CHARACTERISTICS OF A FINANCIAL STATEMENT
One factors being looked upon in making wise investment choices is the financial statement. To become a skilled investor, one must be able to interpret and analyze balance sheets, income statements, and cash flow statement in order to determine the company’s investment qualities. The following are the characteristics of a financial statement.
Scorecards. Aside from mutual funds, millions of individual investors worldwide directly invest in stocks. Prudent investing practices show investors look for quality firms with sturdy balance sheets, solid earnings, and good cash flows. Interpreting a financial statement, whether doing it by yourself or with the help of an investment professional, can be very useful.
Usage. The balance sheet, the income statement, and the cash flow statement are the ones being used in investment analysis. The general investing public tend to focus only on the balance sheet and the income statement, hence making cash flow statement a secondary priority. But the cash flow statement comprises the critically significant analytical data.
Numbers. Numbers reflect true world events. Before crunching the numbers, know the company’s activities, its products and/or services, and the industry where it operates. Figures are nothing if the investor cannot visualize the underlying realities of these data.
Diversity. Financial statements are not fit into a single mold. Many articles and books about financial statement analysis discuss one-size-fits-all approach. But that is not the case. The diverse nature of business activities is equivalent to diversity in the financial statement presentation, most especially in the balance sheet.
Financial Jargon. If an investor fails to know the meaning of financial reporting terminologies, he won’t be able to grasp many financial statement account entries. Complicated jargons can confuse a budding investor, but having a handy financial dictionary can be of big help.
Accounting as an Art. Presenting a firm’s financial position is influenced by estimates and judgments of its management. The management is honest and candid while outside auditors are demanding, precise, and uncompromising. Whichever, a prudent investor takes an inquiring and skeptical technique in analyzing financial statements, especially when if the statement is not clear or exact.
Two Major Accounting Conventions. Companies use generally accepted accounting principles (GAAP) in preparing financial statements. Investors must have a basic understanding of at least two of its conventions: historical cost and accrual accounting. GAAP states assets are valued at their historical cost or purchase price, which may be higher or lower than their current market value. Firms record revenues when products and/or services are delivered, and expenses when incurred.
Information beyond Financial Statement. Insights on financial statement, although an important element, is just one piece of the bigger investment information puzzle. There are also other details beyond a financial statement including the overall economic state, industry and competitive considerations, technological change, market forces, management quality, and the workforce.
Ratios and Indicators. Again, the numbers in financial statements have little or no importance for investment analysis if the investor cannot see the rationale behind these figures. In order to reflect trends, one must view the ratios and indicators over the extended time periods. Metrics may vary by company, development state, and industry.
Footnotes to the Financial Statements. These are the additional information provided in a firm’s financial statements, which is done for clarification purposes since these notes can be quite long. Aside from the numbers, the investor must thoroughly understand the footnotes to financial statements in order to review the entity’s financial condition and performance. The accompanying notes are a vital part of these statements.
The Auditor’s Report. A financial statement is invalid if it is not audited, which is a requirement for all publicly traded firms. Before analyzing the statement, one must read the auditor’s report, which can be benign or serious. It indicates whether the investor should proceed or not.
Consolidated Financial Statements. The term consolidated appears in the financial statement, as in a consolidated balance sheet. Combining the activities of a parent firm and its majority-owned subsidiaries are expressed as one economic unit, which is preferable than making separate statements for each entity.
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