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- by Richard Loth
What You Need To Know About Financial Statements
Knowing how to work with the numbers in a company's financial statements is an
essential skill for stock investors. The meaningful interpretation and analysis of balance sheets, income
statements and cash flow statements to discern a company's investment qualities is the basis for smart
investment choices. However, the diversity of financial reporting requires that we first become familiar with
certain general financial statement characteristics before focusing on individual corporate financials. In this
article, we'll show you what the financial statements have to offer and how to use them to your
advantage.
Financial
Statements Are
Score-cards
There are millions of individual investors worldwide, and while a
large percentage of these investors have chosen mutual funds as the vehicle of
choice for their investing activities, a very large percentage of individual investors are also investing directly
in stocks. Prudent investing practices dictate that we seek out quality companies with strong balance sheets,
solid earnings and positive cash
flows.
Whether you're a do-it-yourself or rely on guidance from an investment professional, learning certain fundamental
financial statement analysis skills can be very useful - it's certainly not just for the experts. Over
thirty years ago, businessman Robert Follet wrote a wonderful little book entitled "How To Keep Score In Business"
(1987). His principal point was that in business you keep score with dollars, and the scorecard is a financial
statement. He recognized that "a lot of people don't understand keeping score in business. They get mixed up about
profits, assets, cash flow and return on
investment."
The same thing could be said today about a large portion of the investing public, especially when it comes to
identifying investment values in financial statements. But don't let this intimidate you; it can be done. As
Michael C. Thomsett says in "Mastering Fundamental Analysis" (1998):
"That there is no secret is the biggest secret of Wall Street - and of any specialized industry. Very little
in the financial world is so complex that you cannot grasp it. The fundamentals - as their name implies -
are basic and relatively uncomplicated. The only factor complicating financial information is jargon, overly
complex statistical analysis and complex formulas that don't convey information any better than straight
talk."
What follows is a brief discussion of twelve common financial statement characteristics to keep in mind before you
start your analytical journey.
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