Financial Statements
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Lesson Objectives
By the end of this module, you will be able to:
Read and Interpret the Income Statement, Balance Sheet, and Cash Flow Statement.
Understand the Story each statement tells about a company's profitability, financial position, and liquidity.
Master the Linkages that connect the three statements into a single, dynamic financial picture.
Perform Two Key Valuation Methods: Discounted Cash Flow (DCF) for intrinsic value and Comparable Company Analysis (Comps) for relative value.
Understand Financial Modelling as a whole.
Part I: Deconstructing the Financial Statements
Section 1.1: The Income Statement: A Story of Profitability Over Time
Analogy: Think of the income statement as a video recording of a company's financial performance over a period (like one year). It shows the flow of money from sales all the way down to final profit.
Core Question: Did the company make or lose money this year?
The terminology you need to understand:
Revenue (Top Line): Total sales.
Cost of Goods Sold (COGS): Direct costs of the product.
Gross Profit: Profit from the product itself (Revenue - COGS).
Operating Expenses: Costs to run the business (salaries, marketing).
SG&A: Selling, General & Administrative.
R&D: Research & Development, crucial for tech companies.
EBIT (Operating Income): Profit from core business operations. This is a key metric for comparing operational efficiency.
Net Income (Bottom Line): The final profit for shareholders.
For example: Apple Inc.
Source: Apple Inc., Form 10-K for the fiscal year ended September 30, 2024.
The story is in the margins. A company with a high Gross Margin but low Operating Margin has a profitable product but is spending too much on overhead. Using Apple's annual report in the "Consolidated Statements of Operations" section, Notice their massive revenue and high gross margin.
Section 1.2: The Balance Sheet: A Snapshot of Financial Position
Analogy: If the income statement is a video, the Balance Sheet is a photograph. It captures what a company owns and what it owes at a single moment in time.
Core Questions: "What are the company's resources?" and "Who has a claim on those resources?"
It is governed by the single most important equation in accounting:
Source: Apple Inc., Form 10-K for the fiscal year ended September 30, 2024.
Terminology
Current Assets: Resources expected to be used or converted to cash within a year. For example, look at Apple's huge Cash and cash equivalents balance. You'll also see Accounts receivable (money owed by customers) and Inventory.
Non-Current Assets: Long-term assets. See the value of Apple's Property, Plant and Equipment, net.
Current Liabilities: Debts due within one year. This includes Accounts payable (money owed to suppliers) and the Current portion of term debt.
Non-Current Liabilities: Long-term debts, like Term debt.
Shareholders' Equity (The Owner's Stake): The residual value belonging to the owners after all debts are paid.
Final note:
The Balance Sheet reveals a company's strategy. A high level of Debt relative to Equity (high "leverage") means the company is using borrowed money to fuel growth, a risky but potentially high-reward strategy. The composition of its assets shows where it's placing its bets, heavy investment in PP&E signals a focus on manufacturing, while high intangible assets might signal a technology-focused company.
Section 1.3: The Cash Flow Statement
Analogy: If the income statement is the story and the Balance Sheet is the photo, the Cash Flow Statement is the detective's report. It follows the actual cash. Net Income can be manipulated with accounting rules, but cash is much harder to fake.
Core Question: "Where did the company's cash actually come from, and where did it go towards to?"
Source: Apple Inc., Form 10-K for the fiscal year ended September 30, 2024.
It reconciles the Net Income (from the Income Statement) to the change in the Cash balance (on the Balance Sheet) by looking at three activities:
Cash Flow from Operations (CFO): Cash from the main, day-to-day business. This is the engine of the company. A healthy company must have strong, positive CFO. It starts with Net Income and adjusts for non-cash expenses like Depreciation and amortization.
Cash Flow from Investing (CFI): Cash used to buy or sell long-term assets. You'll see a large negative number for Apple here, showing Purchases of marketable securities and Payments for acquisition of property, plant and equipment (this is Capex). This shows Apple is investing its cash for future growth.
Cash Flow from Financing (CFF): Cash flows between the company and its investors. Look at Apple's report: you'll see massive cash outflows for Repayment of debt, Payment of dividends, and Repurchases of common stock. This shows Apple is using its cash to return huge amounts of capital to its shareholders
The pattern of cash flows reveals a company's lifecycle stage. It is how an investor see if a company is viable.
For example:
High-Growth Startup: Negative CFO (burning cash), negative CFI (investing heavily), positive CFF (raising money).
Healthy Mature Company: Strong positive CFO (generating lots of cash), negative CFI (reinvesting to stay competitive), negative CFF (returning cash to investors via dividends/debt repayment).
Disclaimer: Everything on this page is for informational and entertainment purposes only - none of it is financial advice.
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