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Financial Statements

Terminology

Balance Sheet Statement

A financial statement contained in the annual or quarterly report that is issued by companies and it shows the company's assets, liabilities and stockholders' equity at the end of that period. The total assets less the total liabilities are equal to the stockholders' equity.

Cash Flow Statement

A financial statement contained in the annual or quarterly report that is issued by companies and it shows the cash a company received and paid during that period (even though the income or expense may have been booked in a prior period on the income statement).

Income Statement

A financial statement contained in the annual or quarterly report that is issued by companies and it shows the revenue a company received and expenses incurred during that period. The income statement (which used to be referred to as the profit and loss statement) shows when the revenue and expenses occurred, whereas the cash flow statement shows when the actual payment was received form the revenue and the payments where made for the expenses (which may be in the next period).

Reporting of the Financial Statements

Understanding the Financial Statements - Reporting; picture of an investor analyzing the financial statements on a computer screen for earnings and revenue growth trends

Companies report their financial activities by lodging a financial report to the U.S. Securities and Exchange Commission (SEC). These reports are typically lodged every quarter for the first three quarters and then for the fourth quarter they lodge a final report that covers the entire fiscal year's financial activities. The quarterly reports are known as '10-Q filings' and the annual report is known as a '10-K filing'.

The financial reports are quite comprehensive and lengthily documents that can be well over a hundred pages long. The report outlines management's goals and direction for the company and details how they propose to be achieve these. Pretty much any thing pertaining to the operation of the company is detailed in these reports.

The most important information contained in the financial report for the stock investor is the financial statements and managements future direction for the company.

All financial reports contain three main financial statements which are the Income statement, Balance sheet statement and the Cash Flow statement. Typically, a fourth statement called the Stockholders' Equity statement is also include which is actually a detailed section of the balance sheet statement.

While the financial report may at first seen extremely lengthy, a large portion of the report deals with information that is not really of interest to the stock investor. For example, the stock investor is not normally concerned with the details of the company's pension plan or other employee benefit plans.

The main benefits to the stock investor in reading these financial reports is that, firstly it provides a through outline of how the company makes its money and how management plans on increasing its profits into the future. Secondly it provides the stock investor with the important financial information that is required to perform a through fundamental analysis of the company, which is extracted from the financial statements contained within the report.

The financial statements contained in the report universally conform to a standardized layout, thus making it easier for the stock investor to become familiar with reading these financial statements as all companies essentially use the same basic layout.

The series on reading the financial statements gives investors practical experience with reading actual income and balance sheet statements with instructional guidance.

Accounting conventions are generally conservative so that the opportunities for companies to distort the financial statements are limited, thus increasing the reliability of the information presented in these financial statements.

Understanding the Financial Statements - Reporting; picture of the financial statements printed out on paper with a calculator on top of paper sheets with a pen

As an example of this conservative approach, assets are always reported at their original cost, thus even if the asset has increased in value this is not reflected in the statement. Further more, any depreciation of the asset is included as an item in the financial statement, which means that the true market value of the asset may well be higher than that indicated within the financial statement.

If the discrepancies between the assets market value and that reported are significant, this is included in the notes of the financial statement. These notes contain valuable and important information about the various items in the financial statements.

The financial report also contains supplemental schedules which provide greater detail of specific items where needed. Additional information is also available in the notes to the financial statements.

The stock investor does not need to take a course in accounting in order to understand what is contained within these financial statements, as the standardized format and rules of reporting are fairly simple and straight forward. It merely takes a bit of time to read and understand the basic layout of these financial statements. Once understood, they are all basically the same.

Some stock investors may have heard of accounting scandals with companies cooking the books or key employees embezzling funds from the company. To a large extend this is minimized by the independent auditing of each company's financial statements. The auditing firms thoroughly examine the company's income and expenditures and strive to ensure that the information presented is accurate.

While cooking the books or embezzling may not be immediately detected through creative accounting, it is only a matter of time until these auditing firms detect these abnormalities, which is usually sooner than later. In all fairness, most companies do the right thing and report their financial position as it is rather than run the risk of criminal prosecution.

The information that is contained in these financial statements is readily available in a summarized format through various websites which can be found in the resources page. While the stock investor does not necessarily need to go through these statements, it is extremely beneficial to at least understand the key components that are contained within these financial statements. Investors without any accounting experience will find the article understanding basic accounting useful for understanding the basic accounting principles.

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