Companies produce three major financial statements that reflect their business activities and profitability for each accounting period. These statements are the balance sheet, income statement, and statement of cash flows. The cash flow statement shows how well a company manages cash to fund operations and any expansion efforts. In this article, we’ll examine the balance sheet and income statement and their differences.
Investors and creditors analyze the balance sheet to determine how well management is putting a company’s resources to work. The balance sheet shows assets, liabilities, and shareholders’ equity. Total assets should equal the sum of total liabilities and shareholders’ equity. The liabilities section reflects how those assets are financed. Shareholders’ equity is the difference between assets and liabilities, or the money left over for shareholders for the company to repay all its debts.
To best analyze the key areas of the balance sheet and what they tell us as investors, we'll look at an example.
Below is the balance sheet for Apple (AAPL) at the end of its 2017 fiscal year.
The top section contains current assets, which are short-term assets typically used up in one year or less.
Next on the balance sheet are long-term assets.
Current liabilities are short-term liabilities due within one year.
Not all of Apple's long-term liabilities are broken out, but they typically include:
The income statement, often called the profit and loss statement, shows the revenues, costs, and expenses over a period which is typically a fiscal quarter or a fiscal year. The income statement tells investors whether a company is generating a profit or loss. Also, the income statement provides valuable information about revenue, sales, and expenses.
Below is the income statement for J.C. Penny (JCP) for its fiscal year ending Feb. 3, 2018. The top section includes total revenue or sales for the period.
J.C. Penney is a great example of the importance of looking at the complete financial picture. Although $12.5 billion in revenue appears impressive, debt servicing costs meant the company took a loss for the year. It's worth noting that examining the financials of any company works best when comparing over multiple periods and against other companies within the same industry.
The balance sheet displays what a company owns (assets) and owes (liabilities), as well as long-term investments. Investors scrutinize the balance sheet for indications of the effectiveness of management in utilizing debt and assets to generate revenue that gets carried over to the income statement.
The income statement shows the financial health of a company and whether or not a company is profitable. Both revenue and expenses are monitored closely. It's crucial for management to grow revenue while keeping costs under control. For example, revenue might be growing, but if expenses rise faster than revenue, the company may eventually incur a loss. Investors and analysts keep a close eye on the operating section of the income statement to gauge management's performance.
However, investors and analysts scrutinize the balance sheet just as closely, as both the balance sheet and income statement together provide a fuller picture of a company's current health and future prospects.
Apple. "2017 Fiscal Year 10-K," Page 41.
J.C. Penny. "2017 Fiscal Year Annual Report," Page 26.
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Fundamental Analysis
Financial Statements
Accounting
Financial Statements
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