Financial Analysis 101: An Introduction to Analyzing Financial Statements for beginners

By Reuel Matthew

This book provides a path to understanding the complexity of financial statements, financial ratios, and financial metrics savvy investors tend to focus on in order to measure a company's financial health.

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• Language: English
• Publisher: Fulton Books, Inc.
• Release date: Jul 6, 2022
• ISBN: 9781639857142

Book preview

Financial Analysis 101

Reuel Matthew

Copyright © 2022 Reuel Matthew

All rights reserved

First Edition

Fulton Books

Meadville, PA

Published by Fulton Books 2022

ISBN 978-1-63985-713-5 (paperback)

ISBN 978-1-63985-714-2 (digital)

Printed in the United States of America

A person in a suitDescription automatically generated with low confidence

CONTENTS

Introduction

Chapter 1: Intro to Financial Statements: Assets

Chapter 2: Intro to Financial Statements: Long-Term Assets, Liabilities, and Equity

Chapter 3: Intro to Financial Statements: Income and Expenses

Chapter 4: Analyzing Financial Ratios

Chapter 5: Starting a Business with Debt Versus Equity

Glossary

INTRODUCTION

Analyzing financial statements is one of the most important aspects of financial literacy to learn as early as possible in one’s professional career. This book was designed as a quick read to help people at all levels better understand how to read and interpret financial statements. Before starting off with this book and heading toward learning financial analysis, let me share my learning journey.

I started my professional career working for Ernst & Young right out of graduating from Baruch College with a bachelor’s in accounting and a master’s in tax in 2011. By 2014, EY sponsored my CPA license, and I met my required two years of experience to be officially certified as a CPA in the state of New York. However, I spent the early years of my career focusing too heavily on reconciling numbers, tying out accounts, and making sure numbers agree rather than looking at the big picture of a company’s financial health and whether operating trends even made sense. Starting at any big firm, unfortunately, you find yourself in the weeds and not ultimately getting a high-level view of the plains. Said differently, no one in their first one to two years in Corporate America typically knows or understands the big picture of what they are doing. It takes years of experience and reaching a supervisory or managerial role (where you are now reviewing other people’s work, and you now report to upper-level directors and partners where understanding the big picture is key) for most people to finally understand the big picture. That understanding finally came to me about five years into my career and with starting my own business.

I wrote this book to encourage other young professionals, like myself, who start at large firms and find themselves getting lost in the details of client data, to take a step back before you dive in and simply understand your clients and the issues they face at a high level. In my experience, it helps professionals at every stage, whether you’re an auditor, tax professional, consultant, banker, or attorney, better perform the services that they are tasked to do. So, let’s get started! We shall begin with some 2020 public financial data of two publicly traded (or listed) companies, T-Mobile and AT&T.

The information disclosed in the chart below is from the respective companies’ website and contains annual disclosed financial statement information filed with the SEC. This information can easily be accessed from the company website.

CHAPTER 1

Intro to Financial Statements

Assets

Let’s start with some definitions of items that appear on the basic financial statements. There are three basic financial statements that every company discloses to their investors: (1) balance sheet, (2) income statement, and (3) the statement of cash flows. Depending on the industry, companies may provide additional statements. These statements can look very different or go by many names. However, for purposes of simplifying this illustration, we will refer to the three basic financial statements as balance sheet, income statement, and the statement of cash flows.

1.1 What is a financial statement

Financial statements are written records that convey the business activities and the financial performance of a company. Financial statements are often audited by government agencies, accountants, firms, etc. to ensure accuracy and for tax, financing, or investing purposes. Financial statements include:

1.2 Types of financial statements

There are three basic financial statements that every company discloses to their investors:

Balance sheet

Income statement

The statement of cash flows

1.2.1 Balance sheet

The balance sheet conveys the assets and liabilities that a company holds at a specific date (usually the last day of the year). The balance sheet is effectively a snapshot of a company’s financial position at a given time. It shows how many liquid assets a company has, how much long-term debt a company has, how many upcoming debt obligations a company has, and how much long-term debt obligations a company has. The balance sheet also lets readers of the financial statements know how much net equity or deficit the company has generated since inception, which allows readers of the financials to know and understand how well money invested into the company was managed. Let’s take a deeper dive into current assets or assets that can be quickly converted to cash on the next page.

1.2.1.1 Current assets

Current assets include cash and cash equivalents, accounts receivables, inventory, prepaid expenses, and other assets. Let’s discuss each category.

Fig. 2.2.1.1

1.2.1.2 Cash and cash equivalents

The first line item shown above is the consolidated cash and cash equivalents for T-Mobile US Inc. as of December 31, 2020, as shown in figure 2.2.1.1. The term consolidated just means it includes all cash balances of all subsidiaries and affiliates of T-Mobile. Cash, as its name implies, is the cash a company keeps in bank accounts, safe-deposit boxes, or on hand as petty cash. Cash equivalents are short-term investments, such as stocks, money market accounts, government bond investments, undeposited funds, or uncashed checks. Cash equivalents are generally items that can be quickly converted to cash and are measured at fair market value, or the amount that could be sold to an active market.

1.2.1.3 Accounts receivable

The next line item is accounts receivable, which refers to expected collections from customers for goods and services already provided. These are simply payments you expect to receive from your customers at some point after selling something to them, excluding any amounts for any delinquent or insolvent customers and any damaged goods that may have been shipped or any discounts that might have been offered. Accounts receivable is normally presented as a net number. The word net simply means that amounts were deducted from the gross amount (or original amount expected to be received). On the balance sheet above for T-Mobile, receivables are further divided into two additional categories, equipment installment plan receivable and accounts receivable from affiliates (see figure 2.2.1.1). This provides the reader more information as to exactly how much customer receipts are expected and what categories they relate to. Companies may tweak their financial statements, similar to how T-Mobile did, if it helps provide more clarity to their readers of financial statements or their stockholders.

Fig. 2.2.1.1

1.2.1.4 Inventory

The next line item is inventory. This category represents products or goods a company intends to sell. It is normally valued at the cost to the company, which is different from the amount the company sells to customers. Companies typically purchase inventory at a low price and sell to customers at a higher price. However, if the market value (or active selling price) dips below cost, a company should revalue its inventory at a lower cost or market value. This is called the lower of cost or market (LCM) inventory valuation method, which ensures the value of inventory is never overstated.

1.2.1.5 Prepaid expenses

The next line item is prepaid expenses. This line item relates to cash paid in advance for goods or services to keep the company operating. A few examples of cash that may be paid up front prior to the delivery of goods and services include insurance premiums and rental security deposits.

1.2.1.6 Other assets

Other assets relate to any other short-lived assets that the company has rights to, which may include deferred tax assets, bond issuance costs, advances to vendors, etc. These are generally small amounts that are incidentals to the financials, so they are grouped together into the other assets category.

This concludes our overview of current assets.

CHAPTER 2

Intro to Financial Statements

Long-Term Assets, Liabilities, and Equity

Fig. 2.2.1.2

1.2.1.7 Land, property, plant, and equipment

We now transition our discussion to long-lived or long-term assets. The first line item is called property, plant, and equipment. This line item includes fixed assets purchased to help with the growth of the business.

1.2.1.8 Land

Land represents the cost of land owned and held by the company as an investment but is not being used in the operations of the company. Land is generally valued at a lower cost or market (LCM) as described earlier.

1.2.1.9 Plant, property, and equipment

Plant, property, and equipment represent physical structures that include buildings, machinery, and vehicles. These structures are owned by the company and used in its operations to generate income. They are presented on the financials at the cost of the structures reduced by the accumulated depreciation.

1.2.1.10 Intangible assets

Intangible assets are those which you cannot touch or see, but they exist in the company. For example, goodwill, patents, and trademarks. Like depreciation, amortization is cost recapture over the useful life of the intangible asset.

1.2.1.11 Liabilities and stockholders’ equity

Fig. 2.2.1.3

1.2.1.12 Liabilities

Let’s move now to liabilities and highlight some key line items. Accounts payable and accrued liabilities refer to the debts the company