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


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.

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

Markets and Economy

Closing Market Update

The S&P 500 and Nasdaq Composite posted their second consecutive weekly declines as inflation concerns weigh on investors.

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

Markets and Economy

Opening Market Update

Despite bearish PPI data and climbing Treasury yields, major U.S. indexes were up early Friday. Consumer sentiment data from University of Michigan is due later.

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

Markets and Economy

Schwab Market Perspective: Under the Surface

Sentiment data is beginning to match relatively strong "hard" economic data.

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)


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.

What are the 3 main financial statements that you will need to be able to interpret in finance accounting? ›

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 three most important elements of company's financial strength? ›

In general, the financial strength of a company can be measured in three key areas: profitability, liquidity and solvency.

Which of the three financial statements is the 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.

How do you measure 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.

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

The four main areas of financial health that should be examined are liquidity, solvency, profitability, and operating efficiency. However, of the four, perhaps the best measurement of a company's health is the level of its profitability.

What are the 3 financial statements and what do they mean? ›

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.

Which of 3 main financial statements needs to be prepared first? ›

The income statement should always be prepared before other statements because it provides an overview of the company's revenue and expenses during a specific period. This information is used in preparing other reports such as balance sheets and cash flow statements.

What is the basic 3 statement financial model? ›

A three-statement financial model is an integrated model that forecasts an organization's income statements, balance sheets and cash flow statements. The three core elements (income statements, balance sheets and cash flow statements) require that you gather data ahead of performing any financial modeling.

What are the three 3 elements of financial management? ›

Most financial management plans will break them down into four elements commonly recognised in financial management. These four elements are planning, controlling, organising & directing, and decision making. With a structure and plan that follows this, a business may find that it isn't as overwhelming as it seems.

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 three 3 main components of the statement of financial position describe each component? ›

The three main components of the statement of financial position are assets, liabilities, and equity, which are broken down into various categories. However, the way in which the statement is presented varies from company to company, depending on the types of assets, liabilities, and equity they have.

What is the best financial statement to evaluate a company? ›

The income statement will be the most important if you want to evaluate a business's performance or ascertain your tax liability. The income statement (Profit and loss account) measures and reports how much profit a business has generated over time. It is, therefore, an essential financial statement for many users.

What are three important uses of financial statements? ›

To serve as a financial foundation for tax assessments. To provide valuable data for foreseeing the company's future earning capacity. To provide accurate information on the fluctuation of economic resources. To offer information on the organisation's net resource changes.

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 analysis tools used in financial statement evaluation? ›

The three major tools for financial statement analyses are horizontal analysis, vertical analysis, and ratios analysis.

What are the three financial statements and how are they connected? ›

The income statement, balance sheet, and cash flow all connect to create the three-statement model. How? Changes in current assets and liabilities on the balance sheet are reflected in the revenues and expenses that you see on the income statement.

What three main financial statements that are important for any business include all of the following except? ›

Answer and Explanation: Correct answer : Option (e) Statement of Cash Flows is the correct answer because the basic financial statements include Income Statement, Statement of Retained Earnings, Balance Sheet, and Statement of Cash Flows, but does not include the Statement of Changes in Assets.

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