How to analyse key financial statements of a company

As discussed in the previous article of this series on investing basics, financial statements are among the most important sections of an annual report. For a novice investor, reading and understanding a company's financial statement is quite intimidating at first sight. However, to study and make good investing decisions, especially for long term investment, it is necessary for one to understand the same.

In this article, we shall go through the key constituents of the financial statements - profit and loss account, balance sheet and cash flow statement.

Key financial statements

Profit & Loss account: The profit and loss account (P&L) shows a company's performance over a specific time frame, usually a financial year or a period of 12 months. In India, most companies follow an April to March financial year (for example - 1st April 2011 to 31st March 2012 will be one financial year). The P&L account is also known as the income statement. It presents information relating to a company's revenues, manufacturing costs, sales and general expenses, interest and depreciation charges, tax costs, other income, net profits, and dividends, amongst others.

A typical P&L statement is as hereunder:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Sourced from Britannia Industries' FY11 annual report

The balance sheet: The balance sheet gives a snapshot of a company's financial strength. The statement shows what a company owns or controls (assets) and what it owes (liabilities plus equity). In accounting terminology, the balance sheet is broken into two parts - 'Sources of funds' and 'Application of funds'. 'Sources of funds' indicate the total value of financing that a company has done, while 'Application of funds' indicates the areas the company has utilised these funds.

As such, sources of funds = application of funds.

Put in other words, assets = liabilities + equity.

As you would be aware, every company has limited resources. What differentiates a good company from an average one is the way in which it utilises such resources.

A typical balance sheet statement is displayed below.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Sourced from Britannia Industries' FY11 annual report

Total Assets	Rs m	Total Liabilities	Rs m
Net fixed assets	3,154	Current liabilities	5,969
Investments	5,450	Shareholders' funds	4,513
Current assets	6,254	Loan funds	4,314
		Deferred tax liability (net)	62
Total	14,858	Total	14,858

 

 

 

 

 

 

 

 

Cash flow statement:

Put in simple terms, a cash flow statement shows the amount of cash and cash equivalents that enter and leave a company. Just as the P&L statement, the cash flow statement shows cash transactions during a particular time frame.

A company can generate or lose cash through its core operations. Further, it can raise or payback cash through financing activities. In addition, it can use cash for investing in assets or receive cash through sales of assets or through dividends. Being the various aspects of any business, these above-mentioned activities cover most of the integral cash transactions of a company. As such, the cash flow statement allows investors to understand how a particular company's business is running, how it has raised capital and how the same is being utilised.

A cash flow statement is typically broken into three broader parts:

• Cash (used in)/ generated from operations
• Net cash used in investing activities
• Net cash from financing activities

An example of a cash flow statement is displayed below.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Sourced from Britannia Industries' FY11 annual report

In the next article of this series, we shall start our detailed discussion on the P&L statement and its key constituents.

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