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Young Investors

Fundamental Analysis – Understand The Structure of Financial Report

Wednesday, 21 February 2014

After previous article on "Introduction of Fundamental Analysis", let’s start with one of the most important lesson of Fundamental Analysis: "Reading the Financial Statement".

A Financial Report has 3 Basic component or statements, they are:

  1. Income Statement (or Profit and Loss Statement) – This presents the company's Revenue or Turnover, Cost and Expenses, Net Earnings, Earnings per share.
  2. Balance Sheet (or Statement of Financial Position) – This presents the company’s Assets, Share Capital and Liabilities, and lastly
  3. Statement of Cash Flows – This presents the company's Cash Inflow and Outflow

Let’s start with a simple example and see how we generate the Financial Report.

Mr Lee started a Sushi Business. He invested RM1,000,000 of his own money as the business capital. Next he went to a bank and borrowed RM500,000. He is to pay back the total borrowed amount at the end of 5th year and during this period, he is to pay an annual interest of 5%. So he has RM1,500,000 to start.

Next Mr Lee spent RM800,000 to buy a shop unit, equipment and spent on renovation. He then spent another RM500,000 to buy food and beverage for the business. He kept RM100,000 as cash on hand and the balance of RM100,000 was deposit in bank with 3% annual interest.

A year later, Mr Lee sold all the food and beverage, and recorded Revenue of RM1,000,000. He has hired 10 workers with wages of RM2,000 / month. Fixed Assets depreciate 2.5% annually. Other cost and expenses amounted to RM36,000 over the first 12 months. Income tax is 26%. The company offers customers 60 days credit term so RM200,000 of earnings have not been received in cash yet. In addition, his suppliers offered him credit term so the company still has RM100,000 to pay to his suppliers.

OK, now let’s take a look at the income statement - this statement only records the company's revenue, cost and expenditure:

Next is the Cash Flow Statement. Statement of cash flows is divided into three segments: Operating, Investing, and Financing. This Statement records only "cash transacted item". Any income and expenses that haven received or paid in cash will contra off in this statement.

Finally, we look at balance sheet, this statement records value of all assets, Shareholders' Capital, and the Liabilities.

Both the Total assets and Total Equities & Liabilities must be tally.

Now, I am sure you know how a financial statement was constructed and which figures are important. Which figures you would prefer to increase over time: Revenue, Net Profit, Net Cash, etc.? And which figures you would like to see them decrease over time: cost, expenses, liabilities, etc.?

If you do not understand any of this or you have further enquiries, you can contact the author by clicking the “Contact tab” at our website and send us an email.

**In next article, we will teach you some of the important figure that should look at, as well as financial ratios analysis.

By the Young Investors Team