“You have to understand accounting and you have to understand the
nuances of accounting. It’s the language of business and it’s an
imperfect language, but unless you are willing to put in the effort
to learn accounting─how to read and interpret financial
statements─you really shouldn’t select stocks yourself.”
─Warren Buffett
Parties interested in the organization’s financial performance:
Investors─they assess whether the company is worth putting their money into.
Creditors─they evaluate the company’s creditworthiness, ensuring they get paid.
Owners or Stockholders─they measure the company’s bottom line, ensuring growth, profitability, and sustainability.
Employees─they make sure stability and income.
Governmment agencies─like the Internal Revenue Service (IRS), the Securities and Exchange Commission (SEC), state franchise tax boards to ensure accurate financial information that meets reporting requirements.
Three most important sources of information for assessing the company’s financial performance:
Balance sheet─this financial statement details what assets the company owns and all the claims (company liabilities) against these assets. The balance sheet provides a snapshot of the company’s financial performance at a point in time. Basic equation: Assets minus liabilities equals Owner’s or Shareholder’s Equity.
Income statement or Profit and loss statement─provides information on how much revenue the company made during the accounting period. Basic equation: Sales minus Expenses equals Income (or Loss).
Cash flow statements─these financial statements provide information on the sources and uses of cash, which include (a) cash flows from operating activities [cash received from the sale of goods and services minus cash paid for operating expenses], (b) cash flows from investing activities [cash received from the sale of investments, and from the sale of property, plant, and equipment], and (c) cash flows from financing activities [cash received from the sale of capital stock or the borrowing of funds minus cash paid for dividends on repayments of debts, reacquiring or redeeming of capital stock].
