How to Review a Financial Statement

Co-authored by Alan Mehdiani, CPA

Last Updated: October 23, 2024

A financial statement is the lifeblood of any business. You rely on these financial statements to know the condition, performance and ability to efficiently sustain past and future operations of a particular business. But how do you read these things?

1

Review financial conditions with a balance sheet.

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Look at how the business manages its Asset, Liabilities, and Equity. Basic Equation of a Balance Sheet: Asset = Liability + Equity.^{[1]
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- Asset = Remember that an asset adds worth to a business. You look at how well it manages its asset by checking the financial value allocated to cash, receivables, short-term and long-term investments, inventory, fixed assets, furniture and fixtures, land, and building. By doing so, you can determine if a business is able to sustain and grow operations or if it will close down.
- Liability = Take note that liability consists of all the outstanding loan obligations of a business. Obtaining loans is one of the ways to generate capital to support a business operation. A liability account will enable you to look at the balances of the account's payables, bills payables notes payables, and all other payables. Most often, depending on a given situation, when you see that a business has a high amount of liability, it may be a sign of trouble and inability to sustain its operation.
- Equity = Equity is meant to be the capital of a business. It is the major source of money to support and sustain a business operation. When you look at the equity account, check the number of stocks, common and preferred, that were issued. In the equity account, you will be able to see the real value of a business in terms of ownership. When you see a high equity balance, it can be a good indicator that the business is able to sustain and grow. The opposite means it is in trouble of closing down its operation.

2

Review the income statement report.

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This shows you the overall performance and profit or loss in a given period. Basically, it comprises of the following:^{[2]
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- Revenue = This account will show you the amount of sales derived in a given period. It may come from the service fees or sales price of goods sold, depending on the type of business being run. Take note that when a business has a high amount of revenue, it indicates good marketing and sales process that resulted in high sales volume of products or services. However, beware for it doesn't necessarily mean the business is profitable.
- Expenses = Signify the amount of cost to produce an item sold. It includes the cost of the materials used, cost of the service rendered, interest expense, depreciation, bad debts expenses, etc. When you verify the expenses account, you can check if the business is spending on improving its product, investing a lot of money in marketing (like an advertisement), giving high salaries and benefits to employees, or just plainly wasting money.
- Profit(Loss) Before Tax = Remember that revenue alone doesn't necessarily mean the business is profitable. Because of the expense account, even if the business has high revenue, if it spends just the same level, it wouldn't be as profitable as it should be. Here are the guidelines to know if a business is profitable or not: Profit means the amount of sales was higher than the amount of cost to produce (Revenue > Expense). When there’s profit, it means the operation of the business was doing good. On the other hand,Loss means the amount of sales was lower than the cost to produce (Revenue < Expense). When there’s a loss, it means the operation of the business was doing badly.
- Income Tax = the amount of obligation the business has to pay to the government. In determining the income tax, check the country in which the business operates because Income tax is derived from the tax rate given by a particular country multiplied against the Profit Before Tax.
- Profit(Loss) After Tax = Finally, once you determined the income tax to be paid, you'll be able to compute the real amount of profit or loss after deducting the applicable amount of tax.

3

Look at the Cash Flow Statement.

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This shows you the movement of cash in a given period. There are two types of Cash Flow Statements, an indirect method, and direct method.^{[3]
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- Direct Method = presents you condensed cash receipts and cash disbursements statement.
- Indirect Method = presents you cash movements by adjusting net income for items that affected reported net income but didn't affect cash.

4

Check the Statement of Stockholder’s Equity.

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You will be able to verify in detail the total ownership of a business, like how many stocks it is allowed to issue and how many it was actually able to sell. The movement you will see in this report includes, common stock, preferred stocks, additional paid-in capital, and retained earnings.^{[4]
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5

Look at the Notes to the Financial Statement.

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It will explain to you the standards that were used to measure each account in the previous four financial statements, the balance sheet, income statement, cash flow statement, and stockholder’s equity. Also, you will be able to check the future plans and operations of a business.^{[5]
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What do you mean by "reviewing the casting of financial statement"?

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Casting of the financial statement has to do with the arithmetical accuracy of the financial statement to confirm its accuracy, completeness and validity.

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