Fundamental Analysis Tutorial – Components of a shares financial report

In our last installment we introduced shares financial statements and the annual report and gave a brief overview of the information they contain. We are now going to dive deeper so that we can see each individual component (financial statements) of a shares financial report and what they are used for.

What are the main components of a financial report?

Balance sheet – The balance sheet shows assets and liabilities. Assets are what the company owns and liabilities are what the company owes. The balance sheet is a summary of the financial balances of a sole proprietorship, a business partnership or a company. Assets, liabilities and ownership equity are listed as of a specific date, such as the end of its financial year. A balance sheet is often described as a snapshot of a company’s financial condition. Of the four basic financial statements, the balance sheet is the only statement which applies to a single point in time.

Income statement – The purpose of the income statement is to show managers and investors whether the company made or lost money during the period being reported. It indicates how the revenue (money received from the sale of products and services before expenses are taken out, also known as the “top line”) is transformed into the net income (the result after all revenues and expenses have been accounted for, also known as the “bottom line”). It displays the revenues recognized for a specific period, and the cost and expenses charged against these revenues, including write-offs (e.g., depreciation and amortization of various assets) and taxes.

Changes in equity – Explains the changes in a company’s retained earnings over the reporting period. It breaks down changes affecting the account, such as profits or losses from operations, dividends paid, and any other items charged or credited to retained earnings. This statement can show either all changes in equity, or changes in equity other than those arising from transactions with equity holders acting in their capacity as equity holders.

Cash flow statement – This is a financial statement that shows how changes in balance sheet accounts and income affect cash and cash equivalents, and breaks the analysis down to operating, investing, and financing activities. Essentially, the cash flow statement is concerned with the flow of cash in and cash out of the business. The statement captures both the current operating results and the accompanying changes in the balance sheet. As an analytical tool, the statement of cash flows is useful in determining the short-term viability of a company, particularly its ability to pay bills.

What now?

So you might be asking yourself at this point, “How do I use these various financial statements within a company’s annual report to my advantage in order to find hot shares to buy”? All this information can appear a little confusing to the beginner at first, but as you spend more time reading annual reports and studying the basic accounting principles that are used to construct shares financial reports it will become easier to make sense of them.

Some simple tings you can do to quickly utilize the information in a company’s financial report is to check the headline figures such as net profit, also check cash flow, and level of debt. If you are the type of person who likes to read the fine print, the notes to the financial numbers in a report can provide some very interesting reading due to key information getting “strategically” placed there. You can also find the salaries of the most senior management employees as well as a list of the biggest shareholders in the company.

If you are not one to analyze numbers and charts than you can try reading the director’s report. This report is usually located at the beginning of the annual report and is a good review of the key achievements over the last year, and will generally give an indication what lies ahead for the company.

Check out the next installment of this shares fundamental analysis tutorial which introduces the shares financial ratio.