Whether you are an investor, employee, board member or owner of your own SME, knowing how to read a financial statement is a skill you will need to call upon if you want to make informed decisions regarding spending, investing and more.
Sure, you might rather leave the interpretation of financial documents to your accountant but in order to be the best investor, board member or owner that you can be, you should be able to read the basics yourself. This will allow you to understand the financial situation of the company and communicate better with your accounting team – allowing you to make high-level decisions with a deeper understanding of the financial implications.
A financial statement is an overview
Think of a financial statement as an overview of a company at a certain time. You want to choose to align yourself with companies that have strong profits and profit indicators, assets, access to capital, solid business plans and a history of profits.
You will either have to take a guess about a business’s health before you invest or you can know for sure by learning how to interpret a financial statement. It’s much safer to know how to read the statement.
Three basic parts
For most basic purposes, the documents you will need to look at include the balance sheet, income statement, and cash flow statement.
1) Balance sheet
The balance sheet lets you know the amount of assets and liabilities the company holds. Most often, the reader will see the assets listed on the left-hand side and the liabilities on the right side.
Assets are most commonly listed in the order of those that are most easily liquidated if needed. You are most likely to see cash, product stock, accounts receivable and other assets specific to a certain industry or business. Current assets are those assets which mature into cash in one year or less
Liabilities are what a company owes to others. This list might include bank loans, accounts payable and lines of credit. Almost every business differentiates between current and noncurrent liabilities. Current liabilities are those liabilities that are due within a year and noncurrent are all other liabilities.
2) Income statement
An income, or profit-and-loss statement, tracks the amount of capital a business gains and spends over a certain period of time. On the document, the income is balanced against the cost of running the business, such as employee salaries, manufacturing goods and marketing. These are often produced at the end of the year but, depending on the business, may be produced at another time of year. For example, a snow removal company might create their profit-and-loss statement in the summer to get a clearer picture of how successful a winter season has been.
3) Cash flow statement
The cash flow statement shows a detailed picture of the movement of money in an organization. It gives a full picture of each dollar earned and where it comes from. It also shows where each dollar was spent. This document is key for both owners and investors to ascertain if the company’s finances and operations are healthy.
All financial reports won’t be identical
Most of what you see above are general rules for financial statements. However, because of the diverse nature of companies and industries, not all financial statements will look the same or contain all of the same information.
Let your accountant teach you
A great way to reach a deeper understanding of financial statements is to simply set up a one-on-one appointment with your trusted accountant. Your accountant can easily walk you through what is important and how to interpret it. In fact, most accountants truly enjoy talking about and explaining their work and will appreciate the chance for an attentive audience.
Once you learn the basics of reading financial statements, you are on your way to becoming a better investor, board member or business owner.
If you don’t yet have an accountant, Asia Accountants Network can provide access to verified, qualified accountants working in your area. Simply filter a search by specialty and location and find experienced accountants near you!
This article is written by Adrian Mah from Asia Law Network.
This article does not constitute legal advice or a legal opinion on any matter discussed and, accordingly, it should not be relied upon. It should not be regarded as a comprehensive statement of the law and practice in this area. If you require any advice or information, please speak to practicing lawyer in your jurisdiction. No individual who is a member, partner, shareholder or consultant of, in or to any constituent part of Interstellar Group Pte. Ltd. accepts or assumes responsibility, or has any liability, to any person in respect of this article.