What You Should Know About Financial Reports
For stock investors, it is an essential skill to know how to read and work with the entries on a company’s financial report. The analysis and meaningful interpretation of balance sheets, cash flow statements and income statements to discern the investment qualities of a particular company is the basis for making smart investment choices.
However, financial reports are very diverse and would require you to get familiarized with the general financial report characteristics first before you can start focusing on the individual corporate financials. Read through the article because we will show you everything that financial reports have to offer as well as on how to use them for your advantage!
* Financial statements are scorecards
There are millions and millions of individual investors all over the world. A huge portion of them have opted to invest on mutual funds as their main investing activity. There are also those that choose to invest directly on stocks. A prudent investing practice is to seek out only the quality companies that have strong balance sheets, positive cash flows and solid earning. These companies are the best ones to put your money into. You will know the financial status of a particular company through their financial reports.
* The specific type of financial report you should use
Balance sheets, cash flow statement and the income statement are the financial reports you need to use or look out for if you are going to conduct an investment analysis. The statements of retained earnings and shareholders’ equity which companies rarely present, contain nice-to-know data but they are not informative and critical. Financial analysts stay away from them since they don’t have much use.
A word of advice: a lot of people from the general investing public tend to focus on the balance sheet and the income statement. Although this will do, you will have a tendency to relegate the cash flow considerations on a secondary status. Financial analysts would tell you that this is a mistake you should avoid doing. For now since this is a beginner’s guide on financial reports, just remember that the cash flow statement holds myriads of critical information and important analytical data and that you need to look into it along with the other two reports.
* Understanding the numbers
The numbers in the financial reports of a company reflect events of the real world. The financial indicators or ratios and the numbers are all derived from them because investment analysis will become easier to grasp if the analyst will imagine the underlying realities to the provided quantitative information. Case in point: before you begin crunching the numbers, you first need to have an understanding as to what your company does as well as its products and services and the industry it is operating in.
* Financial reports are diverse
You cannot expect that final reports can be fitted into one single mold. A lot of books and articles on financial report analysis take on an approach that analysts call as one-size-fits-all. For a less experience investor, he will surely get lost as soon as he encounters a different presentation of accounts than what he is normally accustomed to. What you should do is to remember that the presentation of accounts reflects the diversity of the activities of the business. The more diverse the activities of the business are, the more diverse the financial reports would be. This is apparent in a company’s balance sheet but the cash flow statement and the income statement are less affected to this phenomenon.
* Understanding financial jargon is certainly a challenge
There is a lack of standardization for financial reporting terminology and this complicates a beginner’s understanding to the long list of financial report account entries. It can even be confusing to experienced investors. One can only hope that this circumstance will change in the near future. For now, a financial dictionary will suffice.
* Accounting is not a science, but an art.
As it will be portrayed in the financial reports, management judgments and estimates influence the presentation of a certain company’s financial position. In an ideal world, the management is scrupulously candid and honest while outside auditors are the ones that are uncompromising, strict and demanding. However, whatever the case is, there is definitely an imprecision in the whole accounting process. This means that you as an investor should take a skeptical and inquiring approach toward the analysis of the financial reports.
* The two most important accounting conventions
GAAP or the generally accepted accounting principles are used as a guideline in the preparation of financial reports. For investors, having the basic understanding to even two of the conventions like the accrual accounting and historical cost would have a great impact on your future investing decisions.
* Financial indicators and ratios
For investment analysis, absolute numbers that are in financial reports only possess of little value which should in fact transform the numbers into a basis in judging a company’s financial condition and performance. The resulting indicators and ratios need to be of your knowledge for an extended period of time so you will have the chance to notice trends. This will also give time for the trends to reflect on the financial report.
Again, be cautious of the one-size-fits-all mentality. All evaluative financial metrics differ greatly especially between industries, in a company’s stage of development and size.
* Notes written in the financial reports
It is hard for financial report numbers to give the disclosure the regulatory authorities require. Most professional analysts would say that providing thorough notes in the financial reports would help substantially on the proper evaluation of a company’s financial performance and status. Auditors have noted that the accompanying notes on the financial report are an integral part to the entire process. As a potential investor, you must take the notes and comments seriously.
The financial report perspectives that has been explained in this article is compiled to give you an overview of the big picture. As an amateur investor, you need to take all the things mentioned above into consideration and have them all put to heart so you can be better prepared in coping the complex learning process that you still need to go through. Take time in learning all of the analytical details that will discern the investment qualities of a company’s financial reports and you will be well on your way to succeeding in this endeavor.