Important things to Know about financial statements
"1. Financial Statements Are Scorecards
There are millions of individual investors worldwide, and while a large percentage of these investors have
chosen mutual funds as the vehicle of choice for their investing activities, a very large percentage of
individual investors are also investing directly in stocks. Prudent investing practices dictate that we seek
out quality companies with strong balance sheets, solid earnings and positive cash flows.
Whether you're a do-it-yourself or rely on guidance from an investment professional, learning certain
fundamental financial statement analysis skills can be very useful - it's certainly not just for the experts.
Over 30 years ago, businessman Robert Follet wrote a book entitled ""How To Keep Score In
Business"" (1987). His principal point was that in business you keep score with dollars, and the scorecard
is a financial statement. He recognized that ""a lot of people don't understand keeping score in business.
They get mixed up about profits, assets, cash flow and return on investment.""
The same thing could be said today about a large portion of the investing public, especially when it comes
to identifying investment values in financial statements. But don't let this intimidate you; it can be done.
As Michael C. Thomsett says in ""Mastering Fundamental Analysis"" (1998):
""That there is no secret is the biggest secret of Wall Street - and of any specialized industry. Very little in
the financial world is so complex that you cannot grasp it. The fundamentals - as their name implies - are
basic and relatively uncomplicated. The only factor complicating financial information is jargon, overly
complex statistical analysis and complex formulas that don't convey information any better than straight
talk."" (For more information, see Introduction To Fundamental Analysis and What Are Fundamentals?)
What follows is a brief discussion of 12 common financial statement characteristics to keep in mind
before you start your analytical journey.
2. What Financial Statements to Use
For investment analysis purposes, the financial statements that are used are the balance sheet, the income
statement and the cash flow statement. The statements of shareholders' equity and retained earnings,
which are seldom presented, contain nice-to-know, but not critical, information, and are not used by
financial analysts. A word of caution: there are those in the general investing public who tend to focus on
just the income statement and the balance sheet, thereby relegating cash flow considerations to somewhat
of a secondary status. That's a mistake; for now, simply make a permanent mental note that the cash flow
statement contains critically important analytical data. (To learn more, check out Reading The Balance
Sheet, Understanding The Income Statement and The Essentials Of Cash Flow.)
