Financial Statements- Types, Components, How to read them
Financial statements provide a snapshot of a company's financial position at a specific date, usually the end of the financial year. We will delve into main components of a balance sheet and profit & loss statements.
By the end of this blog, you will have a clear understanding of how these components contribute to the overall financial position of a company.
Understanding Assets and Liabilities
Let's start by understanding what assets and liabilities represent on a balance sheet.
Assets
Assets are the resources a company possesses that contribute to its growth and revenue. Assets can be divided into two types:
1. Current Assets: These are assets that can be converted into cash within a year. Examples of current assets include cash, cash equivalents, stock-in-trade, and receivables. For instance, if Reliance Industries Ltd. has ₹500 crores in cash, it would be considered a part of their current assets.
2. Non-Current Assets: Non-current assets are resources that are expected to provide benefits to the company over a longer period, usually more than a year. Examples of non-current assets include property, plant and equipment, long-term investments, and intangible assets. For example, the factories owned by Tata Motors would be categorized as non-current assets.
Liabilities
On the other hand, liabilities represent the obligations that a company must fulfill. Liabilities can also be divided into two types:
1. Current Liabilities: These are obligations that are expected to be settled within a year. Examples of current liabilities include short-term debt, accounts payable, and taxes payable. For instance, if Infosys has to pay ₹100 crores in short-term debt, it would be considered a part of their current liabilities.
2. Long-term Liabilities: Long-term liabilities are obligations that extend beyond a year. Examples of long-term liabilities include long-term debt, deferred tax liabilities, and pension obligations. For instance, the long-term loans held by HDFC Bank would be classified as long-term liabilities.
Calculating Net Worth
As we learned in our earlier courses, net worth is calculated by subtracting total liabilities from total assets. This formula can also be applied to calculate the net worth of a company. For example, if a company has total assets worth ₹1000 crores and total liabilities of ₹600 crores, its net worth would be ₹400 crores.
Importance of Balance Sheet
The balance sheet provides valuable insights into a company's financial health and overall financial position. By analyzing the components of the balance sheet, investors and stakeholders can assess a company's ability to meet its obligations, its asset base, and its net worth. Understanding the balance sheet is crucial for making informed investment decisions and evaluating a company's financial stability.
Understanding Profit and Loss
Let's begin by understanding what profit and loss mean in the context of a company. Profit refers to the money a company earns after deducting its expenses from its revenue. When a company's revenue exceeds its expenses, it generates a profit. On the other hand, a loss occurs when a company's expenses exceed its revenue. Assessing profit and loss accurately gives us an idea of a company's financial health.
How to Calculate Profit and Loss?
To calculate profit and loss, we first need to understand total revenue and gross profit. Total revenue represents the money a company earns from selling its products or services.
For example, if a company like TATA Motors sells cars worth ₹50,000 crores, its total revenue will be ₹50,000 crores.
Gross profit, on the other hand, is the money left after subtracting the cost of goods sold (COGS) from the total revenue. Suppose TATA Motors spends ₹30,000 crores on manufacturing cars; their gross profit would be ₹20,000 crores (total revenue - COGS).
By now, you should have a good understanding of total revenue and gross profit calculations. However, it's important to delve deeper into other essential financial terms, such as operating expenses, net profit, and net loss.
Operating Expenses, Net Profit, and Net Loss
Operating expenses refer to the costs incurred by a company to run its regular operations. These expenses include salaries, rent, utilities, and other necessary expenses. Operating expenses are deducted from gross profit to calculate net profit or net loss.
Net profit is the amount of money left after subtracting operating expenses from gross profit. For instance, if TATA Motors' operating expenses amount to ₹10,000 crores, their net profit would be ₹20,000 crores (gross profit) - ₹10,000 crores (operating expenses), equaling ₹10,000 crores.
On the contrary, net loss occurs when operating expenses exceed gross profit. For example, if TATA Motors' operating expenses amount to ₹25,000 crores, their net loss would be -₹5,000 crores (gross profit) - ₹25,000 crores (operating expenses), resulting in a net loss of ₹5,000 crores.
Profit and Loss (P&L) Statements
Profit and Loss (P&L) statements play a vital role in assessing a company's financial performance. These statements summarise a business's revenue, cost of goods sold, gross profit, operating expenses, and net profit or net loss. P&L statements provide valuable insights into a company's financial health and overall performance.
Conclusion
Understanding financial statements is essential in evaluating a company's financial position. By comprehending terms such as assets, liabilities, capital, total revenue, gross profit, operating expenses, net profit, and net loss, investors can gain valuable insights into a company's performance. P&L statements serve as crucial documents for analysing a company's financial performance.