An Introduction To Financial Statements

Financial statements are among the most important sections of a company’s annual report. For a novice investor, reading and understanding a company’s financial statements is quite intimidating at first sight. However, to study and make good investing decisions, it is necessary to understand them.

Profit & Loss account: The profit and loss account (P&L) shows a company’s performance over a specific time frame, usually a financial year or a period of 12 months. In India, most companies follow a April to March financial year . The P&L account is also known as the income statement. It presents information relating to a company’s revenues, manufacturing costs, sales and general expenses, interest and depreciation charges, tax costs, other income, net profits, and dividends.

For a typical P&L statement refer to the  image below:

The balance sheet: The balance sheet gives a snapshot of a company’s financial strength. The statement shows what a company owns or controls (assets) and what it owes (liabilities plus equity). In accounting terminology, the balance sheet is broken into two parts – ‘Sources of funds’ and ‘Application of funds’. ‘Sources of funds’ indicate the total value of financing that a company has done, while ‘Application of funds’ indicates the areas the company has utilised these funds.

As such, sources of funds = application of funds.

Put in other words, assets = liabilities + equity.

Every company has limited resources. What differentiates a good company from an average one is the way in which it utilises such resources.

Reworked balance sheet to simplify understanding

Cash flow statement

Put in simple terms, a cash flow statement shows the amount of cash and cash equivalents that enter and leave a company. Just as the P&L statement, the cash flow statement shows cash transactions during a particular time frame.

A company can generate or lose cash through its normal operations. Further, it can raise or payback cash through financing activities. In addition, it can use cash for investing in assets or receive cash through sales of assets or through dividends. Being the various aspects of any business, these above-mentioned activities cover most of the integral cash transactions of a company. As such, the cash flow statement allows investors to understand how a particular company’s business is running, how it has raised capital and how it is being spent.

A cash flow statement is typically broken into three broader parts:

Cash (used in)/ generated from operations

Net cash used in investing activities

Net cash from financing activities