Investing in stocks can be exciting. You’ve probably heard stories of people who bought shares in a company and watched their money grow. But before you click “buy” on that next stock, there’s one thing every smart investor should do: check the company’s financial statements.
Now, you might be thinking, “I’m not an accountant. Why should I read those?”
The truth is, financial statements are like a health report for a business. They help you figure out whether the company is growing, struggling, or simply standing still.
Don’t worry, this isn’t about complicated formulas or spreadsheets. This guide will walk you through the basics, step-by-step, so you can feel confident about where your money is going.
The Income Statement: Is the Company Making Money?
Think of the income statement as a company’s report card. It shows how much money the company made (revenue), how much it spent, and how much it kept as profit.
Here are a few key terms you’ll want to know:
- Revenue: Also referred to as “topline”, revenue is the total money the company earned from selling its products or services. If revenue grows each year, it’s usually a good sign.
- Profit Before Tax (PBT) – This shows how much profit the company made before paying taxes. It gives you a clearer picture of how the business is performing without the impact of different tax rates.
- Profit After Tax (PAT) – Also referred to as “bottom-line”, PAT is what’s left after taxes. It tells you how much the company keeps. The higher the amount, the healthier the business.
- Earnings Per Share (EPS) – This shows how much profit is made for each share. If EPS is increasing, it usually means the company is growing and becoming more valuable to investors.
The Balance Sheet: What the Company Owns and Owes
The balance sheet tells whether a company is financially strong. It highlights three basic things: What the company owns (assets), what it owes (liabilities), and what’s left over for shareholders like you (equity). In analyzing a company’s balance sheet, you need to look out for:
- Debt-to-Equity Ratio – This shows how much debt the company has compared to its own money. Too much debt is risky, especially if sales slowdown.
- Current Ratio – This measures whether the company has enough short-term assets (like cash) to cover short-term bills. A number above 1 is usually good.
- Book Value Per Share – This tells you what each share would be worth if the company sold everything and paid off all its debts. It helps you see if the stock is over- or under-valued.
The Cash Flow Statement: Is the Business Bringing in Real Cash?
The cash flow statement shows how much actual money is coming in and going out. You look out for:
- Net Cash Flow from Operating Activities: This shows how much cash is made from the company’s day-to-day business. It should be positive and growing.
- Net Cash Flow from Investing Activities: It shows the cash used for buying or selling long-term assets, things the company needs to grow or operate, like buildings, machinery, or even other businesses.
- Net Cash Flow from Investing Financing Activities: It reveals how the company raises money (from investors or lenders) and how it pays it back.
Key Ratios to Spot Red Flags or Good Signs
- Return on Equity (ROE) – How well is the company using your money to make more money? A higher ROE usually means better performance.
- Profit Margin – This shows how much profit the company makes from every N1 in sales. Bigger margins mean better efficiency.
- Price-to-Earnings (P/E) Ratio – This tells you how much investors are willing to pay for N1 of earnings. Compare it to similar companies to see if it’s expensive or a bargain.
Final Thoughts: You Don’t Need to Be a Finance Expert
Financial statements might look intimidating at first, but they’re simply the story of how a company makes, spends, and manages its money. You don’t need to understand every line. Just focus on the key numbers and trends.
At the end of the day, investing is about owning a piece of a business. The more you understand that business, the better decisions you’ll make.
