Learning how to handle finance, particularly understanding the three core financial statements, is a valuable skill for personal financial management, business operations, and investment decisions. These three statements – the Income Statement, Balance Sheet, and Cash Flow Statement – provide a comprehensive picture of a company’s financial health.

Here’s a step-by-step guide to help you teach yourself how to read and understand these financial statements.

Step 1: Understanding the Income Statement

What is an Income Statement?

The Income Statement, also known as the Profit and Loss (P&L) Statement, shows a company’s revenues and expenses over a specific period, highlighting whether the company is profitable.

Key Components:

• Revenue (Sales): Total income from goods sold or services provided.

• Cost of Goods Sold (COGS): Direct costs attributable to the production of goods sold.

• Gross Profit: Revenue minus COGS.

• Operating Expenses: Costs necessary to maintain the business, such as salaries, rent, and utilities.

• Operating Income: Gross profit minus operating expenses.

• Net Income: Total profit after all expenses, including taxes and interest, are deducted.

How to Analyse:

• Profitability: Assess whether the company is making a profit.

• Cost Management: Evaluate how well the company controls its expenses.

• Trends: Compare the current statement with previous periods to identify trends in revenue and expenses.

Step 2: Understanding the Balance Sheet

What is a Balance Sheet?

The Balance Sheet provides a snapshot of a company’s financial position at a specific point in time. It details what the company owns (assets), what it owes (liabilities), and the shareholders' equity.

Key Components:

• Assets:

  • Current Assets: Cash, accounts receivable, inventory (assets expected to be used or converted into cash within a year).

  • Non-Current Assets: Property, plant, equipment (long-term investments).

• Liabilities:

  • Current Liabilities: Accounts payable, short-term debt (obligations due within a year).

  • Non-Current Liabilities: Long-term debt, deferred tax liabilities.

• Equity:

  • Shareholders’ Equity: Retained earnings and common stock (the residual interest in the assets of the entity after deducting liabilities).

  
  

How to Analyse:

• Liquidity: Assess the company’s ability to meet short-term obligations.

• Solvency: Evaluate long-term financial stability by comparing debt levels to equity.

• Asset Management: Review how efficiently the company utilizes its assets.

Step 3: Understanding the Cash Flow Statement

What is a Cash Flow Statement?

The Cash Flow Statement tracks the flow of cash in and out of the business over a period, divided into operating, investing, and financing activities.

Key Components:

• Operating Activities: Cash flows from primary business operations (e.g., cash received from customers, cash paid to suppliers).

• Investing Activities: Cash flows from the purchase and sale of assets (e.g., equipment, investments).

• Financing Activities: Cash flows from transactions with owners and creditors (e.g., issuing stock, repaying debt).

How to Analyse:

• Cash Generation: Evaluate the company’s ability to generate cash from operations.

• Investment Strategy: Understand how the company is investing its cash.

• Financial Health: Assess how the company is financing its operations and growth.

Steps to Learn

1. Read Financial Statements:

   • Start with real company reports. You can find these on public companies’ own websites (public companies publish their financial statements quarterly and annually), or on news websites such as MorningStar or Reuters.

2. Online Courses and Tutorials:

   • Platforms like Coursera, edX, and Khan Academy offer courses on financial accounting and analysis.

3. Books and Resources:

   • “Financial Statements: A Step-by-Step Guide to Understanding and Creating Financial Reports” by Thomas Ittelson.

   • “The Intelligent Investor” by Benjamin Graham for understanding the investor's perspective.

4. Practice with Real Data:

   • Use financial data from websites like Yahoo Finance or Google Finance to practice analysing statements.

5. Join Finance Communities:

   • Participate in forums and groups on platforms like Reddit, LinkedIn, and finance-specific websites to discuss and learn from others.

   
   

Conclusion

Mastering the three financial statements is crucial for anyone interested in finance. By understanding the Income Statement, Balance Sheet, and Cash Flow Statement, you can gain valuable insights into a company’s financial health and make informed decisions. With practice and the right resources, you can teach yourself to navigate the world of finance effectively. Understanding these is also a stepping stone to learning more about financial modelling and it's advantages.

If you would like an experts assistance to guide you through your financial statements, you can book a meeting with us to see what steps we can take to help you gain confidence in interpreting your business' finances. If financial modelling is your area of interest, you can also attend a financial modelling workshop or find out more on our blog.