It isn't easy. Even accountants get confused by the way financial statements are presented. The purpose of this article is to highlight certain numbers and explain what they mean, and why they are important to note. In particular, we will focus on the balance sheet, income statement and the cash flow statement.

Balance Sheet
The balance sheet is a snapshot of a company's financial state at a particular moment in time. If a balance sheet is dated, as at 31 December 2001, it means on that day, in that year, that was the state of financial affairs. It would be different on another day, or another year. The balance sheet reveals the asset value of the company. By comparing the current assets and the current liabilities, the resulting surplus is supposed to be a guide to the company's liquidity and its ability to pay its bills on time. However, companies can manipulate the categorisation of liabilities and assets such that even those that are in financial trouble often report a sound current ratio (current assets /current liabilities).

To begin with, look for the shareholders' funds or shareholders' equity which represent money paid to the company for the business' future expansion. The company is expected to give dividends to its shareholders in return for the funds.

There is also the minority interests which arise when one company owns a part of another company. They are the outside shareholders' share of subsidiary companies that are partly-owned by the group company.

Why is it important to know these numbers? The ratio between the various sources of finance is crucial in assessing the risks the directors are taking in funding a company. The easiest to understand is the percentage of shareholders equity plus minority interests to the total funding. This is called the equity ratio and it tells the lenders and suppliers how much is available to them in the form of shareholders' funding. An equity ratio of over the generally accepted minimum of 40% indicates that the company is relatively low-geared and therefore not taking excessive financial risks. The lower the equity ratio, the higher the gearing and greater is the financial risk assumed by the company. Nevertheless, remember that it important to compare with what is prevailing in the industry. How are other companies in the industry doing? Are they equally low or high in gearing?

Looking at assets
Property, plant and equipment used to produce the goods usually incur high costs such as depreciation and maintenance, and as such if the percentage of such assets to the total assets yield a high number, this means that the company's business is more likely to be affected by fluctuations in the business cycles.

Long-term investments are investments the company have in other businesses in the form of shares, loans and other financial instruments and they tie up cash. Generally, large increasing amounts in long-term investments need further investigation as to why this company is acquiring such assets.

The other assets of stocks (or inventory), debtors and prepayments represent the day-to-day assets required to run the business. Excessive levels of stocks and debtors may indicate that a company is having trading or collection problems. These figures need to be compared with the annual revenue. If the annual revenue has gone down compared to previous years while the stocks and debtors have risen, there could be cash flow problems. Yet, large amounts of surplus cash could mean a number of things, one of them being that the company has borrowed money from a financial institution such as a bank. What is the money for?

Generally, the above information from the balance sheet gives us a feel of the gearing of the company. Is it operating on too much borrowed money? How much assets are tied up and how much liquidity is there? Are there a lot of stocks and debtors compared with revenue received?

Another point to note in the balance sheet is the item "Reserve" usually after "Share capital". What is posted under reserve can affect the net assets of the company, and therefore increase or decrease the shareholders' wealth. To see what is included under reserves, you would need to refer to the notes. Revaluation of assets is reflected here. If the company has substantial overseas operations or owns shares of companies overseas, currency differences arising from the translation of these foreign subsidiaries or investments will be reflected here. Such information under "Reserve" can affect the overall shareholders' wealth and are therefore worth looking at.