How to Read a Company’s Financial Statements Before Buying Its Stock

A beginner once bought a stock because “everyone on WhatsApp was talking about it.” Three months later, the company announced heavy losses and the share price crashed. The problem was not bad luck, it was not checking the financial statements of the company before buying its stock.

It is always important to do your background check on a company you want to buy its stock before venturing into it. Unfortunately, many people do not know how to read a company's financial statement.

In this article, we would explore what to look out for in a company's financial statement before buying its stock.

The 3 Statements That Matter

They are income statement, balance sheet and cash flow statement.

1. Income Statement

This shows revenue, expenses, and profit. Look for: revenue growth, net profit growth and consistent earnings. If sales are rising but profits are falling, that’s a warning sign.

2. Balance Sheet

This shows what the company owns and owes. Check: cash position, total debt and shareholders’ equity. A company with huge debt and little cash is riskier.

3. Cash Flow Statement

This is my favorite statement because cash is harder to fake than profit. Focus on Operating Cash Flow. A healthy company should generate positive cash flow from its core business.

5-Minute Stock Check

Before buying any stock, ask these questions:

• Is revenue growing?

• Is the company profitable?

• Is debt under control?

• Is operating cash flow positive?

• Has the company paid dividends consistently?

If you answer “yes” to at least four, the company is worth investing in. 

Red Flags

• Revenue falling for several years

• Negative cash flow

• Debt growing faster than profit

• Frequent share dilution

• Auditors raising concerns

Conclusion

You don’t need an accounting degree to read financial statements. Start with revenue, profit, debt, and cash flow. Those four numbers alone can help you avoid many bad investments and make more confident stock decisions.

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