Table of Content
Financial statements, simply put, are a type of scorecard for companies and other business entities, used to determine whether they are making a profit. However, it is also accurate to describe them as a language, a complex business language used to communicate with the public or the government. This description holds because they are filled with numerous terms and concepts that often make them difficult for the average person to understand.
Being able to read financial statements is crucial, especially if you have a habit of investing. A good financial statement indirectly indicates a company's long-term or recent operational status. If you want to find a company with potential to invest in, you need to thoroughly understand its financial reports.
Let's set aside the complex and intricate financial background for now. This article will approach financial statements from the perspective of personal finance and daily life, allowing readers to uncover the secrets hidden within them.
Summary of Financial Statements
Financial statements are composed of three types of reports: the income statement, the balance sheet, and the cash flow statement. These three reports must be read in conjunction with one another to reveal the true operational status of a business. Any single report can be easily manipulated or used to obscure important details.
The income statement indicates how much a company earns or loses over a specific period, essentially representing revenue minus expenses. It shows the company's profit or loss on paper. For an individual, it's similar to calculating the money you earn in a month minus all your expenses. These expenses include everything from food, clothing, housing, transportation, education, and entertainment to fixed costs such as insurance premiums, loan payments, and taxes.
The balance sheet primarily illustrates how many assets a company owns and how much debt it owes. For a company, assets equal liabilities plus shareholders' equity. For an individual, it reflects the total value of bank deposits, real estate, stocks, etc., compared to loans and borrowed money.
The cash flow statement is used to record any cash activities. Any money flowing into the company is a "+" value, and any money flowing out is a "-" value. For an individual, this can be simplified as salary income being cash inflow and purchasing stocks being cash outflow, among other examples. Remember, it only tracks pure cash activities.
| Income Statement | Balance Sheet | Cash Flow Statement |
|---|---|---|
| Operating Revenue | Total Assets | Cash Inflows from Operating Activities |
| Cost of Goods Sold | Cash and Cash Equivalents | Cash Outflows from Investing Activities |
| Gross Profit | Accounts Receivable | Cash Inflows from Financing Activities |
| Operating Expenses | Inventory | Net Cash Flow |
| Operating Income | Prepaid Expenses | |
| Other Income/Expenses | Other Current Assets | |
| Earnings Before Interest and Taxes (EBIT) | Machinery and Plant Equipment | |
| Interest Income/Expenses | Land | |
| Income Tax | Goodwill | |
| Net Income (NI) | Intangible Assets | |
| Earnings Per Share (EPS) | Total Liabilities | |
| Accounts Payable | ||
| Long-term Debt Due Within One Year | ||
| Long-term Debt | ||
| Other Long-term Liabilities | ||
| Shareholders' Equity | ||
| Common Stock | ||
| Retained Earnings | ||
| Capital Surplus |
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Income Statement
- Operating Revenue: The total income a company earns from selling its products or services.
- Cost of Goods Sold: The direct costs incurred in producing products or providing services, such as raw materials and labor expenses.
- Gross Profit: The profit a company makes after subtracting operating costs from operating revenue, representing the profit earned after covering direct costs.
- Operating Expenses: The expenses incurred during the business operations, including administrative expenses, sales expenses, and more.
- Operating Income: The profit obtained by subtracting operating expenses from gross profit, reflecting the profitability of the company's core business activities.
- Other Income/Expenses: Income or expenses that are not related to the main business operations, such as investment gains or interest income.
- Earnings Before Interest and Taxes (EBIT): Operating income plus other income minus other expenses, reflecting the company's profitability before deducting interest and taxes.
- Interest Income/Expenses: Interest paid on loans or interest earned from deposits.
- Income Tax: The taxes a company must pay.
- Net Income (NI): The final profit after deducting income tax from EBIT.
- Earnings Per Share (EPS): Net income divided by the total number of shares, reflecting the profitability of each share of stock.
Operating Revenue can be thought of as your monthly salary, the total income you earn from your job. Imagine receiving your paycheck at the beginning of the month; this amount is your operating revenue for that month.
Operating Costs are the direct expenses you incur to work, such as transportation and meals. If you spend part of your income on commuting and lunch every month, these expenses are your operating costs. Subtracting these costs from your salary leaves you with Gross Profit, the amount remaining after covering the costs of working.
However, this isn't your final disposable amount. We must also consider Operating Expenses, which include your living expenses like rent, utilities, and food. After deducting these daily expenses from your gross profit, the remaining money is Operating Income, the balance left after all "necessary expenses," which can be saved or spent on leisure activities.
Additionally, you might have some Other Income/Expenses, such as investment gains or loan interest payments. These extra items affect your total income status. Including these items gives you Earnings Before Interest and Taxes (EBIT), similar to your total income before deducting all expenses and additional outlays.
Yet, there's one unavoidable expense in life: Income Tax, akin to the taxes you must pay each month. Subtracting taxes from EBIT gives you Net Income (NI), the money you truly have at your disposal.
Lastly, an interesting item is Earnings Per Share (EPS). If you have siblings, imagine dividing the net income among all of them. The amount each person receives is similar to earnings per share, helping you understand the profitability of each company share.
Balance Sheet
- Total Assets: The total value of everything a company owns.
- Cash and Cash Equivalents: The cash a company has on hand and assets that can quickly be converted to cash.
- Accounts Receivable: The amount of money owed to the company for goods or services that have been sold but not yet paid for.
- Inventory: The value of goods or raw materials the company has available for sale.
- Prepaid Expenses: Payments made in advance for services or goods, such as insurance premiums or rent, that have not yet been used.
- Other Current Assets: Other assets that can be converted to cash within a short period.
- Machinery and Plant Equipment: The machinery and buildings a company uses to produce products or provide services.
- Land: The land assets owned by the company.
- Goodwill: The excess amount paid when acquiring another company, beyond the value of its net assets.
- Intangible Assets: Non-physical assets owned by the company, such as patents and trademarks.
- Total Liabilities: The total amount of debts a company owes.
- Accounts Payable: The money a company owes for goods or services it has received but not yet paid for.
- Long-term Debt Due Within One Year: Long-term debt that is due to be paid within the next year.
- Long-term Debt: Debt that is due to be paid more than one year in the future.
- Other Long-term Liabilities: Other liabilities that are due more than one year in the future.
- Shareholders' Equity: The net assets of the company that belong to the shareholders.
- Common Stock: The capital raised by issuing common shares.
- Retained Earnings: The accumulated profits of the company that have not been distributed to shareholders.
- Capital Surplus: The accumulated premium over the par value of shares issued and other sources of capital.
Imagine you are a well-planned and financially savvy individual. At the end of each month, you decide to take stock of your financial situation, much like a company reviews its balance sheet.First, let's look at your total assets. This represents the total value of all your wealth. Your total assets include cash on hand, bank deposits, real estate, vehicles, and even valuable collectibles.
Your cash and cash equivalents are like the cash in your wallet and the money in your bank account that you can withdraw at any time. This money is immediately accessible and highly flexible, ready to be used for shopping or emergencies.
Next is accounts receivable, which is like money you lent to friends who have promised to pay you back but haven't yet. Although this money isn't in your hands right now, you know it's coming. This part of your assets represents your future income.
Next, let's look at inventory. This is like the daily supplies and food reserves you have at home. These items are necessary for your daily life and can be sold for cash if needed. Your pantry stock, laundry detergent, and even those stockpiled toilet paper rolls are included here.
Prepaid expenses are like your gym membership fees or insurance premiums that you've already paid for but haven't fully used yet. Imagine paying for a year's gym membership but having only gone a few times. The money is spent, but the service is yet to be enjoyed.
Look at the tools you use for work. These are your machinery and plant equipment. Your laptop, phone, and even your multifunction printer are essential tools that help you earn income. These fixed assets play an important role in your financial health.
Now, imagine owning a piece of land or real estate. These are your land assets. These long-term investments don't provide immediate cash flow, but they are valuable assets that can appreciate over time.
Goodwill and intangible assets might be more abstract, but you can think of them as your personal reputation or brand value in the market. These represent the trust and relationships you've built in society. They are invisible but crucial to your life.
Next, let's look at your total liabilities. This includes all the debts you owe, such as credit card balances, mortgages, car loans, etc. These are the amounts you need to repay, representing your financial obligations.
Accounts Payable: This is like your unpaid utility bills and phone bills. These are short-term liabilities you need to settle soon, representing the small expenses you face each month.
Long-term Debt Due Within One Year: These are loans that need to be repaid within the next year. Imagine part of your mortgage or car loan is due this year; these upcoming due liabilities are ones you need to pay special attention to.
Long-term Debt: These are loans that need to be repaid over a period longer than one year. For example, a student loan you recently took out might have a repayment period of several years. These long-term debts are your future financial responsibilities.
Shareholders' Equity: This represents your net assets. It's the value of your assets minus all your liabilities, the wealth that truly belongs to you.
Common Stock: This can be seen as the capital you’ve gained from investments, such as money you’ve put into buying stocks. This part of the capital is your investment in the market, expected to bring future returns.
Retained earnings are the money left after deducting all expenses from your monthly income. This is the amount you save for emergencies or future use, and it is a key indicator of your financial health.
Capital Surplus: This might be harder to picture, but you can think of it as your additional savings or extra income accumulated over time. These are the extra wealth you’ve built up in your life.
Cash Flow Statement
- Cash Inflows from Operating Activities: This includes cash received from the company's daily operations, such as cash from sales of products or services and collections of accounts receivable. This cash inflow reflects the company's ability to generate cash from its core business activities.
- Cash Outflows from Investing Activities: This includes cash paid by the company for investment activities, such as purchasing fixed assets (e.g., machinery, equipment, land, buildings) and buying stocks or other investment instruments. This cash outflow shows the company's spending on long-term assets and investments.
- Cash Inflows from Financing Activities: This includes cash obtained by the company through financing activities, such as issuing stocks, taking out loans, or raising funds through bonds. This cash inflow indicates the company's use of external funding sources to support its operational and investment needs.
- Net Cash Flow: This is the amount of cash remaining after subtracting cash outflows from cash inflows over a period. This figure shows the net change in the company's cash position and is an important indicator of financial health. A positive net cash flow indicates that the company has surplus cash, while a negative net cash flow means that the company’s expenditures exceed its income.
Imagine you are a finance enthusiast who regularly tracks your monthly cash flow.First, let's look at your operating cash inflows. This includes your monthly salary, part-time income, and any other forms of income. Imagine at the beginning of each month, you receive your salary, earnings from part-time jobs, and even money borrowed from friends. All of these can be considered operating cash inflows.
Next is the cash outflow from investing activities. This is like your monthly investment expenses. For example, you might purchase stocks, mutual funds, or buy long-term use equipment like a new computer or phone. These expenses are not part of your daily spending but are investments made for future returns.
Cash inflows from financing activities are equivalent to money you borrow from banks or friends and family. Suppose you want to buy a house but don't have enough cash on hand, so you apply for a loan from the bank. This loan is your financing cash inflow.
Finally, let's look at net cash flow. This is the amount of cash remaining after subtracting all cash outflows from all cash inflows each month. If this number is positive, it means your cash flow for the month is healthy, and you have extra cash to save. If it's negative, it means your expenses exceed your income, and you need to be cautious about your financial situation.
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Case Analysis
When we walk into two seemingly similar stores, who would have thought that their financial situations could be worlds apart? Today, let's delve into the financial statements of Store A and Store B to see whose operational status is truly better. Ultimately, you'll understand that evaluating a business's health requires a comprehensive analysis of the three major financial statements.
A First Look at the Income Statement: Who Earns More?
When we first look at the income statement, it is a report that records a business's revenues and expenses, much like a report card for a store.
| Items | Store A (NT$) | Store B (NT$) |
|---|---|---|
| Operating Revenue | 3000000 | 2500000 |
| Cost of Goods Sold | 2000000 | 1800000 |
| Operating Profit | 1000000 | 700000 |
| Pre-tax Net Income | 800000 | 500000 |
| Post-tax Net Income | 640000 | 400000 |
Store A's revenue reaches NT$3,000,000, while Store B's is only NT$2,500,000. At first glance, it seems like Store A is earning more, right? Store A's post-tax net income is also a hefty NT$640,000, far surpassing Store B's NT$400,000. This seems to suggest that Store A's operational status is better. But wait, is that really the case?
A Deeper Look at the Balance Sheet: Who Has Better Financial Health?
Next, we turn to the balance sheet, which is like a health check report for a business, revealing its financial health status.
| Items | Store A (NT$) | Store B (NT$) |
|---|---|---|
| Total Assets | 5000000 | 4000000 |
| Total Liabilities | 1000000 | 2000000 |
| Shareholders' Equity | 4000000 | 2000000 |
Store A has NT$5,000,000 in assets with only NT$1,000,000 in liabilities, while Store B has NT$4,000,000 in assets but NT$2,000,000 in liabilities. Based on these numbers, Store A's financial situation appears more stable, and its shareholders' equity is twice that of Store B. Does this make us more confident that Store A is better? But is it really that simple?
Unveiling the cash flow statement: cash is king
Now, we come to the most revealing part, the cash flow statement. This report tells us about the company's cash flow, simply put, how much cash the company actually has on hand to use.
| Items | Store A (NT$) | Store B (NT$) |
|---|---|---|
| Cash Inflows from Operating Activities | 100000 | 400000 |
| Cash Outflows from Investing Activities | -500000 | -200000 |
| Cash Inflows from Financing Activities | 200000 | 100000 |
| Net Cash Flow | -200000 | 300000 |
Seeing this, you might be shocked. Store A's net cash flow is negative, at -NT$200,000! Meanwhile, Store B has a positive net cash flow of NT$300,000. What does this mean? It turns out that, despite Store A's seemingly high revenue and profit, it doesn't have enough cash to cover its daily operations and investment needs. On the other hand, Store B, although not as profitable as Store A, has very robust cash flow management, ensuring sufficient cash to meet future needs.
Conclusion: All three financial statements are indispensable
Relying solely on the income statement or balance sheet, we cannot fully understand a company's financial health. The cash flow statement reveals the company's cash management ability, which is a crucial indicator of its short-term survival capability.
In this case, Store A ultimately faces difficulties, possibly even bankruptcy, due to a cash flow shortage, while Store B continues operating smoothly thanks to robust cash flow management. This is why we need to consider the income statement, balance sheet, and cash flow statement together to make informed decisions.
The combination of the three financial statements not only allows us to see a company's profitability but also helps us understand its financial stability and cash flow liquidity. Only by doing this can we truly grasp a company's health and make correct judgments and decisions. I hope this case study helps everyone better understand the importance of financial statements and how to apply this knowledge flexibly in daily life and work.
