Why do you need financial statements

KEY TAKEAWAYS

• Financial statements provide a snapshot of a corporation's financial health, giving insight into its performance, operations, and cash flow.

• Financial statements are essential since they provide information about a company's revenue, expenses, profitability, and debt.

• Financial ratio analysis involves the evaluation of line items in financial statements to compare the results to previous periods and competitors.

Financial statements are the financial records that show a company's business activity and financial performance. Companies are required to report their financial statements on a quarterly and annual basis by the U.S. Securities and Exchange Commission (SEC). The SEC monitors the markets and companies to ensure that everyone is playing by the same rules and that markets function efficiently. There are specific guidelines that are required by the SEC when issuing financial reports so that investors can analyze and compare one company with another easily.

Financial statements are important to investors because they can provide enormous information about a company's revenue, expenses, profitability, debt load, and the ability to meet its short-term and long-term financial obligations. There are three major financial statements.

Balance Sheet

The balance sheet shows a company's assets (what they own), liabilities (what they owe), and stockholders' equity (or ownership) at a given moment.

Income Statement

The income statement reports the revenue generated from sales, the operating expenses involved in creating that revenue as well as other costs, such as taxes and interest expense on any debt on the balance sheet. The net amount or the bottom line of the income statement is the net income or the profit for the period. Net income is revenue minus all of the costs of doing business.

Cash Flow Statement

The cash flow statement (CFS) measures the cash generated for a period, including all of the transactions that added to or subtracted from cash. Cash flow is important because it shows how much cash is available to meet short-term obligations, invest in the company, or to pay dividends to shareholders. Dividends are typically cash payments to shareholders as a perk for investing the company.

Financial Ratios

Financial ratios help investors break down the enormous amount of financial data that are reported by companies. A ratio is merely a metric to help analyze the data and make useful comparisons with other companies and other reporting periods.

Financial ratio analysis analyzes specific financial line-items within a company's financial statements to provide insight as to how well the company is performing. Ratios determine profitability, a company's indebtedness, the effectiveness of management, and operational efficiency.

It's important to consider that the results from financial ratios are often interpreted differently by investors. Although financial ratio analysis provides insight into a company, they should be used in tandem with other metrics and evaluated against the overall economic backdrop. Below are some of the most common financial ratios that investors use to interpret a company's financial statements.