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I’m receiving annual reports from companies in which I invest, but I don’t know how to interpret the financial statements. What are the essentials I should consider?

The following are the main sections of a company’s financial statements, and what they show:

The balance sheet shows you a company’s financial position on a specific date. In annual reports, that date is the last day of the company’s fiscal year. While many companies have a fiscal year ending Dec. 31, this is not always the case. Banks and trust companies, for example, traditionally end their fiscal year on Oct. 31. One side of the balance sheet shows you what the company owns and what is owing to it. These items are called assets. The other side of the balance sheet shows what the company owes, called liabilities, and the company’s shareholders’ equity or net worth, which represents the shareholders’ interest in the company. The earnings statement shows how much revenue a company earned during the year selling its products and services, and its expenses for wages, materials, operating costs, taxes or other expense items. The difference between the two is the company’s profit or loss for the year. The amount left over, after payment of income taxes, is net earnings, out of which dividends may be paid to the shareholders. The retained earnings statement shows profits retained in the business year after year. The profit or loss in a company’s most recent year is determined in the earnings statement and then transferred to the retained earnings statement. Retained earnings are profits earned over the years that have not been paid to shareholders as dividends. These retained profits usually accrue to the shareholders through higher share values. While the balance sheet shows a company’s financial position at a specific date, and the earnings statement summarizes the company’s operating activities for the year, neither shows how the company’s financial position changed from one period to the next. The statement of changes in financial position, also called the cash flow statement, provides information about how the company generated and spent its cash during the year. This statement helps you assess the company’s ability to generate cash internally, repay debts, reinvest, and pay dividends to shareholders. It’s essential for investors to read the notes to financial statements and understand them. They offer important details about the company’s financial condition, including accounting policies, description of fixed assets, share capital and long-term debt, commitments and contingencies. Excerpted from “How to Read Financial Statements”, published by the Canadian Securities Institute. For more information on this publication, look in the Books section of our web site.