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Stocks · 07 / 13
Understanding the companyLevel 2Products10 minUpdated

What do the numbers tell you about a company?

Three reports answer three different questions. Once you know what each one answers, the financial statements stop being a wall of numbers.

What you'll learn
  • Which question each of the three reports answers
  • What the key lines of the income statement mean
  • Why earnings and cash flow can differ

Three reports, three questions

Income statement
How much did the company sell and what was left at the bottom line? Covers one period, for example a quarter.
Balance sheet
What does the company own and how much does it owe? A snapshot on a single day.
Cash flow
How much money actually moved in and out? Covers a period, like the income statement.
Chart · illustrative example
The same company from three angles
A fictional company, figures in millions of euros.
How much was sold and what was left?

Income statement

Revenue
120
Gross profit
48
Operating profit
18
Net income
13
Covers one period. Operating margin 15%.
What is owned, what is owed?

Balance sheet

Total assets
200
Equity
120
Liabilities
80
Equity ratio
60%
A snapshot on a single day. 60% equity, 40% debt.
How much money actually moved?

Cash flow

From operations
16
Investments
−9
Financing
−4
Change in cash
+3
Net income 13, operating cash flow 16: a healthy ratio.

A rule of thumb: the income statement tells you about earnings, the balance sheet about position and the cash flow statement about money. When operating cash flow is close to or above net income, the earnings are typically of high quality.

The income statement from top to bottom

  • Revenue: sales during the period. The single most important measure of growth.
  • Gross profit: revenue minus the cost of the goods sold. Tells you about the product's basic profitability.
  • Operating profit (EBIT): earnings before financing costs and taxes. Describes the profitability of the business without the effect of the financing structure.
  • Net income: what is left for the owners after everything. Earnings per share are calculated from this.

Margins are calculated by dividing these by revenue. The operating margin tells you how many cents of every euro of sales are left as operating profit. It's worth comparing it to the company's own history and to companies in the same industry, not to companies in a different industry.

The balance sheet: assets and liabilities

The balance sheet has two sides that are always equal. The assets side tells you what the company owns, and the equity and liabilities side tells you how it is financed: with equity or with debt.

Equity
The owners' share of the company.
Built up from the owners' investments and from profits that haven't been paid out. Doesn't have to be paid back.
Debt
Debt that has to be paid back.
With interest and on schedule, regardless of how the company is doing. This is what creates financial risk.

Why do earnings and cash flow differ?

The income statement records a sale when it is earned, not when the money arrives. That's why a company can show a profit and be short of cash at the same time.

Check operating cash flow in particular. If it stays clearly below reported earnings for a long time, it's worth finding out why.

This content is for information purposes only and should not be construed as investment advice or a recommendation. Investing always involves the risk of losing capital. The value of financial instruments and investments can go up or down, and past performance is no guarantee of future returns.

Check question
Test yourself: financial statements
Pick an answer to see the explanation right away.
Kysymys 1 / 2
Which question does the balance sheet answer?
Kysymys 2 / 2
How can a company show a profit and be short of cash at the same time?
Score: 0 / 2

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