potential problems.

💡Gross Profit

Gross profit is the profit a company makes after deducting the costs associated with producing its goods or services. The video explains that it is calculated by subtracting the cost of goods sold from total revenue and is a key figure for evaluating a company's efficiency in production and sales.

💡Operating Income

Operating income, also referred to as operating profit, is the profit generated from a company's core business activities, excluding income from non-operating sources. The video highlights its importance in showing how well a company’s day-to-day operations are generating profit before considering taxes and interest.

💡Liquidity

Liquidity refers to a company’s ability to meet its short-term financial obligations by converting assets into cash. In the video, liquidity is discussed in relation to the cash flow statement, where cash on hand is evaluated to determine whether the company can sustain its operations and avoid insolvency.

Highlights

Understanding a company's past, current, and future financials is crucial for potential investment analysis.

Many investors overlook financial statements and focus only on products and services.

Financial statements can seem complex, but they are not as difficult as they appear once the basics are understood.

A company's financial health can reveal opportunities or risks that might not be apparent from its products or services alone.

The three main financial statements are the balance sheet, income statement, and cash flow statement.

The balance sheet shows a company's assets, liabilities, and equity at a specific point in time.

Assets on the balance sheet are listed by liquidity, with current assets expected to be used or sold within a year.

Non-current assets like property and equipment are expected to be held for longer than a year.

Liabilities are split between current liabilities, due within a year, and non-current liabilities, due later.

Shareholders' equity shows the residual interest in the company after liabilities are deducted from assets.

The income statement shows earnings and expenses over a specific period, unlike the balance sheet, which is a snapshot.

Cash flow statements reveal how much cash a company has on hand and its liquidity.

Cash flow is divided into three sections: operations, investing, and financing.

A good grasp of financial statements allows investors to better understand the company's operations and financial health.

Analyzing different financial statements from various industries can improve understanding of how companies operate.

Transcripts

an important part of analyzing a company

for a potential investment is

understanding their past current and

potential future financial situation

unfortunately a lot of investors skip

past this part and focus just on the

products and services the company offers

and whether they feel that they have a

good future or not and we're not even

talking about Wall Street bears Yolo

type investors either we're talking

about everyday investors who take

unnecessary risks by not looking into

the financial health of the companies

they're investing in the most common

reason for this is that they don't

understand the financial statements and

that's quite understandable because

they're full of numbers strangely worded

items and can seem a bit confusing or

complicated but in reality they really

aren't so complicated at all and are

nothing to be afraid of in fact once you

know the basics it can actually be quite

interesting to dive into the financial

statements of a company and analyze how

the company's being run and any

potential opportunities or threats that

there may be there are a number of

different ways to analyze the financial

statements but before you get to that

stage you need to know how to read them

so you know what it is that you're

looking at in this video we all go

through the basics of a financial

statement and explain the key sections

so you can see how straightforward it

really is now as I'm sure you can see

from the length of this video we're not

going to go into detail about absolutely

everything but we're just going to go

through the main sections so you can get

a good understanding and in any case

most of the items once you understand

how these statements work are pretty

self-explanatory they're actually

labeled and you can figure out what it

is that they're showing you as an

example for this video we'll be looking

at the latest quarterly results from

Tesla now it's important notes that

financial statements may differ slightly

depending on the company or the industry

or the country they report in however

for us listed companies like Tesla the

financial statements would be included

in the 10k and 10-q filings which are

mandatory for all publicly traded

companies in the US by the SEC the 10k

is an annual statement and the 10-q is

quarterly the 10k will provide more

information about the company and it is

audited so the information you see in it

will be more dependable and more

accurate but let's take a look at what

Tesla provided in its most recent report

which was for the first quarter of 2020

the financial statements for company are

usually made up of three main statements

we have the balance sheet the income

statement and the cash flow statement

the balance sheet is typically the first

statement to appear and it gives a

snapshot of the company's assets

liabilities and shareholders equity at a

specific point in time these three

aspects make up what is known as the

balance sheet equation also known as the

accounting equation this stays that

asses are equal to liabilities and

equity the balance sheet is split into

five sections current assets non current

assets also known as long-term assets

current liabilities non current

liabilities

also known as long-term liabilities and

equity which is also known as

shareholders equity or shareholders

funds let's start by looking at the

assets these will be listed in order of

how liquid they are which means how

easily they can be changed or converted

into cash so current assets are assets

that are expected to be either used or

sold within the next year this will

include things such as cash cash

equivalents money owed by customers

inventory and goods and services that

have been paid for but not yet used the

non current assets are assets that are

not expected to be sold or used within

the next year Tesla includes things such

as leased vehicles and solar energy

systems but there are also more common

items also listed such as property

plants and equipment

along with Lisa's intangible in other

words non-physical assets and goodwill

the next section shows the liabilities

again we have current liabilities which

are the obligations that are due within

the next year and this includes things

like money owed to suppliers even money

that has been paid but the good or

service is yet to be delivered along

with the portion of long term debts that

has jude's be repaid this year then we

have the non current liabilities which

are obviously obligations that are not

you within the next year this includes

long-term debt and again money that's

received but the good or service has not

yet been delivered the last section is

equity which is often referred to as

shareholders equity or shareholders

funds you could think of this as being

whatever would be left over for

shareholders if all assets were

liquidated and all liabilities were paid

off

therefore if the figure is positive it

means the company has enough assets to

cover its liabilities and if it's

negative it means that it doesn't

shareholders equity will include

information about shares that were

issued any capital paid in by

shareholders paying for shares in the

company and retained earnings which is

money accumulated from the company's

earnings and kept in the company the

next financial statement is the income

statement this is also known by other

names including statement of operations

and profit and loss statement amongst

many others this statement is going to

show us that earnings and expenses of a

company over a specific period of time

this important to keep in mind the

balance sheet was a snapshot at a

particular point in time whereas the

income statement is looking at what

happens over a specific period of time

so the income statement is helping us to

see a company's financial performance

for that period companies will structure

the income statement differently but

listed companies like Tesla

we'll typically follow what we refer to

as a multi-step income statement which

separates the operation revenue and

expenses from those coming from a non

operating activity so we're looking at

gross profit operating income or loss

the income or lost before taxes and then

the income or loss after taxes to get to

the gross profit with typically look at

total revenue minus the cost of that

revenue so traditionally here you'll

have sales revenue and in the costs you

may have heard of the term cost of goods

sold so this gives us the gross profit

we can then look at operating expenses

things like research and development for

creating new products selling general

and administrative expenses which are

all the costs not directly involved in

production of a product or service but

needed of the day-to-day business

operations this will include things such

as rent salaries for executives and

other management expenses admin staff

and basically any non sales people so

ultimately we end up with our income or

loss from operations we can then look at

any interest paid or received to find

our income or lost before taxes and then

finally the income or loss after taxes

the third of the three major parts of a

financial statement is the cash flow

statement so the income statement that

we just looked at may show us the profit

or loss generated during a period but

that doesn't necessarily equal cash a

company will need cash to survive so the

cash flow statement is going to help us

by giving information about company's

liquidity and solvency solvency means

having enough funds or liquid assets to

make necessary debt payments and funds

the company's operations if the company

runs out of cash it could be insolvent

which is one of the main reasons for

businesses failing the cash flow

statement will tell us the amount of

cash or

- equivalents coming into the company or

leaving the company therefore showing us

how much cash is on hand for a company

to make is necessary payments the cash

flow statement is usually split into

three main sections cash from operations

cash from investing activities and cash

from financing activities

the first section shows us the cash flow

from the primary revenue generating

activities of a company so this includes

the company's products or services

things like cash from sales rent

payments salary payments and so on cash

flows from current assets and current

liabilities next are the cash flows from

investing activities the focus here is

on acquiring or getting rid of long term

assets this will show us outflows due to

investments made in things like property

and inflows when assets are sold however

this statement doesn't detail the

investments and so the quality of those

investments can't really be assessed and

finally we have the cash flow from

financing activities which shows us cash

coming in or going out due to any equity

capital or borrowings it tracks cash

flow between the company is owners

creditors and lenders including

stockholders so there you have it simple

wasn't it those are the main sections of

the three main statements that make up a

company's financial statements the

balance sheet the income statement and

the cash flow statement now we didn't go

into lots and lots of detail this was a

high-level overview but just by

understanding those main sections and

how the statements are laid out and how

they relate to each other in the jobs

they do you can already get a good grasp

of what's going on in the company and

you should now be able to read a

company's financial statement and

understand what you're seeing

I'd recommend downloading the financial

statements of companies from different

industries and seeing how they differ

from one another and whether you can

read them now and get a better

understanding of what's going on in

those specific companies and if you like

video and want to see more on this topic

such as how we can take this a step

further and use ratios to analyze the

financial statements then hit that

thumbs up button to let us know and if

you're looking for something to watch

next why not check out our legends of

investing video about the story of

Warren Buffett someone who reads more

financial statements than practically

anyone and as always if don't forget to

subscribe to the channel for more videos

and thanks so much for watching see you

soon