The Three Financial Statements in One Sitting

A company can report a profit every quarter and still run short of cash. Reading one statement at a time can hide that. All three together will.

Where the statements live

Open the company’s 10-K on EDGAR, the SEC’s free filing system, and go to Item 8, Financial Statements and Supplementary Data, where the audited statements sit, followed by the notes that explain each line in more detail. The quarterly versions are in each 10-Q, near the front, and they’re unaudited. Start with the annual one. A full year smooths seasonal swings, and an auditor has checked it.

Most filings show two or three years side by side. Use that. One year tells you little on its own.

The income statement: what it earned over a period

The income statement starts with revenue, the money the company billed customers during the year, and subtracts costs in layers until it reaches net income at the bottom.

The usual order goes like this. Cost of revenue comes off first and leaves gross profit. Operating expenses such as salaries, marketing and research come off next and leave operating income, the profit from running the business itself, and then interest on debt and income taxes come off last. What remains is net income. Divided by the share count, it gives earnings per share. You’ll need that in the P/E lesson. It’s also the number earnings estimates try to forecast.

It covers a period. “Year ended” at the top of the column tells you so.

The balance sheet: what it owns and owes on one date

The balance sheet is a snapshot taken on the last day of the period. Assets are on one side: cash, money customers still owe, inventory, buildings, equipment. Liabilities are on the other: money owed to suppliers, loans, bonds, taxes due. Whatever is left belongs to shareholders, and the statement always obeys one equation.

Assets = liabilities + shareholders’ equity

If you ever find a balance sheet that doesn’t balance, you’ve misread a line. Check the totals.

Note the date at the top of the column. Then compare cash with the debt due in the coming year, because a company holding little cash against a large short-term debt has a problem that the income statement, which only measures profit, won’t show you.

The cash flow statement: where the cash went

Profit is an accounting measure. It counts a sale when it’s made, even if the customer pays in ninety days, and it spreads the cost of a new warehouse over many years. The cash flow statement strips that back to money actually in and out. It has three sections.

Operating cash flow is cash generated by running the business. Most companies start from net income and adjust it, adding back noncash charges like depreciation and subtracting cash tied up in things like unpaid customer bills and unsold inventory. Investing cash flow is mostly spending on property and equipment, called capital expenditures, plus any businesses bought or sold, while financing cash flow covers borrowing and repaying debt, issuing shares, buying them back and paying dividends.

Free cash flow comes from this statement.

That $75 million is what’s left after paying for equipment. It’s the money available for dividends, buybacks, paying down debt or saving. Capital expenditures usually appear as a negative figure in the investing section, labeled something like “purchases of property and equipment,” so subtract the amount, never add it.

Reading the three together

The statements are linked. Net income is usually the first line of the operating section. Ending cash on the cash flow statement ties to cash on the balance sheet, and profit the company keeps adds to retained earnings, which is part of shareholders’ equity, so the three keep checking one another.

Those links are why reading them together catches things. Put net income beside operating cash flow for each year shown. Over time the two should roughly track each other, and when a company reports rising profits year after year while operating cash flow stays flat or falls, the gap is usually sitting somewhere on the balance sheet, most often in receivables growing faster than sales or in inventory piling up in a warehouse, and that deserves a question before you buy.

For practice, run the free cash flow sum on your own company’s 10-K. Set it beside net income for the same year. The measuring growth course later uses these same statements to judge whether a company’s growth pays for itself, and the next lesson takes the earnings figure from the bottom of the income statement and holds it against the share price for a first valuation check.