Are Financial Statements Helpful for Investing?
If you want to know about the financial health of a company you want to invest in, check its financial statements. Reviewing a company's financials allows you to do your own analysis of the business. The three main reports -- the balance sheet, income statement and cash flow statements -- tell you a lot of what you need to know about a stock.
Required Financial Filings
Securities and Exchange Commission rules require that publicly traded companies submit quarterly financial results three times a year and annual results once a year. The quarterly (10-Q) and annual (10-K) earnings reports let you access financial information directly from the company. The 10-Q and 10-K reports provide a snapshot of a company's financial heath and the risk factors which can affect the business. The financial statements in the reports must meet generally accepted accounting principals, or GAAP. In addition, the annual report contains audited financial statements.
The income statement provides detailed information on a company's sales, cost of goods sold, expenses, operating margins and profits. Quarterly and annual income statements provide data from the current operating period as well as comparisons with results from previous years. This is information is especially important to investors because it lets you know how the company's performance has improved or declined. In most cases, companies that show strong sales and earnings growth are likely to see their stock prices rise, while those with flat or declining sales and earnings are likely to see a decrease in stock value.
Cash Flow Statement
The cash flow statement shows what a company did with its inflows and outflows of cash. Some of this information will be the same as revenue and expenses on the income statement. The cash flow statement also shows other items, such as investments made by the company and whether the reported revenue was in the form of cash or accounts receivable. The cash flow statement can be used to verify that the profits shown on the income statement are backed by cash in the bank or dividends paid to investors. Cash flow statements are helpful for investors because they show the amount of money the company brings in from its actual business -- called operating activities -- and how much money is available to cover expenses.
The balance sheet lists a company's assets, liabilities and shareholder equity at the end of the reporting period. Assets include tangible items such as cash, accounts receivable, property and equipment as well as intangible items such as the value of patents and copyright information. Liabilities are what the company owes, such as short and long-term debts and accounts payable. Shareholder equity -- the value of the business owned by the investors -- is what is left when you subtract liabilities from assets. The amount of debt a company carries is one of the most important items to be found on the balance sheet. Interest on a large amount of debt can become a major expense, which can hurt a company's bottom line. As a general rule, companies with large amounts of debt and little or no growth make riskier investments.
Tim Plaehn has been writing financial, investment and trading articles and blogs since 2007. His work has appeared online at Seeking Alpha, Marketwatch.com and various other websites. Plaehn has a bachelor's degree in mathematics from the U.S. Air Force Academy.