Compounding

Understanding a Company's Financial Statements

Every publicly listed company must file financial statements with stock market regulators (SEBI in India). These statements tell you where the company's money came from, where it went, and what the company owns and owes. The three main statements are the income statement, balance sheet, and cash flow statement.

Income Statement

The income statement shows the company's profitability over a period (usually one quarter or one year). It starts with revenue (total sales), subtracts the cost of goods sold to get gross profit, then subtracts operating expenses (salaries, rent, marketing) to get operating profit, and finally subtracts interest and taxes to get net profit. Net profit divided by the number of shares outstanding is earnings per share (EPS). The income statement answers: how much did the company make, what did it cost, and how much profit was left?

Balance Sheet

The balance sheet is a snapshot of the company's financial position on a specific date. On one side, it lists assets (cash, investments, inventory, land, buildings—everything the company owns). On the other side, it lists liabilities (money owed to banks, suppliers, and others) and shareholders' equity (the net worth of the company, which belongs to the shareholders). The fundamental equation is: Assets = Liabilities + Shareholders' Equity. The balance sheet answers: what does the company own, what does it owe, and what's left for the shareholders?

Cash Flow Statement

The cash flow statement shows where cash came from and where it went. It separates cash flows into three categories: operating (cash from the business), investing (cash spent on assets), and financing (cash from debt/equity or paid out as dividends). A company can be profitable on the income statement but run out of cash if it's not collecting from customers or is spending heavily on expansion. Cash flow is reality; profits can be distorted by accounting choices.

  • Income statement = profitability.
  • Balance sheet = financial position.
  • Cash flow statement = cash reality.
  • A company can be profitable but still run out of cash.