How to Read a Financial Statement: Simplified for Beginners

December 14, 2022

How to Read a Financial Statement: Simplified for Beginners

Whether you’re a business owner, investor, entrepreneur, or business manager, it’s important to be able to assess the financial situation of any company, and one of the best ways to do that is to read and analyze a company’s financial statements.

However, unless you have a background in accounting or bookkeeping, you probably weren’t taught how to read financial reports. So, let’s take a closer look at how to read financial statements and understand the most important information.

What Is a Financial Statement? 

A financial statement is a detailed record of the financial performance and activities of a company. It can tell you how much money the company has on hand, how much it has made and lost over a particular period, and whether the business is in good financial health or not.

The good news about finding out how to read financial statements is that they all follow the same basic format, so once you’ve mastered the skill, you will be able to read any financial statement for any business.

How Do You Read Financial Statements? 

While you’re wondering how to read financial statements, it’s important to understand that financial statements are made up of various different reports and documents, including the balance sheet, income statements, cash flow statements and more. All of these reports, read together, give you the full picture of the company’s current financial situation, as well as it’s performance over time.

So, the first thing you need to do when you are learning to read financial statements – whether here or in a financial statement course, is to understand what each of the individual reports are, and what they can tell you.

Types of Financial Statements 

Before you can truly learn how to read financial statements – and use the information you get from them – you need to know what the different types and parts of financial statements are. These include:

·  The balance sheet, which lists and totals assets, including liabilities and owner equity, and, as the name suggests, this should always balance!

·   Income statements tell you how much a company has earned, but also breaks down revenue, cost of goods sold, expenses, gross profit, operating income, depreciation, EBITDA and more

·   The cash flow statement is often one of the most important parts of the financial statement, and this document tells you not only how much a business has sold, but also how much money they have collected – don’t forget that cash flow can make or break a business!

·   Annual reports are consolidated documents that include all this information and more, usually in an easy to read and understand format – also sometimes known simply as “financials”

These are the main parts of financial statements, but there might also be other reports and breakdowns included in the report you see when you ask to see financial statements. Always remember that if you don’t know how to read financial statements, your accountant can almost certainly help!

There are also different types of financial statements for different entities, so you could have corporate financial statements, personal financial statements and so on.

What Are the 5 Ways to Analyse the Financial Statements? 

There are different ways to read financial statements, depending on what you want to learn from them. So, if you’re wondering how to read financial statements for a specific reason, these tips are for you!

1. Assess the company’s debts, and its ability to repay them, by analyzing income statements

2. Review profit and loss data – a company needs to make enough profit on their products and services to not only break even but also to grow

3. Compare current financial statements with previous years’ reports, to see what the trends are in profit, loss, revenue and so on

4. If the company needs investment to grow or expand, how much investment will be needed, and what are the likely returns on that investment?

5. Analyze company expenses in relation to profit – this is often done when companies are working to restructure and cut costs

Different people will analyze financial statements differently, depending on what they want to learn. Investors, for instance, will want to ensure that companies they’re considering investing in are profitable. Operations managers and consultants might analyze expenses and costs to produce goods, so they can look for ways to be more efficient and to cut costs. Business owners and managers might use financial statements to decide if they should open another branch or expand into a new region.

1. Assess

There are many reasons why someone might need to assess the financial position of a company. Often, this is very important when you want to buy or sell a business, invest in one, or approach a bank to finance your own business. Knowing how to read financial statements makes it easy to get a quick overview of the health of the business.

2. Review Profit and Loss 

Revenue is important for any business, but profit and loss are the real make or break issue. Understanding how to read financial reports will help you to figure out how much money the company is making – or losing.

3. Compare 

The best way to know if a business is growing, stagnating, or shrinking its market share is to compare your financial reports from different years.

Ideally, when you read financial statements to assess business performance, profits and revenue will increase by a larger percentage than expenses. This would mean that company is making more money year over year, which is a great sign for growth.

4. Apply

Whenever you apply for financing for your business, or even when you approach angel investors or want to have a partner buy into your business, they will want to read financial statements before they put any money on the table.

Reading financial statements for your business allows lenders and investors to get a clear picture of where your business is, where it’s heading, and if there are any red flags.

5. Analyze

Whether you do a financial statement course or learn how to read financial statements yourself, it’s a great tool to analyze what you’re doing right (and wrong!) in your business.

Compare your expenses to previous years. Review how much profit you are making relative to expenses. Identify areas where you might be overspending, and brainstorm how you can reduce those costs.

Your company financials tell you so much about your business. Even if you’re not involved in the hands on, day to day management of a business, they’ll tell you everything you need to know.

Who Might Need to See Your Financial Statements?

Financial statements are a lot like medical records are for individuals. They tell you a lot, but they’re not something you want to share with just anyone!

However, there are some people you might want or even need to read your financial statements, including:

·  Your accountant and financial management team

·  Your sales managers and directors

·  Your bank or finance company

·  Large clients who want to be sure your company is in good health and can deliver their order or project

·  Potential investors

·  Potential buyers if you ever want to sell your company

Each of these people and organizations will look at different elements of your financial statements, but they will all use your financials to get the information they need to make the right decisions.

Long before you ever give your financials to a third party, you need to know how to read them yourself, so that you can address any problem areas first. Very often, submitting financials happens later in the process in any of these scenarios, and it really can make or break a deal.

Why Is It Important to Read and Understand Financial Statements?

When most people start a business, as non accountants, they focus more on marketing, sales, and growth. We all know that the more sales you make, and the more customers you have, the better your business is likely to do. In the early days of your business, that’s very likely exactly what happens. You’re also so busy building your business, you don’t have too much time to analyze financial statements and data.

However, as your business grows, there will be many reasons to learn how to read financial statements. You’ll want to review your business’s performance year over year, so you can plan for the next year or two. If you need to apply for financing, you’ll need to ensure that your financial statements are healthy and attractive to lenders and investors.

Reading financial statements can also help to identify problem areas in your business. If one department or branch is not performing the same, there might be something specific you need to address there.

If you aren’t sure how to read financial statements, your accountant or bookkeeper can usually help, and because financial statements usually follow the same format, once you’ve learned this skill, you will be able to review any future reports with ease. Book a demo with us for more insights on financial reporting.

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