Value Investors Tribe

Understanding business of any kind requires understanding its financials which requires understanding accounting basics. In this series of blogs focused on accounting basics, we will try to understand accounting principles required to decode financials of a business.

Financial statements of all the publicly listed companies can be found on the company’s website in the investor relations section. Best source to financial statements are annual reports and 10-Ks, these are available on company’s website and 10-Ks can also be found on SEC’s website. There are basically 3 financial statements required to get started in understanding business’ financial statements they are 1) Income Statement 2) Balance Sheet and 3) Cash flow Statement.

1. Income Statement

Income statement represents how much the business earned during a set period of time. This period is typically 3 months i.e. quarterly reports also known as 8-Ks and 12 months i.e. 10-Ks. This basically represents how much sales did the business do, how much did the raw material cost (also known as cost of goods) and what was the profit or loss incurred by the business during this period of time. There are several other items in income statement which will be discussed in subsequent blogs.

2. Balance Sheet

Balance sheet represents the assets and liabilities of the business. Assets are things that help business earn which includes plants, machinery, land, inventory etc. Liabilities are the things that business owes or the things for which business has to pay such as debt, lease obligations etc. If we subtract liabilities from assets we get equity which is also known as net worth of the company. Balance sheet is not for a period of time but for a particular point in time. In theory, balance sheet can be produced for each day for the business but are typically published for the day when a particular accounting period ends. Details of items listed on Balance Sheet will be discussed in subsequent blogs.

3. Cash Flow Statement

The Cash Flow statement tracks all the cash that has entered or flowed in the business and the cash that has exited or flowed out of the business. Cash flow statement is for a period of time similar to the Income Statement; they are developed quarterly i.e. for every 3 months and annually i.e. for every 12 months. Cash flow statement helps in understand how much of the cash business is generating or is requiring to maintain its operations. Detailed breakdown of Cash flow statement will be discussed in subsequent blogs.

The blogs that will follow from now on relating to accounting principles will be broken down into these three categories. We will first try to understand Income Statement, followed by Balance Sheet and then the Cash Flow Statement. We will also explain critical ratios such as return on equity, return on assets, gross margin, return on capital employed and similar others required to analyze the business.