3 Financial Statements to Measure a Company's Strength (2024)

Stocks

February 13, 2023

When looking for trade opportunities, be sure to check the income statement, the consolidated balance sheet, and the statement of cash flows.

3 Financial Statements to Measure a Company's Strength (1)

When the stock market boomed in the 1920s, investors essentially had to fly blind in deciding which companies were sound investments because, at the time, most businesses had no legal obligation to reveal their finances. After the 1929 market crash, the government enacted legislation to help prevent a repeat disaster. To this day these reforms require publicly traded companies to regularly disclose certain details about their operations and financial position.

The income statement, balance sheet, and statement ofcash flowsare required financial statements. These three statements are informative tools that traders can use to analyze acompany's financial strengthand provide a quick picture of a company's financial health and underlying value.

This article will provide a quick overview of the information that you can glean from these important financial statements without requiring you to be an accounting expert.

Statement #1: The income statement

The income statement makes public the results of a company's business operations for a particular quarter or year. Through the income statement, you can witness the inflow of new assets into a business and measure the outflows incurred to produce revenue.

Profitabilityis measured by revenues (what a company is paid for the goods or services it provides) minus expenses (all the costs incurred to run the company) and taxes paid.

The income statement is read from top to bottom, starting with revenues, sometimes called the "top line." Expenses and costs are subtracted, followed by taxes. The end result is the company's net income—or profit—before paying any dividends. This is where the term "bottom line" comes from.

Income statement example for YYZ Corp.* for the year ending Dec. 31, 2022 (in millions)

Chart showing an example income statement for the hypothetical YYZ Corp, showing data from 2021 and 2022.
Revenues 2021 2022
Sales $350 $270
Costs of goods sold –$250 –$190
Gross profit 100 80
Depreciation expense –$10 –$10
Taxes on income –$15 –$20
Net income $75 $50
Average common shares outstanding (in millions) 25 25
Earnings per share (EPS) $3 $2
Dividends declared per common share $0.050 $0.045

As you can see in this example, net income for YYZ Corp. declined from $75 million to $50 million.

The next line in the income statement, after net income, displays the average number of common shares of the company's stock that are held by investors. Next comes the firm'searningsper share, which is calculatedby dividing net income by the number of shares.

Finally, the last line shows thedividendsdeclared per common share, which is the cash payment per share (if any) the company makes to stockholders. The amount of any dividend payment is at the discretion of the company's board of directors.

Statement #2: The balance sheet

While the income statement is a record of the funds flowing in and out of a company over a given time period, the consolidated balance sheet is a snapshot of a company's financial position at a given point in time. In other words, the balance sheet shows what a company owns (its assets) and owes (its liabilities) and the difference between the two (stockholders' equity). This difference represents the book value of the stockholders' stake in the company. It's called a balance sheet because both sides of the equation must balance: assets equal liabilities plus stockholders' equity.

The balance sheet displays:

  • The portion of those assets financed with debt (liability)
  • The portion of equity (retained earnings and stock shares)
  • Assets listed in order from most liquid to least liquid (in other words, assets that can be most quickly converted to cash are listed first)
  • Liabilities listed in order of immediacy (those that have the most senior claim on a firm's assets are listed first)

Balance sheet example for YYZ Corp. for the year ending Dec. 31, 2022 (in millions)

3 Financial Statements to Measure a Company's Strength (2)

The amount by which assets exceed liabilities is listed as total shareholders' equity, and this represents the net worth of a company, or the book value of the stock. Shareholders' equity includes common stock, additional paid-in capital, and retainedearnings.

Statement #3: The statement of cash flows

As with an income statement, the statement of cash flows reflects a company's financial activity over a period of time. It shows where a company's cash comes from and how it's used to pay for operations and/or to invest in the future. By showing how a company has managed the inflow and outflow of cash, the statement of cash flows may paint a more complete picture of a company's liquidity (the ability to pay bills and creditors and fund future growth) than the income statement or the balance sheet.

Statement of cash flows example for YYZ Corp. for the year ending Dec. 31, 2022 (in millions)

3 Financial Statements to Measure a Company's Strength (3)

Cash flow from operations

Income and expenses on the income statement are recorded when a company earns revenue or incurs expenses, not necessarily when cash is received or paid. Similarly, the depreciation of owned assets is added back to net income, as this expense is not a cash outflow.

Analysts often look to cash flow from operationsas the most important measure of performance, as it's the most transparent way to gauge the health of the underlying business. A decrease in cash flow due to a sharp increase in inventory or receivables can signal that a company is having trouble selling products or collecting money from customers.

Cash flow from investing and financing

Cash flow from investing includes cash received from or used for investing activities, such as buying stock in other companies or purchasing additional property or equipment. Cash flow from financing activities includes cash received from borrowing money or issuing stock, and cash spent to repay loans.

Measuring a company's financial strength

The stock price for a given company can advance or decline based on a wide variety of factors. However, companies that perform well financially by increasing their earnings, net worth and cash flow are typically rewarded with a higher stock price over time. When it comes to trading, knowledge is power. Even traders who generally rely ontechnicalfactors to make their trading decisions may benefit from learning to use standard financial statements to home in on companies that are experiencing strong or improving fundamentals.

Just getting started with stocks?

Learn the basics

3 Financial Statements to Measure a Company's Strength (4)

Markets and Economy

Closing Market Update

Technology remained under pressure but other sectors advanced as investors waited for producer prices report.

3 Financial Statements to Measure a Company's Strength (5)

Markets and Economy

Opening Market Update

After an overnight climb, stock indexes turned as Treasury yields climbed amid weak demand. Producer prices and retail sales data will be released Thursday.

3 Financial Statements to Measure a Company's Strength (6)

Trading

Short Selling: The Risks and Rewards

Make sure you understand the risks of short selling before taking the plunge.

Related topics

Trading Investments Stocks Portfolio Management

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market or economic conditions. Data contained herein from third party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

Investing involves risk including loss of principal.

Schwab does not recommend the use of technical analysis as a sole means of investment research.

Past performance is no guarantee of future results.

3 Financial Statements to Measure a Company's Strength (2024)

FAQs

3 Financial Statements to Measure a Company's Strength? ›

The balance sheet, income statement, and cash flow statement each offer unique details with information that is all interconnected. Together the three statements give a comprehensive portrayal of the company's operating activities.

What are the three financial statements to measure a company's strength? ›

The balance sheet, income statement, and cash flow statement each offer unique details with information that is all interconnected. Together the three statements give a comprehensive portrayal of the company's operating activities.

Which of the three financial statements is most important? ›

Typically considered the most important of the financial statements, an income statement shows how much money a company made and spent over a specific period of time.

What are the three most important elements of a company's financial strength? ›

three most important elements of a company's financial strength are its assets, liabilities, and owners equity. Three other key financial elements for a business are the amount of sales, expenses, and profits. A company reports its assets, liabilities, and owner's equity on the balance sheet.

What are the three primary financial statements and what do they measure? ›

The income statement illustrates the profitability of a company under accrual accounting rules. The balance sheet shows a company's assets, liabilities, and shareholders' equity at a particular point in time. The cash flow statement shows cash movements from operating, investing, and financing activities.

What is a 3 statement financial statement? ›

A three-statement model combines the three core financial statements (the income statement, the balance sheet, and the cash flow statement) into one fully dynamic model to forecast future results. The model is built by first entering and analyzing historical results.

How do you measure the financial strength of a company? ›

Typically, financial strength is measured by cash flow ratios. The overall cash flow of any business tells whether that business is generating what it needs to sustain, grow and return capital to owners.

Which 3 financial statements are the ones most critical to small businesses and what does each one tell the owner? ›

They provide a snapshot of a company's financial health and performance. The three primary financial statements are the balance sheet, income statement, and cash flow statement. Each one provides valuable information that can be used to make decisions about the future of the business.

What is common in all three financial statements? ›

The concept of retained earnings is the centerpiece that links the three financial statements together. The retained earnings balance in the current period is equal to the prior period's retained earnings balance plus net income minus any dividends issued to shareholders in the current period.

How to tell if a company is profitable from a balance sheet? ›

The two most important aspects of profitability are income and expenses. By subtracting expenses from income, you can measure your business's profitability.

What are the three main ways to analyze financial statements? ›

Financial accounting calls for all companies to create a balance sheet, income statement, and cash flow statement, which form the basis for financial statement analysis. Horizontal, vertical, and ratio analysis are three techniques that analysts use when analyzing financial statements.

What are the financial strengths of a company? ›

At its most basic level, financial strength is the ability to generate profits and sufficient cash flow to pay bills and repay debt or investors. Most business owners are focused on generating sales to increase profitability, however, sales alone do not build financial strength.

What are the three keys to financial success? ›

Three keys to financial success are: Always spend less than you earn. Avoid splurging. Invest the rest.

What are the 3 main financial statements called? ›

The income statement, balance sheet, and statement of cash flows are required financial statements. These three statements are informative tools that traders can use to analyze a company's financial strength and provide a quick picture of a company's financial health and underlying value.

Which financial statement shows net worth? ›

The balance sheet or net worth statement shows the solvency of the business at a specific point in time. Statements are often prepared at the beginning and end of the accounting period (i.e. January 1).

What are the three most essential ratios to check a company's financial strength? ›

Operating Cash Flow Ratio: A measure of how many times an organization can cover current liabilities from operating activities. Current Ratio: Measures your ability to pay short-term obligations over twelve months. Quick Ratio (Acid Test Ratio): Evaluates the number of liquid assets available to cover liabilities.

What are the 3 major components to a company's annual financial statements? ›

The three main types of financial statements are the balance sheet, the income statement, and the cash flow statement. These three statements together show the assets and liabilities of a business, its revenues, and costs, as well as its cash flows from operating, investing, and financing activities.

What are the 3 common tools of financial statement analysis name and define them? ›

Tools of Financial Statement Analysis

The three major tools for financial statement analyses are horizontal analysis, vertical analysis, and ratios analysis. You might have used some of them and just never knew their academic name. Horizontal analysis is also called comparative analysis.

Top Articles
Latest Posts
Article information

Author: Kelle Weber

Last Updated:

Views: 5331

Rating: 4.2 / 5 (53 voted)

Reviews: 84% of readers found this page helpful

Author information

Name: Kelle Weber

Birthday: 2000-08-05

Address: 6796 Juan Square, Markfort, MN 58988

Phone: +8215934114615

Job: Hospitality Director

Hobby: tabletop games, Foreign language learning, Leather crafting, Horseback riding, Swimming, Knapping, Handball

Introduction: My name is Kelle Weber, I am a magnificent, enchanting, fair, joyous, light, determined, joyous person who loves writing and wants to share my knowledge and understanding with you.