Financial statements (FS) is an official and legal record of the financial activities of a business. This important and useful document helps managers evaluate financial performance, shareholders assess risks and return on investment, investors evaluate investment opportunities and forecasts, credit institutions determine credit limit, creditors assess the creditworthiness of a business, … to make business decisions in the most accurate and effective way.
Analysts give analysis based on data provided in the financial statements, which includes in: Balance Sheet, Cash Flow, Profit and Loss Account, and Interpretation on FS. In financial statement, figures and tables are clearly displayed and well arranged, however, it calls for vast financial and economic knowledge to understand financial statements.
With more than 20 years of experience in providing business information, VietnamCredit has generated more than 600,000 company reports which include the same number of financial statements. In addition, we have also established relations with many clients who are analysts, policymakers, investors, banks and credit institutions. VietnamCredit is eager to share with you some useful tips to read a financial statements effectively to get to the point.
Let’s get started by erasing all those financial and accounting theories out of your mind!
Suppose you are in need of more financial information than what is acquired from articles. Annual financial statements of public companies carry a lot of information including: a letter from the Managing Director, highlights, run charts, financial statements, extensive annotations for financial statements, historical overview, and are of “poser”. On the contrary, financial statements of most private enterprises are a lot shorter and simply what they are supposed to be with footnotes.
You may read the main points and go with the flow. You should also read the letter from the Managing Director sent to the shareholders. It is the summary of business developments in the letter that is worth reading. However, be cautious that such letters from the executives are often about how good they are and if the the expected results are not met, they are of course faultless. Keep reading but keep your mind sharp.
Many public companies release a shortened version of annual financial report. This version is scaled-down and simplified, which is enough for average stock investors to use. They are not for serious investors and professional investment managers. Investors and money managers need full financial statements.
The income statement, balance sheet and cash flow statement are the core of a financial report. To better understand financial statements, it requires at least a basic knowledge of finance and accounting.
You do not need to be an accountant but those who prepare the financial statements automatically assume that you are versed in accounting terms and the nature of the FS. If you know nothing about accounting, financial statements will be a Sodoku quiz. There is no way, in actuality, for those who want to read a financial statements but are accounting illiterate to understand it. After all, accounting is business language.
A business earns profits by selling goods and keeping the expense lower than the sales, therefore, the best point to get down to analyzing profit performance is not the bottom line but the first line: sales revenue.
One last thing: Put the business profit performance in the general economic situation.
As you know, public companies normally report net income in the income statements and EPS is also reported there, right below the total profit in the period. In other words, ESP is the BOTTOM LINE of the income statement of a public company.
Private businesses do not have to report EPS, however, it is quite easy to calculate EPS of a private business: Divide its net income by the number of shares held by the equity investors in the company. Market value of a public company’s share depends greatly on EPS. Obviously, individual investors pay their attention to EPS, which is the driver of what they invest. The book value per share of a private company is the closest proxy you have to the market price of its equity. The higher the EPS, the higher the market value of a public company. And the higher the EPS, the higher the book value per share of a private company.
Just simply think that if net income increases 10% compared to last years, it may lead to the increase of 10% of EPS (not so fast). EPS – the driver of market value and book value per share can change more or less than 10%.
Now compare the increasing/decreasing percent in total profit over the year with the correlative increasing/decreasing percent in EPS. Why is that? Because the change in percent in ESP and in total profit can differ. For a public company, use its diluted EPS if any; if not, use the basic EPS.
There are many things to investigate your time in rather than to read financial statements. FS is an important source of information, but investors should also stay up-to-date with the common trends and development of the economy, political events, business takeovers, executive changes, techonology changes or the like.
When you read a financial statement, bear in mind that these accounting reports are somehow temporary and conditional. Accountants make many estimates and forecasts when putting in record of sales revenue, cost and losses. In financial statements, soft numbers are mixed with hard number. In conclusion, financial statements are not certain to some extent. There is no way to avoid such limitation of accounting.
Therefore, understanding financial statements is among ways that can help investors and managers to position businesses and make decisions. To save time and to read FS effectively, readers have to identify the purpose to read the FS; understand the structure of the FS and go straight to what you want to know; equip yourselves with basic accounting knowledge; be cautious of accounting frauds and apply critical thinking. It seems simple but it calls for focused, sharp and analytical mind, and experience.
Let’s get started with reading your own company’s financial statement or financial statements furnished by VietnamCredit. Be wise in any business decisions!