READING FINANCIAL STATEMENTS
Plain English
Every public company files three financial statements: the Income Statement (profit/loss), the Balance Sheet (what it owns and owes), and the Cash Flow Statement (actual cash coming in and out). Together, they tell you whether a business is healthy, growing, and creating real value — or just reporting impressive-looking accounting numbers.
Going deeper
The three core financial statements: (1) Income Statement — shows revenue, cost of goods sold, gross profit, operating expenses, and net income over a period. Revenue is the top line; net income (earnings) is the bottom line. Gross margin = gross profit / revenue. Operating margin = operating income / revenue. Net margin = net income / revenue. (2) Balance Sheet — a snapshot at a point in time. Assets = Liabilities + Equity. Current assets (cash, inventory, receivables) vs. long-term assets (property, equipment, goodwill). Current liabilities vs. long-term debt. Book value = total equity. Debt-to-equity ratio = total debt / total equity. (3) Cash Flow Statement — often the most honest view of a business. Three sections: Operating cash flow (actual cash generated by the business), Investing cash flow (capex, acquisitions), Financing cash flow (debt and equity transactions). Free Cash Flow (FCF) = Operating cash flow minus Capital expenditures. Companies can show positive net income but negative cash flow — a major red flag.
Examples
Profit vs. Cash Flow Divergence
Company A reports $100M net income but generates only $20M in operating cash flow. Investigation shows $80M of income came from accounts receivable — customers owe money but haven't paid yet. If those receivables are never collected, the 'profit' evaporates. Always check whether net income is backed by actual cash.
Balance Sheet Stress
Company B has $50M cash and $200M in long-term debt. Annual interest payments are $15M. If revenue drops 20%, can it still service its debt? Quick ratio = (cash + receivables) / current liabilities. If quick ratio falls below 1.0, the company can't cover near-term obligations with liquid assets — a solvency warning sign.