How to read financial statements

Publicly traded companies report their financial performance through three primary statements, accessible via tools like a stock screener or directly on a company's market page.

The three financial statements

Income statement: Details revenue, expenses, and profitability over a specific period (quarter or year). Key components include total revenue, cost of goods sold (COGS), operating expenses, operating income, EBIT, net income, and earnings per share (EPS).
Balance sheet: Provides a snapshot of a company's financial position at a specific point in time. It follows the formula: Assets = Total Liabilities + Shareholders' Equity.
Cash flow statement: Tracks the movement of cash in and out of the business. It operates on either accrual accounting (recording revenue and expenses when a transaction occurs) or cash accounting (recording them only when cash changes hands).

Accounting standards and principles

Financial reporting follows standardized frameworks to ensure consistency and transparency:

GAAP (Generally Accepted Accounting Principles): A strict, rules-based standard mandatory in the United States.
IFRS (International Financial Reporting Standards): A broader, principles-based framework recognized globally.

Regardless of the framework, statements adhere to core accounting principles: accrual basis, going concern, consistency, materiality, faithful representation, comparability, substance over form, historical cost, and full disclosure.

Approaches to financial analysis

Analysts evaluate financial statements using three main methods:

Vertical analysis: Calculates each line item as a percentage of a base figure (like total revenue) for a single period to evaluate internal structure.
Horizontal analysis: Compares financial data across multiple periods to identify trends, growth, or decline.
Ratio analysis: Evaluates overall business health by comparing relationships between financial metrics across categories such as profitability, liquidity, leverage, and activity.