Why should you know how to read a financial statement?

If you downloaded s-peek, you'd probably guess the answer: financial statements are the primary source of information for understanding a company's health. And they are also the key documents upon which banks and investors choose whether to finance a business or withdraw an investment.

But what exactly should you look at? How can you tell if the data are good or worrying? 

Balance sheet and income statement

A financial statement depicts the economic and financial position of a company at the end of the financial year. The report is split into two sections: the balance sheet and the income statement.

What a company owns: the balance sheet

The balance sheet portrays what a company owns and owes at the end of the financial year, highlighting the resources available to tackle the next financial year.

The items are divided between assets and liabilities. The first includes the tangible and intangible assets the company' owns, like estates and plants, machinery and tools, but also cash resources, stocks, and even credits toward customers.

Liabilities reveal the company's financing sources, which, on the other hand, are the main source of debt. Here we find short and long terms financial debts but also trade payables to suppliers.

The difference between assets and liabilities gives the company's equity. This provides the first information on the company's condition. If the shareholders' equity is negative, the company does not have enough assets to repay its debts.

How the company used its resources: the income statement

The balance sheet is followed by the income statement. Here we find information on how the company employed the resources available at the beginning of the financial year during the following twelve months.

The income statement divides items into two categories: revenues and costs. Along with costs and revenues from production and sales activities, the income statement also lists revenues and costs from financial operations and expenses or income not related to the company's core business.

The difference between revenues and costs gives the company's profit/loss, which flows into the balance sheet affecting the resources the company will have at its disposal for the following year.

Profits and shareholders' equity alone do not determine whether a company is healthy. Do production costs outweigh earnings? Is it worth investing in the company? Is the company able to pay its suppliers? The balance sheet can answer these and other questions, as we will see in the second part of this article.