Financial statement analysis in Decision Making

03 JAN 2018

Financial statement analysis is critical in making effective stock investment decisions. If you do not research your stock investments, you essentially engage in glorified gambling. The good sense of company’s overall financial picture can be analyzed using;

  1. Balance sheet
  2. Income statement
  3. Cash flow statement
  4. Statement of owner’s equity

Balance sheet

The balance sheet is the best statement to get a good overall view of company’s financial position. The balance sheet preparation follows the basic accounting equation of assets equal liabilities and capital of the business. The difference between what a company has and it owes equals the equity. High net worth in a company indicates that the company is relatively debt free, particularly if owners’ equity is higher to the percentage of assets than other companies in the industry.

Income statement

The income statement tells the investors how much money the company made from and spent over a certain period of time, usually a year. It includes gross profit and operating income. The gross profit is based on revenue – cost of producing the goods or services the company sells and it is called as cost of goods sold. The above shows how efficiently company is generating income from its production. On the other hand, operating income considers other types of costs which includes overheads, depreciation etc. This is important for any company in determining profitability of the company when compared to previous period and other companies in the industry. Increasing operating income is a good and positive sign and less likely to affect long term concerns for company.

Cash flow statement

Cash flows of a company reveal the useful information for investors in making investment decisions. It indicates the net change in company’s cash position in a given period of time. Company can cover short term debt payments and expenses if it is having stable and constant growth in cash flows and it can also help in meeting the long term debt obligations of the company. Cash flows can be generated by operating activities as well as financing and investment activities. If the company’s operating income of cash exceeding its net income is always a good sign.

Owners’ equity

The primary purpose of the owners’ equity is to show the retained earnings of the company. Retained earnings are the accumulated profits of the company and even dividend is not paid for the investors. The higher retained earnings relates to less dividend income. It can be interpreted that company is looking to grow and is holding the profit for reinvestment rather than paying out in the near term.

Written by;

Rakesh H M

Director for Professional Studies and Industry Integration

CRESTA School of Management