How to understand financial statements in 5 minutes

Many times in running a business or selecting stocks for investment, we need to look at financial statements. Occasionally, the abundance of information can be overwhelming and confusing. This happened to me when a relative sent me an Excel file containing financial statements. Faced with such a file, I didn’t even know which sheet to open first.

Today’s article will guide you on how to easily understand financial statements by recalling the basics from AC201 or financial accounting, a required course for all business administration students. In fact, this should be taught to everyone from high school.

The main financial statements include the Income Statement, Statement of Equity, Balance Sheet, and Statement of Cash Flows. Each statement provides different insights.

The Income Statement

The Income Statement is perhaps the most favored by business owners. It tells us about our revenue and expenses over a given period (e.g., the current month, past year, year-to-date, this quarter, etc.). By subtracting expenses from revenue, we get the company’s profit. Simply put, this statement helps us determine whether we are profitable or not.

In addition to profit or loss, the Income Statement provides various insights, such as:

Net Profit Margin = 3%: Calculated from profit/revenue. For every 100 baht in sales, we make a profit of 3 baht. A high ratio indicates high profitability, while a low ratio may prompt us to reduce costs or increase sales prices.
COGS (Cost of Goods Sold) = 62%: This shows what percentage of the sales price is accounted for by the cost of goods. For online sales, COGS should ideally be under 50-60% because, after deducting platform fees and other expenses, we might end up with no profit. In reality, many products have COGS as low as 10-25%.
Product Breakdown: This helps us see the revenue proportion from each product and provides insights into EBIT (Earnings Before Interest and Taxes), Gross Profit (profit from sales before other expenses), etc.

The Statement of Equity

The Statement of Equity might have seemed unnecessary during school, but for investors, it’s quite valuable. It tells us how the value of our investment has changed over time. The increase or decrease is primarily influenced by the company’s profits or losses and dividends. Other factors include capital increases. Like other statements, it is reviewed over a period, such as the year 2024.

The Balance Sheet

The Balance Sheet, or statement of financial position, has caused headaches for many accounting students. It states that Assets (A) = Liabilities (L) + Equity (E), but when manually recording entries, the totals often don’t match. Unlike other financial statements, the Balance Sheet is not reviewed over a period but at a specific point in time, such as November 5, 2024. Typically, it is reviewed at the end of the year. The left side lists Assets, such as cash, equipment (like laptops), inventory, and accounts receivable. Accounts receivable are considered assets because they will convert to cash when due. The right side includes Liabilities, such as bank loans, bonds, or even borrowed money from a friend, and accounts payable. The remaining difference is Equity, which should match the ending balance of the Statement of Equity.

The Statement of Cash Flows

The Statement of Cash Flows is another crucial financial statement for business owners. It shows the movement of cash within the business over a given period (e.g., the current month, this quarter, past year, etc.), divided into three main sections: Operating Activities, Investing Activities, and Financing Activities. Reviewing the Statement of Cash Flows helps us understand the business’s liquidity and plan cash usage more effectively. For example, if we have positive cash flow from operating activities but negative cash flow from investing and financing activities, it indicates that we have enough cash for business operations and long-term investments. Additionally, this statement helps us monitor cash usage in each activity, providing essential information for future business decisions.

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