Reading a business
Three financial statements tell you most of what you need to know about a company. You don't need to be an accountant to read them.
The profit and loss statement
It shows revenue, expenses and profit over a period. Look for steady revenue growth, stable or rising margins (profit as a share of revenue), and profits that aren't propped up by one-off gains.
Profit and loss
Is it profitable, and is profit growing?
Balance sheet
Is it strong? What does it own and owe?
Cash flow
Are profits turning into real cash?
The balance sheet
It shows what the company owns (assets) and owes (liabilities) at a point in time. Watch debt: a company with debt far larger than its equity is fragile when business slows. A debt-to-equity ratio below 1 is comfortable for most non-financial businesses.
The cash flow statement
Profit is an accounting number; cash is real. Healthy companies turn most of their profit into operating cash flow. If profits rise for years while cash flow stays weak, ask why.
Add one more measure: return on equity (ROE), profit divided by shareholders' money. Businesses that earn 15% or more on equity consistently, without heavy debt, are often worth a closer look.
Key takeaways
- 1P&L: is it profitable and growing?
- 2Balance sheet: is it strong, with manageable debt?
- 3Cash flow: are the profits turning into real cash?
Finish this lesson
Reaching the end marks it complete. You can also mark it yourself.
Educational content, not investment advice. Figures are illustrative.