Using Financial Statements to Evaluate Investment Opportunities

While some investors have a background in finance or accounting, you don’t need a specialized degree to read a company’s financial statements and glean valuable information that can help you make your investment decisions.

There’s a wealth of financial data about a company’s operations, investments, indebtedness and much more easily accessible to investors who know where to look. This data is reported on standard financial statements, including the following:

• Balance Sheet – The balance sheet provides information about a company’s financial health. You can compare what a company owns (assets) vs. what it owes (liabilities). Assets include property, cash, investments, trademarks and patents, among other things. Liabilities include borrowed money, rent, taxes, payroll, money owed to suppliers and more. Subtracting liabilities from assets yields shareholders’ equity, which is a rough estimate of the company’s net value if all the company’s assets were sold and liabilities were paid off, with the remaining amount of money going to shareholders. Studying a company’s balance sheet and comparing it to industry peers can help you assess its financial health. Learn more about some of the important ratios to monitor.
• Income Statement – The income statement details a company’s revenue, expenses, gains and losses, which collectively help reveal its growth and profitability. You can calculate various sales and profit margins that quantify a company’s performance and how it compares to its peers. Learn more about important financial metrics available from income statement data. 
• Cash Flow Statement – The cash flow statement lists a company’s inflows and outflows of cash. Inflows include cash generated by operations or investments, while outflows pay for business activities and investments. The bottom line of the cash flow statement shows the net increase or decrease in cash for the period. Cash flows from operating activities, investing activities and financing activities are generally listed separately. The cash flow statement shows how much actual money a company gained or lost by taking reported profits and adding back expenses that didn’t require cash payments, such as wear-and-tear on equipment. Cash flow is an important metric since even a profitable company can run into liquidity problems if it doesn’t generate enough cash to pay its bills.

Don’t ignore the footnotes in financial statements; they sometimes contain important information on topics including accounting practices, income taxes, pension plans and stock options.

Required Filings

The Securities and Exchange Commission (SEC) requires public companies to file several reports on a timely basis, some of which contain the financial statements above. These materials are available to the public through the SEC’s EDGAR database:

• 10-Q – This is a quarterly snapshot of a company’s financial performance. It includes unaudited financial statements and provides a continuing view of the company’s financial position during the year. The 10-Q is due after each of the company’s first three fiscal quarters.
• 10-K – This annual report, due after the end of the company’s fiscal year, is similar to the 10-Q except that it reports figures for an entire year and the financial statements are audited. Although similarly named, the annual report on Form 10-K is distinct from the annual report to shareholders, which a company must send to its shareholders when it holds an annual meeting to elect directors.
• 8-K – Form 8-K requires public companies to make prompt disclosures upon certain material corporate events. For example, events that trigger an 8-K filing include entering bankruptcy, releasing quarterly or annual financial statements and submissions of matters to a vote of security holders.

See the SEC’s How to Read a 10-K/10-Q and FINRA’s Market Data Center for more information about using freely available financial data to evaluate investment opportunities.

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