The Layman’s Guide to Understanding Financial Statements

To keep with the theme of the I Power Ideas site, this will not be an in-depth review but rather selecting highlights to pique your interest in the book and its concepts to then read the book and take a deeper dive into the details of these concepts. Enjoy.

 

To provide additional context, we included definitions and other pertinent information from other sources to provide a deeper understanding.

 

Basic Terms

Asset is any and all items of value owned by the company.

Current Assets are anything that can be converted within 1 year into cash (i.e. cash, inventory, AR, etc.).

 

Fixed Assets are anything that cannot be converted within a 1 year period (i.e. machinery, real estate, etc.).

 

Balance Sheet – summarizes the company’s assets, liabilities, and owner’s equity within a given time frame.

 

Using it helps to determine the growth of a business over the years.

 

From Investopedia: The Balance Sheet refers to a financial statement that reports a company’s assets, liabilities, and shareholder equity at a specific point in time. Balance sheets provide the basis for computing rates of return for investors and evaluating a company’s capital structure.

 

Cash Flow – AR and AP, where it all goes.

 

Diversification – allocate capital to various assets, possibly to reduce risks.

 

GAAP – Generally Accepted Accounting Principles.

 

General Ledger – contains all financial transactions.

 

Current Liabilities – Debts that can be paid within 1 year, long term liabilities more than 1 year.

 

Profit and Loss Statement – profit and loss use to summarize a company’s performance by reviewing revenues, expenses, and costs overt a given period.

 

From Investopedia: The Profit and Loss (P&L) Statement is a financial statement that summarizes the revenues, costs, and expenses incurred during a specified period.

 

ROI – Return on Investment

 

Deeper Dive

3 Main Financial Statements
1. Balance Sheet
2. Income Statement
3. Cash Flow Statement

Financial Statements tell you how company is doing.

 

From Investopedia: The Financial Statements are used by investors, market analysts, and creditors to evaluate a company’s financial health and earnings potential. The three major financial statement reports are the balance sheet, income statement, and statement of cash flows. Not all financial statements are created equally.

 

5 elements of Financial Statement
1. Assets
2. Cash
3. Equities
4. Liabilities
5. Revenues

 

These two are what you most need to know:
Balance Sheet – an overview of the assets and liabilities to determine the position of the company, its financial stability.
Income Statement – focuses on the revenues and expenses.

 

From Zoho: An Income Statement is a financial statement that shows you the company’s income and expenditures. It also shows whether a company is making profit or loss for a given period. The income statement, along with balance sheet and cash flow statement, helps you understand the financial health of your business.

 

The Balance Sheet helps you gauge the net worth of a company while the Income Statement gauges the current performance in the terms of profits. The Income Statement will help determine the net income of the company after deducting expenses and taxes.

 

The Balance Sheet explanation:
Assets = Liabilities + Owner’s Equity

 

Main Assets in Balance Sheet
• Cash accounts
• Accounting receivables
• Inventory

 

Main Liabilities in Balance Sheet
• Short and long term debts
• Accounting payables

 

Cash Flow Statement will help measure how the company generates funds to pay its debts, it mainly focuses on operational costs and expenses.

 

From Investopedia: A Cash Flow Statement provides data regarding all cash inflows that a company receives from its ongoing operations and external investment sources. The cash flow statement includes cash made by the business through operations, investment, and financing—the sum of which is called net cash flow.

 

Formula for Income Statement
Net Income = Revenue – Expenses

 

Gross Profit = Gross Revenue – Direct Costs

 

Gross Margin = Gross Profit / Gross Revenue

 

Benefits of knowing this info (the “why”):
• Level of debt of company
• How quickly customers are paying
• Decline of increase in short term cash
• Number of assets and long term
• Whether products returned or purchased faster or slower over time
• Number of days or months to sell inventory
• Is money invested in infrastructure and development is paying off (ROI)
• Interest rate on loans
• Profits used to invest or spend

 

Buy the Book

 

I Power Seeds

Here are our takeaways and thoughts - pause and reflect, then nourish and grow!

A few notes about the book:

Caught numerous spelling and missing numbers which you have to catch to fully understand the concept being presented.

 

Microsoft Excel was with upper and lower case “E”, not consistent.

 

Cost of Sale (COGS) – wrong acronym – should be COS, whereas COGS is Cost of Goods Sold.

 

 

But still a good overall book on financial terms.

 

Here is a link to a financial sheet guide that is incredibly helpful.

Financial Sheet Guide

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