How to Read a Financial Statement#

Understanding a company's accounts is a fundamental skill for any investor. Whether you are analyzing Apple, LVMH, or a small business, the financial statements tell the story of its economic health. This guide gives you the keys to reading them.

The Balance Sheet: Assets, Liabilities and Equity#

The balance sheet is a snapshot of the financial position at a single point in time. It breaks down into three parts: assets (what the company owns), liabilities (what it owes), and shareholders' equity (the difference, meaning the net value belonging to shareholders). The fundamental equation is: Assets = Liabilities + Equity.

• Current assets: cash, inventory, trade receivables (recoverable within 12 months)
• Non-current assets: property and equipment, patents, goodwill (long term)
• Current liabilities: trade payables, short-term borrowings
• Non-current liabilities: bond debt, pension provisions
• Shareholders' equity: share capital + reserves + net income

The Income Statement#

The income statement shows performance over a period (a quarter or a year). It starts from revenue and progressively deducts costs to arrive at net income. The intermediate margins (gross, operating, net) are essential for comparing companies against one another.

The Cash Flow Statement#

Often neglected by beginners, the cash flow statement is nevertheless the most reliable document. It shows real cash coming in and going out, split into three categories: operating, investing, and financing. Positive net income alongside negative operating cash flow is a warning sign.

The Five Key Ratios to Know#

1. P/E (Price-to-Earnings): share price / earnings per share. A P/E of 15 means you are paying 15 years of earnings.
2. P/B (Price-to-Book): price / book value. A P/B below 1 can signal an undervalued stock.
3. ROE (Return on Equity): net income / shareholders' equity. Measures profitability for shareholders (above 15% is excellent).
4. Debt-to-equity ratio: measures leverage. Above 2, the company is heavily indebted.
5. Current ratio: current assets / current liabilities. Above 1.5, the company can meet its short-term obligations.