Before investing in any company, understanding its financial health is crucial. Here's a practical guide to reading the three main financial statements.
The Balance Sheet
Think of the balance sheet as a snapshot of what a company owns (assets) and owes (liabilities) at a specific point in time. The fundamental equation is: Assets = Liabilities + Shareholders' Equity.
Key ratios to calculate:
- Current Ratio = Current Assets / Current Liabilities (healthy: above 1.5)
- Debt-to-Equity = Total Liabilities / Shareholders' Equity (lower is generally better)
The Income Statement
This shows how much money a company made (revenue) and spent (expenses) over a period. Key metrics include:
- Revenue growth - Is the top line growing year over year?
- Profit margins - Gross, operating, and net margins reveal efficiency
- EPS (Earnings Per Share) - Profit divided by outstanding shares
The Cash Flow Statement
Cash is king. A company can show profits on paper while running out of cash. The cash flow statement tracks actual money movement through three activities: operating, investing, and financing.
Red Flags to Watch
- Revenue growing but cash flow declining
- Increasing debt without corresponding asset growth
- Frequent "one-time" charges that aren't really one-time
- Accounts receivable growing faster than revenue
Free Resources
Public company filings are available for free through SEC EDGAR (US), Companies House (UK), and equivalent databases worldwide. Use them.