Running a business involves meeting obligations in different areas. Financial statements are one of these requirements, which are very important to understand and master.

What are a company’s financial statements?

The financial statements represent accounting documents making it possible to precisely inform the managers of the company but also its partners (banks, industrial partners, etc.) or even third parties (potential investor, pension funds, etc.). These financial statements of a company must make it possible to synthesize precise analyzes but also to make chronological comparisons (from one year to another) or competitive (the financial statements of companies in a sector of activity are compared between them).

In principle, all companies are required to prepare these financial statements, regardless of their activity (trade, industry, etc.) or their nature (artisanal, commercial, liberal, etc.).

The obligations are more restrictive for companies, which must generally prepare all financial statements. On the other hand, the obligations are less extensive for sole proprietorships, which are often exempted from producing the annex in particular. You have to refer to your local government authorities which required documentation you need to fill and provide.

For exemple some companies are required to file these financial statements with the registry of their commercial court, or for civil companies as for sole proprietorships, this obligation to file annual accounts may not exist. Although some companies concerned can request the confidentiality of these filings, the general rule is that the filing of these financial statements of the company is published and made public.

Company financial statements

The company’s financial statements, in the accounting and legal sense of the term, are broken down into three distinct statements:

– The profit and loss account: it is a tool for analyzing the profitability of the company making it possible in particular to define the operating result or the financial result.

– The accounting balance sheet: this is a very precise analysis at a given time (most often at the end of the calendar year and in all cases at the end of an accounting year) of all the assets of the company (assets and passive).

– The appendix: this financial statement is actually an information note allowing a better understanding of the financial statements which are the income statement and the balance sheet. Thanks to this appendix, reading the financial statements of the company should be easier and faster.

Financial Statements allow to understand many aspects of the company

Financial statements are documents that a company must present to its annual general meeting. Usually prepared by a chartered professional accountant (CPA) with the assistance of management, they show different facets of a company’s financial health and must be approved by the board of directors. They help directors and officers make good decisions.

As described earlier there are the three main financial statements.

1. P&L (Profit and Loss). It shows the income, expenses and profits over a fiscal year.
2. Balance sheet or statement of financial position. It presents the assets, debts and capital of the company at the precise date of the end of the financial year.
3. Statement of Cash Flows or “Statement of Changes in Financial Position”. It provides information on the company’s activities, its financing with various lenders and its investments. It reports on cash flow.

As investors, you can find valuable information there. Here is some data to look at carefully.

1. Earnings per share

This ratio indicates the amount of net profit relative to the number of shares of the company. In other words, this is the amount you would receive for each share if the company donated all of its profits.

Generally, this data is already calculated in the financial statements of public companies. By comparing it to that of previous years, it allows us to assess the growth rate of the company, and to know the position of it compared to its competitors.

2. Book value per share

Book value per share is an attractive ratio for a future investor. It can indicate whether the company’s stock price is undervalued or overvalued. To calculate it, subtract the value of preferred shares from shareholders’ equity (equity). Then divide the result by the number of shares in circulation.

If the stock price is below its book value, the security may be undervalued. It would then have good growth prospects, and would represent a potentially interesting purchase.

3. Collection of accounts receivable

In financial statements, revenue is expected to grow faster than accounts receivable. To assess this ratio, you need to divide accounts receivable (account receivable) by daily income.

You should be bugged by a high ratio: the company could potentially have a hard time getting paid.

4. Liquidity

The relative liquidity ratio indicates whether the company can meet its immediate obligations without selling inventory and without including its prepaid expenses. To calculate it, you must first add up cash, accounts receivable, and short-term investments. Then you have to divide the result by the current liabilities.

The result will tell you whether the company is having difficulty meeting its commitments or not.

5. Stocks

Another interesting fact about the financial statements: the company’s inventories. To calculate their ratio, you need to divide the cost of goods sold by the average inventory or that of the current period.

Are they climbing at a faster rate than sales? Bad sign! In some industries, such as perishable goods, a low inventory turnover ratio is abnormal. It can mean losses in sight. Conversely, a company that sells its products quickly will generate more money.

6. Taxation

If a business receives a tax cut, it will inflate its bottom line. However, this is probably a one-time event.

As it is very unlikely that the company will be able to reduce its taxes year after year, it is better to assess the pre-tax growth, therefore that attributable to the performance of managers. This will give you a more accurate picture of the situation.

7. Self-generated funds

Self-generated funds are net profits plus depreciation expenses (expenses without cash outflows), after investments in working capital (the amount intended to cover current expenses).

These should ideally exceed the bottom line. Otherwise, it may be a symptom of an upcoming slowdown.

8. Depreciation

Depreciation is intended to include the wear and tear of certain equipment in the accounts. A high depreciation expense can lead to lower profits and vice versa.

A company might be tempted to underestimate depreciation and this is difficult for an investor to perceive. To see it clearly, compare the company’s approach with that of other companies in the same industry. To help you, it is possible to obtain information in the notes to the financial statements of public companies in the same sector.