Reading Financial Statements

Balance Sheet

A snapshot of what a company owns and owes at a specific point in time.

Assets = What the company owns (cash, inventory, property, equipment) Liabilities = What the company owes (debt, accounts payable) Equity = Assets minus Liabilities (what's left for shareholders) Key things to check:

• Current ratio (current assets / current liabilities) — should be > 1
• Debt-to-equity ratio — lower is generally better
• Cash position — how much cash does the company have?

Income Statement

Shows revenue and expenses over a period.

Revenue — Total sales Cost of Goods Sold (COGS) — Direct costs of making products Gross Profit = Revenue - COGS Operating Expenses — Salaries, marketing, R&D, etc. Net Income — The bottom line (profit after all expenses and taxes) Key things to check:

• Revenue growth — is it increasing year over year?
• Gross margin — gross profit / revenue. Higher is better.
• Operating margin — how much profit from core operations
• Net income trend — is the company becoming more profitable?

Cash Flow Statement

Often more important than net income. Shows actual cash coming in and going out.

• Operating Cash Flow — Cash from core business (most important)
• Investing Cash Flow — Cash spent on investments and assets
• Financing Cash Flow — Cash from borrowing or issuing stock

Pro Tip

You don't need to be an accountant. Just focus on the trends: is revenue growing? Are margins expanding? Is debt manageable? Cash flow positive?

These three questions answer most investing questions.