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How To Analyze Financial Statements Of A Business To Invest?

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Accounting is the language of business. You cannot order a dish from the menu if you cannot understand the language of the menu card. Similarly, you cannot understand what type of business you’re buying in the stock market if you are unaware of the underlying concept of Financial Statements. Warren Buffett says, “I don’t read Playboy; I read Financial Statements.” 

Now, you don’t need to worry. Because you don’t need a degree from the College in accounting or a math lecture from your Financial Advisor to understand what financial statements are all about. After all, we’re going to make it easy for you guys.

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Why Are Financial Statements Significant For Investing?

Now, to begin with, let’s assume that you want to invest in a new business; you’re looking to invest in a new restaurant in one of the quietest neighborhoods in the city. And that is going to be quite a challenge. Somehow, you managed to put together the requisite capital you will invest in the business. Because this business was different, you wanted to know if it was a buy or a pass. 

But! Before making any investment decision, you need to learn the difference between the three joint Financial Statements to understand your business’s money problems. And these include the Balance Sheet, Cash Flow Statement, and Income Statement. You need to understand these three statements from the get-go to sort out all those money complexities in the future and the present.

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What Are The Types Of Financial Statements?

There are three types of Financial Statements; Balance Sheet, Cash Flow Statement, and Income Statement. The Balance Sheet is a snapshot in time of the financial condition of the company. On the other hand, the Income and Cash Flow Statements explain what happened financially during a particular period, usually a quarter or a year. Investors can learn much about a business by looking at the Balance Sheet. 

The Balance Sheet is a selfie of your physique during workouts in the gymnasium. In contrast, the Cash Flow Statements and the Income Statements, other training regimes, and diets you are on during specific periods. Simply put, there are two sides to a Balance Sheet: Assets and Liabilities.

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Financial Statements: Balance Sheet

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When planning to invest in a business, you can evaluate its performance by viewing the Balance Sheet. It will tell you about the company’s financial position by showing you the assets and liabilities its business contains.

Suppose you are buying 100 shares of a company, which means you will need to analyze the company’s financial position. You will need to see all the assets and liabilities so that they can cut off a deal. 

Investors can compare current assets and liabilities to determine your business’s liquidity. The Balance Sheet will also enable them to calculate the rate at which the company generates its returns. Many investors compare two or more balance sheets from different periods to see if the business has grown over time or not. In short, the Balance Sheet has received its name because it must always be in Balance. The asset side must be equal to the liabilities and shareholders’ equities.

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Financial Statements: Cash Flow Statement

The Cash Flow Statement is the second crucial financial statement you need to wrap your head around. Cash Flow Statements are directly related to the business models. It also means that they manage finances by tracking an organization’s cash flow and helping determine the company’s performance. 

Coming back to the business you are planning to invest in, you need to look out for the number of sales they’re making and whether their company is attaining any competitive advantage in the market. The cash flow statement will denote all the investments coming into that business. This type of Financial Statement will revolve around the source of the income revolving around that business. And it will also help in enabling Businesses to set up cash forecasts for short-term planning.

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How Cash Flow Statement Works?

You might be wondering how this type of Financial Statement works. Right? So when you’re running a business, it is highly desirable to monitor the amount of money coming in and the amount of money going out. It would be best to understand that cash income comes from operating, investing, and financial activities. This statement will also inform you about the cash outflows such as salaries paid out to the staff and the Dividends given to the shareholders’ maintenance costs, taxes, and all kinds of stuff. 

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In short, the information you will obtain from the cash flow statements is beneficial for managing and regulating a successful business. Ultimately, investors can find great Businesses to invest in by analyzing the Cash Flow Statements. One of the most critical factors is the Cash Flow Statement will help you regulate the positive or the negative cash flow. Businesses usually aim to attain a positive cash flow so they don’t undergo serious debt, and borrowing additional money to keep the business growing becomes difficult.

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The most popular rule of thumb you will learn from any successful businessman or a stock market investor is that a company should always have sufficient cash. It can help pay back those hefty bank loans, grow by investing in the business, and buy commodities to enhance the quality of the underlying business model. 

Financial Statements: Income Statement

The third and final Financial Statement is the Income Statement. The name gives us an idea that Income Statements are Financial Statements that let us know about the income and expenditures of a business. An Income Statement is a record of how net income or profit in a Business was generated. You start with a company’s revenues or sales and subtract its expenses. The Income Statement is sometimes referred to as the statement of payment and costs, which might be a more telling name.

Investors can check whether the company is in an excellent position to grow and whether the company has enough cash flow to support its business or not. For example, when running a restaurant, you need to look out for things like hiring security, electricity bills, and vice versa. It is the reason that investors like analyzing Income Statements as they’re pretty precise and are published quarterly or monthly, unlike other Financial Statements, which are published annually.

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How Income Statements Help Investor To Analyze Business?

With frequent publishing, Investors can have a perfect track of the companies, which helps them make informed decisions. The Income Statement gives investors an overview of the business they will invest in. When we look at the Income Statement closely, it includes a section on revenues and sales, providing investors with a detailed account of the gross sales made by the company.

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The second edition includes the “COGS” (Cost Of Good Sold), revolving around the costs of goods sold. The following section consists of the gross profit, which is the net profit minus the amount expended on producing goods.

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Conclusion

Financial Statements form a core part of any investor’s journey to financial freedom through stock market investing. You’re already halfway there if you can look for those undervalued stocks by having a glimpse of one of these financial statements. Making big profits depends on your ability to analyze business successfully. And that highlights the importance of understanding stocks.

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