How To Analyse Financial Statements

The very basic of investing and understanding a business is to understand the finances of the company. The finances and monetary positions of the company are the backbones of any decision when it comes to investing or understanding the company. 

Though there is no set pattern when it comes to filtering the information from the financials of the company and the type of filtering depends upon the style, need and size of the information. required.

In this article, we will be sharing the basic you should always look for while picking up a company for investing. 

 1. Net Income

In terms of overall profitability, the net income is the obvious starting point when analyzing a financial statement. This bottom-line amount on a company's income statement is an excellent indicator of profitability because it puts a value on the amount a company takes in, once all costs of production, depreciation, tax, interest and other expenses have been deducted.

2. Operating Profit Margin

Operating Profit Margin is a profitability or performance ratio used to calculate the percentage of profit a company produces from its operations, prior to subtracting taxes and interest charges. It is calculated by dividing the operating profit by total revenue and expressing as a percentage. The margin is also known as EBIT (Earnings Before Interest and Tax) Margin.

It often differs across companies and industries and is often used as a metric for benchmarking one company against similar companies within the same industry. It can reveal the top performers within an industry and indicate the need for further research regarding why a particular company is outperforming or falling behind their peers.

3. Earning Per Share ( EPS) 

Earning per share (EPS), also called net income per share, is a market prospect ratio that measures the amount of net income earned per share of stock outstanding. In other words, this is the amount of money each share of stock would receive if all of the profits were distributed to the outstanding shares at the end of the year.

Earnings per share is also a calculation that shows how profitable a company is on a shareholder basis. So a larger company’s profits per share can be compared to a smaller company’s profits per share. Obviously, this calculation is heavily influenced by how many shares are outstanding. Thus, a larger company will have to split its earning amongst many more shares of stock compared to a smaller company.

4. Price Earning ratio (P/E ratio)

The Price Earnings Ratio (P/E Ratio) is the relationship between a company’s stock price and earnings per share (EPS). It is a popular ratio that gives investors a better sense of the value of the company. The P/E ratio shows the expectations of the market and is the price you must pay per unit of current earnings (or future earnings, as the case may be).

Earnings are important when valuing a company’s stock because investors want to know how profitable a company is and how profitable it will be in the future. Furthermore, if the company doesn’t grow and the current level of earnings remains constant, the P/E can be interpreted as the number of years it will take for the company to pay back the amount paid for each share.

Looking at the P/E alone will not be of much of the help unless it is compared with the historical P/S of the company or P/E of the industry or its peers. 

5. Dividend Payout Ratio

The dividend payout ratio is another useful metric that measures a company's growth, financial stability, and returns paid to stockholders. The dividend payout ratio calculates the percentage of company earnings paid out to equity investors, in the form of dividends. The higher the ratio value, the more reliable a company’s earnings can sustain dividend payouts, and the more stable a company is considered to be. Retained earnings, the number of profits not paid out to shareholders as dividends, shows what portion of profits a company is reinvesting in expanding its business.

6. Working Capital 

Working Capital is basically an indicator of the short-term financial position of an organization and is also a measure of its overall efficiency. Working Capital is obtained by subtracting the current liabilities from the current assets. This ratio indicates whether the company possesses sufficient assets to cover its short-term debt.

Working Capital indicates the liquidity levels of companies for managing day-to-day expenses and covers inventory, cash, accounts payable, accounts receivable and short-term debt that is due. Working capital is derived from several company operations such as debt and inventory management, supplier payments and collection of revenues.

7. Assets and Liability 

The breakdown of assets and liabilities contained on a company's balance sheet provides investors with a reliable snapshot of the company's overall financial health, as well as its debt situation. Debt ratios, such as the current ratio, which can be calculated from the information provided in financial statements, let analysts assess a company's ability to handle outstanding debt. Major capital expenditures can be used in evaluating a company's current financial condition and can telegraph the potential for growth

Note: The list is limited and not exhaustive.