If you’ve been following ours or any other coverage of the ZSE you may have realised by now that financial statements are really important things in the world of stock market investing. All well good for the accountants and financial analysts who eat, breathe and sleep financial statements but not so good for the ordinary person who may not be so well or at versed with financial statements. I thought it a good idea to take you through financial statements and explaining what each statement means and the purpose it serves. This will help you know what you are looking at and what to pay particular attention to.
The arrangement of the sections can vary a little depending on the financial report in question. You will find the same things pop up in all reports. If you want a reference point for what I based this article on you can look at ART Corp’s 2020 Full Year Report. Now, let’s look through the sections and what to expect and look out for in them.
I will not immediately speak for everyone but I know many people who skip straight to the figures in a financial report and ignore this usually long and wordy section. In some cases, I am one of those people. I will explain later why I usually skip this when I touch on the section I look at first. That’s not to say this section is not important. While it seems like a lot of watching adults pat themself on back for doing their job it tells you important things about the business case for a company. In this section, you will find a good summary of changes in leadership, plans, projects, a performance brief, dividend decision, important shareholding decisions (like buybacks), values (such as environment and sustainability) and the outlook going forward.
This is the section I look at first in financial statements. The income statement is of course where it all happens. Alternately known as the statement of financial performance it tells us how the business has performed in the period under review. As a shareholder, I own shares, not the whole company. So the first thing I want to look at is earnings per share. In simple terms, this is the profit per share. In the case of Zimbabwean financial statements, my attention is on the inflation-adjusted statements which attempt to state previous year figures in current year values to make information comparable. What we are looking for is growth in EPS. Depending on the industry and company we will also find important information on the Sales revenue, the margin (how much of sales becomes profit), interest expense, taxation, employee costs and more.
The income statement tells us how the company performed in the period under review, the balance sheet tells us how the company stands after that performance. Alternately known as the statement of financial position it contains information on the composition of the company’s assets and liabilities. It also gives us an idea of the capacity the company possesses going forward. Things to look out for in the balance sheet include the current assets, current liabilities, net assets, shareholders equity and reserves. All the information to calculate important ratios will be contained in the two statements.
Statement of Changes in Equity
There are some parts of the financial statements the average investor will look at if they have a query or need to verify something. The Statement of changes in equity is one such segment. It’s not useless, quite the contrary, it just goes beyond the needs of many. This section serves to inform on changes in the owner’s interest in the company. So we understand that profit increases the value of a company. There are other events to consider such as acquisitions and disposals which impact this. So it will help you understand if any of the changes in equity came from events outside business operations.
Statement of cash flows
The statement of cash flows is important because it highlights a very important distinction in business. Profit and cash are not the same. It is possible to be profitable and have poor cash flow. The statement of cash flows looks to reconcile between profit and cash flow position. It also identifies the sources of cash flow between normal business operations, cash generated from investing activities (acquisitions and disposals of assets) and cash from financing activities (borrowing and share issues or buybacks). The concern is information to support the liquidity and solvency position of the company.
Notes to the financial statements
So you’ve been hit with a lot of information in the statements but just how reliable is that information you ask? Well, that is the purpose of the Notes to the financial statements and the audit opinion which we will talk about after this. The notes are used to further explain the details contained in the aforementioned statements. This is useful where deeper information is required, like understanding this whole inflation-adjusted thing and how it works. In the financial statements, things that have a reference number will be explained in the notes under the corresponding note number.
The audit opinion is a somewhat misunderstood section. Financial statements of public listed companies are sent out to the general public. The function of the auditors in financial statement preparation is to ensure the reliability of the information by verifying that firstly it is truthful and secondly it is done per the rules of accounting. While most identify audit as being a fraud detection tool that is not the case. It just so happens that preparers of financial statements tend to not follow rules when they have something to conceal. So auditors will express opinions they have arrived at through testing, observation and sampling to arrive at the level of reliability of the information.