3 Financial Statements to Measure a Company's Strength (2024)

When the stock market boomed in the 1920s, investors essentially had to fly blind in deciding which companies were sound investments because, at the time, most businesses had no legal obligation to reveal their finances. After the 1929 market crash, the government enacted legislation to help prevent a repeat disaster. To this day these reforms require publicly traded companies to regularly disclose certain details about their operations and financial position.

The income statement, balance sheet, and statement ofcash flowsare required financial statements. These three statements are informative tools that traders can use to analyze acompany's financial strengthand provide a quick picture of a company's financial health and underlying value.

This article will provide a quick overview of the information that you can glean from these important financial statements without requiring you to be an accounting expert.

The income statement makes public the results of a company's business operations for a particular quarter or year. Through the income statement, you can witness the inflow of new assets into a business and measure the outflows incurred to produce revenue.

Profitabilityis measured by revenues (what a company is paid for the goods or services it provides) minus expenses (all the costs incurred to run the company) and taxes paid.

The income statement is read from top to bottom, starting with revenues, sometimes called the "top line." Expenses and costs are subtracted, followed by taxes. The end result is the company's net income—or profit—before paying any dividends. This is where the term "bottom line" comes from.

As you can see in this example, net income for YYZ Corp. declined from $75 million to $50 million.

The next line in the income statement, after net income, displays the average number of common shares of the company's stock that are held by investors. Next comes the firm'searningsper share, which is calculatedby dividing net income by the number of shares.

Finally, the last line shows thedividendsdeclared per common share, which is the cash payment per share (if any) the company makes to stockholders. The amount of any dividend payment is at the discretion of the company's board of directors.

While the income statement is a record of the funds flowing in and out of a company over a given time period, the consolidated balance sheet is a snapshot of a company's financial position at a given point in time. In other words, the balance sheet shows what a company owns (its assets) and owes (its liabilities) and the difference between the two (stockholders' equity). This difference represents the book value of the stockholders' stake in the company. It's called a balance sheet because both sides of the equation must balance: assets equal liabilities plus stockholders' equity.

The balance sheet displays:

• The portion of those assets financed with debt (liability)
• The portion of equity (retained earnings and stock shares)
• Assets listed in order from most liquid to least liquid (in other words, assets that can be most quickly converted to cash are listed first)
• Liabilities listed in order of immediacy (those that have the most senior claim on a firm's assets are listed first)

Income and expenses on the income statement are recorded when a company earns revenue or incurs expenses, not necessarily when cash is received or paid. Similarly, the depreciation of owned assets is added back to net income, as this expense is not a cash outflow.

Analysts often look to cash flow from operationsas the most important measure of performance, as it's the most transparent way to gauge the health of the underlying business. A decrease in cash flow due to a sharp increase in inventory or receivables can signal that a company is having trouble selling products or collecting money from customers.