Reading Financial Statements

Reading financial statements is a core skill for financial professionals. Let’s walk through where to find financial statements for a company and how to review each one.

What are Financial Statements?

Accounting’s primary goal is to accurately maintain the three core financial statements of a company.

Balance Sheet: The Balance Sheet is a snapshot of a company’s assets, liabilities, and equity at a specific point in time. Assets are the resources of a company including items such as cash, real estate, and inventory. Liabilities are amounts you owe to other parties such as loans, payroll, and vendor payments. Stockholder’s equity is the value of the company excluding liabilities. This is essentially the “book value.”

Income Statement: The Income Statement shows how profitable a company is over a certain period of time. This statement compares the revenues of an organization against the expenses to determine income. Finance often refers to this as a Profit and Loss Statement (P&L).

Statement of Cash Flows: The Statement of Cash Flows shows cash inflows and outflows during a specific period of time. The statement has three parts: operating activities, financing activities, and investing activities.

Where to Find Them?

Publicly traded companies are required to include their statements in a quarterly 10-Q filing as well as an annual 10-K filing. For a publicly traded company that you are researching, financial statements are usually available directly on investor websites. Search for “[Company Name] Investor” and you will usually find it. Indirectly, you can find financial statements on stock market websites such as Motley Fool or Seeking Alpha.

For this post, we will review Walmart which is #1 on the Fortune 500 as the largest company in the United States. Searching for “Walmart Investor” brings up the Walmart Investor Relations website. From there, you can navigate to financials and find all of the recent filings. For the examples below we will use the Q2 2021 filing which is the most recent available.

Internally, financial statements are available via the finance and accounting teams. Internal management reporting will typically have a much greater level of detail than external filings.

All of the Statements

When you first pull up a financial statement, confirm the time period covered as well as the scale.

In the example below, the statements are reviewing a 6-month period ending July 31st, 2021, and comparing it to the prior-year period. The dollars are in millions as noted in the top left.

Balance Sheet

The balance sheet shows account balances as of a point in time. At the top of each column, you will find the point in time being shown. This balance sheet (most balance sheets for that matter) is showing the current period (Q2 2021), the prior period (Q1 2021), and the prior-year period (Q2 2020).

Remember the balance sheet formula where Assets = Liabilities + Equity. The balance sheet has the same layout. Assets are listed first followed by liabilities and then equity. Within assets and liabilities, current accounts are shown first followed by long-term accounts.

As you review, look for changes in account balances period over period. This will begin to show the story of the business. Walmart has had a significant change in prepaid expenses and accrued liabilities. You might want to know more about this.

Income Statement

Unlike the balance sheet, the income statement shows income over a period of time. Remember the formula Revenue – Expenses = Income. The income statement follows that layout. Walmart’s income statement is showing both the quarter (Q2) as well as year to date (Q1 and Q2).

Publicly traded companies include shares, earnings per share, and dividends on the statement.

Statement of Cash Flows

Similar to the income statement, the statement of cash flows shows cash flow over a period of time. This statement compares the current year-to-date period versus the same period in the prior year.

The statement of cash flows is organized into three sections: operating, investing, and financing activities. A positive number is a net cash inflow while a negative number is a net cash outflow.

How To Analyze Financial Statements

One of the best methods to analyze financial statements is using variance analysis with rate and volume. The goal of variance analysis is to provide insight into actual performance versus a comparable. The comparable can be the prior year, prior month, or a budget/forecast. It’s used to identify and assess reasons for variances in goals or expectations.

In variance analysis, rate and volume are two ways of measuring performance. Rate is the ratio between two data points—for example, sales divided by customers or expenses divided by revenue. Volume refers to the number of times something occurs—like customer purchases or shipping costs.

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