3 Financial Statements Every New Investor Should Know (Even if You’re Not a 'Numbers' Person)
If you're a new investor, you've probably thought, “I’m not a numbers person. I don’t understand financials well enough to invest.” It’s a common concern, especially when faced with a stack of documents filled with terms like "audited," "interim," "consolidated," and "condensed."
But don’t worry! You don’t need to be a math whiz to start investing. I’m here to break down the three basic financial statements that every investor should know—and you’ll see that understanding them is easier than you think.
Before diving into the statements, let’s first ask: Why do we even look at financial statements?
Why Financial Statements Matter
When you invest in a company, you’re essentially buying a small part of that business. To make informed decisions, you need to understand how well that business is performing. This process is known as fundamental analysis.
In addition to considering external factors like the economy and industry trends, financial statements help you see how well a company is managed through its numbers. They provide insights into profitability, stability, and financial health—all crucial elements when deciding whether to invest.
So, let’s get into the three key financial statements.
1. Income Statement (Also called the Profit and Loss Statement)
The Income Statement shows how much money a company makes (its revenue), how much it spends (expenses), and whether it’s profitable.
What we’re looking for:
By reviewing the Income Statement, you can answer one fundamental question: Is this business making or losing money?
When a company earns more than it spends (revenue exceeds expenses), it is profitable—a positive sign for investors.
On the other hand, if a company is consistently losing money, that’s a major red flag. While experienced investors might sometimes find opportunities in loss-making companies, new investors should avoid them until they have more experience.
Financial Terms to remember:
Revenue: The money the company earns from selling products or services.
Expenses: The costs to run the business (e.g., salaries, rent, etc.).
Net Income (Profit): What’s left after subtracting expenses from revenue.
2. Balance Sheet (Also known as the Statement of Financial Position)
The Balance Sheet provides a snapshot of what a company owns and owes at a specific point in time. Think of it as a financial inventory of the company.
What we’re looking for:
The Balance Sheet helps you gauge the company’s financial strength and whether it’s taking on too much debt compared to others in its industry.
The Balance Sheet breaks down into:
Assets: What the company owns (cash, inventory, property, etc.).
Liabilities: What the company owes (debts, loans, etc.).
Equity: The company’s net worth (Assets minus Liabilities).
A healthy company generally has more assets than liabilities. As an investor, you want to ensure the company isn’t overly burdened by debt. A simple formula to remember this relationship is:
Shareholders' Equity = Assets - Liabilities
You also don’t want to see excessive cash sitting in the company’s assets, as it suggests the business isn’t optimally reinvesting its resources—similar to someone who leaves too much cash in the bank instead of investing.
Assets and liabilities are categorized into current (short-term) and non-current (long-term). Current assets and liabilities are expected to be settled within one year, while non-current ones extend beyond a year.
Current Assets: Assets that can be converted into cash within one year (e.g., cash, inventory).
Current Liabilities: Debts or obligations due within one year.
3. Cash Flow Statement
The Cash Flow Statement is vital because it shows how cash flows in and out of the company. A company can be profitable on paper but still face cash flow issues, which can lead to trouble.
What we’re looking for:
The Cash Flow Statement has three sections:
Cash Flow from Operations: Cash generated from everyday business activities.
Cash Flow from Investing: Cash used or earned from buying or selling assets (like equipment, property, or other businesses).
Cash Flow from Financing: Cash movements related to borrowing, repaying debt, or issuing stock.
Positive cash flow from operations is a sign of a healthy core business. Cash flow from investing and financing might vary (and fluctuate between positive and negative) depending on the company’s activities, but consistent positive cash flow from operations is key to maintaining financial health.
The Bottom Line
Financial statements might seem overwhelming, but once you understand the basics, they become powerful tools for making informed investment decisions.
The Income Statement shows if a company is profitable.
The Balance Sheet reveals its financial strength.
The Cash Flow Statement ensures the company can manage its money effectively.
You don’t need to be an expert in numbers to understand these key financials. By focusing on these three statements, you’ll gain a clearer picture of a company’s performance and whether it’s a smart investment for your portfolio.
If you’d like to learn more about how to evaluate companies before investing, watch my webinar replay, “Making Sense of Financial Statements (Even if You’re Not a 'Numbers' Person).” You’ll feel more confident using these financial statements to guide your investment decisions.