As we had discussed in the previous article of this series on investing basics, financial statements are among the most important sections of an annual report. For a novice investor, reading and understanding a company's financial statement is quite intimidating at first sight. However, to study and make good investing decisions, it is necessary for one to understand the same.
In this article, we shall go through the key constituents of the financial statements – profit and loss account, balance sheet and cash flow statement.
- Financial statements mirror financial health of a company and must be studied well before investing in the company
- While P&L account shows the company's performance in a financial year, balance sheet throws light on its total assets and liabilities
- Cash flow statement presents the amount of cash generated and used by various activities/operations
Key financial statements
Profit & Loss account: The profit & loss account (P&L) shows a company's performance over a specific time frame, usually a financial year or a period of 12 months. In India, most companies follow a April-to-March financial year (e.g., April 2008 to March 2009 will be one financial year). The P&L account is also known as the income statement. It presents information relating to a company's revenues, manufacturing costs, sales and general expenses, interest and depreciation charges, tax costs, other income, net profits, and dividends.
A typical P&L statement is as hereunder (Source: Britannia).
Sourced from Britannia Industries' FY08 annual report
Balance sheet: The balance sheet gives a snapshot of a company's financial strength. The statement shows what a company owns or controls (assets) and what it owes (liabilities plus equity). In accounting terminology, the balance sheet is broken into two parts – 'Sources of funds' and 'Application of funds'. 'Sources of funds' indicate the total value of financing that a company has done, while 'Application of funds' indicates the areas in which the company has utilised these funds.
As such, sources of funds = application of funds.
Put in other words, assets = liabilities + equity.
As we are aware, every company has limited resources. What differentiates a good company from an average one is the way in which it utilises such resources.
A typical balance sheet statement is displayed below.
Sourced from Britannia Industries' FY08 annual report
Reworked FY08 balance sheet to simplify the understanding
| Total Assets | Rs. mn | Total Liabilities | Rs. mn |
| Net fixed assets | 2,507 | Current liabilities | 3,477 |
| Inventories | 3,808 | Shareholders' funds | 7,558 |
| Deferred tax asset (net) | 24 | Loan funds | 1,061 |
| Current assets | 5,525 | ||
| Miscellaneous exp | 232 | ||
| Total | 12,096 | Total | 12,096 |
Cash flow statement
Put in simple terms, a cash flow statement shows the amount of cash and cash equivalents that enter and leave a company. Just as the P&L statement, the cash flow statement shows cash transactions during a particular time frame.
A company can generate or lose cash through its normal operations. Further, it can raise or payback cash through financing activities. In addition, it can use cash for investing in assets or receive cash through sales of assets or through dividends. Being the various aspects of any business, these above-mentioned activities cover most of the integral cash transactions of a company. As such, the cash flow statement allows investors to understand how a particular company's business is running, how it has raised capital and how it is being spent.
A cash flow statement is typically broken into three broader parts:
- Cash (used in)/generated from operations
- Net cash used in investing activities
- Net cash from financing activities
An example of a cash flow statement is displayed below.
Sourced from Britannia Industries' FY08 annual report
In the next article, we shall start our detailed discussion on the P&L statement and its key constituents.
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