What You Need to Know About Financial Statements
While we strive to be financially aware every day, this is a great time to learn something new or familiarize yourself with your financial portfolio. There’s no need to be intimidated by corporate financial statements. Here’s what you need to know about reading and understanding financial statements.
Updated on Dec 06 2019
In honor of National Financial Awareness Day on August 14, we are taking a closer look at what investors need to know about reading their financial statements. While we strive to be financially aware every day, this is a great time to learn something new or familiarize yourself with your financial portfolio.
7 Things You Need to Know About Reading Financial Statements
It’s all too common for investors to rely on financial advisors to read financial statements. While you need to have a financial advisor you can trust, it’s always wise to read over financial statements yourself, holding your advisor accountable, and understanding where your money is being invested.
There’s no need to be intimidated by corporate financial statements. Here’s what you need to know about reading and understanding financial statements.
1. There are four types of financial statements.
To understand a financial statement, you will need to know what type of statement you are analyzing. There are four types of financial statements. They are, a balance sheet, an income statement, a cash flow statement, and a statement of shareholders’ equity. A balance sheet will show what a company owns and what it owes at a certain time. Income statements show how much money was made and how much was spent over a certain time. Cash flow statements demonstrate the exchange of money between a company and other entities over a period of time, and a statement of shareholders’ equity will show changes in the interests of the company’s shareholders over time.
These are all important aspects of a company’s financial health and should be reviewed regularly.
2. Not all financial statements are the same.
It’s important to realize that because companies are different, their reports and financial statements will be different too. The diverse nature of business means that reporting will be diverse as well. Don’t be overwhelmed if the financial statement you receive does not look like one in a textbook. Take your time and ask questions of your financial advisor if there is something you do not understand.
3. Take a holistic approach when reading financial statements.
A successful financial statement can look different for different companies. It’s important to consider what the company does when evaluating their financial statements, as well as where they are in their growth. A financial sheet for a startup would (and should!) look very different than one for a company that is more established.
4. Know key accounting conventions
There are two main methods of preparing financial statements. They are Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS). Both are legal in the United States but GAAP is the one more often used. GAAP is more “rules-based” and IFRS is more “principles-based”. It is important to know which method was used to prepare the financial statement because they have different ways of reporting the value of assets, depreciation, inventory, and other key aspects of financial statements.
5. Do not overlook the notes.
Analysts and investors agree that the numbers on a financial statement can not provide the comprehensive photo of corporate health required by regulatory authorities. That’s why taking the time to read and understand the notes to financial statements is crucial to understanding the condition, performance, and well-being of a company. In fact, it’s so crucial that auditors will make a note on financial statements, “the accompanying notes are an integral part of these financial statements.”
6. Review Annual Reports.
Publicly-traded companies are required to provide audited financial statements. A great place to start, before even looking into a company’s financials, is the company’s annual report and 10-K. While both documents provide critical insight into a company’s financial health, an annual report is often designed professionally for shareholders while a 10-K is reported directly to the U.S. Securities and Exchange Commission (SEC) and often includes more detailed information. An annual report will also include an auditor’s report, which will give the reader insight into how accounting principles have been applied and may provide an unbiased opinion into the health of the company.
7. Hire an expert.
In addition to reading the financial statements of your investments, having a trusted financial advisor is key to financial success. To be sure you have an advisor you can trust, make sure that he or she is a fiduciary who has your best interest at heart. They are legally and ethically required to minimize conflicts of interests, put your needs ahead of their own, and even educate their clients on investments.
Having a fiduciary financial advisor and reading the financial statements analysis provided to investors can help you create a financial plan and retirement strategy that grows over time. Taking the time now to understand and read through financial statements can save you headache and heartache down the road. Consider walking through financial statements with your advisor to fully understand the purpose of financial statements, what they mean and how knowing what they are saying can affect your long-term financial strategy.
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