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Analyzing Individual Investments

Lesson 1: Introduction to Financial Statements

Introduction: The Importance of Financial Statements

Imagine trying to buy a business without knowing how much money it makes, how much debt it has, or whether it’s even profitable.

Sounds risky at best, doesn’t it?

That’s why financial statements are your best friend when analyzing stocks.

They show you exactly how a company makes money, what it owns, what it owes, and how cash moves in and out.

In this lesson, you’ll get a clear understanding of the three major financial statements:

Income Statement
Balance Sheet
Cash Flow Statement

Plus, you’ll see how they’re all connected, and how to read them like an investor.

The Big Three Financial Statements

To understand a company, you need to understand these three documents.

Each one tells a different part of the story.

Income Statement (a.k.a. Profit & Loss Statement)

What it shows:

A company’s revenue, expenses, and profit over a specific time (usually a quarter or year).

Key terms:

Revenue: Total money earned
Expenses: Costs of doing business
Net Income (Profit): What’s left after expenses

Think of it as a report card for business performance.

Balance Sheet

What it shows:

What the company owns (assets), what it owes (liabilities), and what’s left for shareholders (equity), all at a specific point in time.

Key terms:

Assets: Cash, inventory, property, etc.
Liabilities: Loans, unpaid bills, etc.
Equity: Assets minus liabilities = shareholder value

Snapshot of financial health, like a picture of the company’s finances.

Cash Flow Statement

What it shows:

How money actually flows in and out of the business - something the income statement doesn’t always show.

Key sections:

Operating activities: Cash from the core business
Investing activities: Buying/selling assets
Financing activities: Loans, dividends, stock issuance

This tells you if the company is actually generating cash, or just showing ‘paper profits’.

How the Financial Statements Are Connected

These three reports are part of a bigger financial story.

This is how they link together:

Income Statement leads to Net Income

At the bottom of the income statement is net income (a.k.a. profit).

This number flows into the balance sheet under “retained earnings.”
It also starts the cash flow statement, as the first line in cash from operations.

Balance Sheet is connected to the Cash Flow Statement

The cash balance at the end of the cash flow statement shows up on the balance sheet’s assets section as “cash and cash equivalents.”

And when a company borrows money (financing activity), that shows up:

On the cash flow statement as inflow from financing
On the balance sheet as a new liability

Why This is Important

You can’t understand a company’s health by looking at just one statement.
The income statement may show profits, but the cash flow statement might reveal cash problems.
The balance sheet may show growth in assets, but how it’s financed (debt or equity) matters too.

Real-World Analogy: A Company is Like a Person

To make financial statements easier to grasp, imagine a company as a person managing their own money.

Income Statement = Paycheck vs. Bills

It shows what the person earns, what they spend, and how much is left over each month.

Balance Sheet = Net Worth Snapshot

It’s like a personal balance sheet that shows:

What they own (house, car, savings)
What they owe (mortgage, student loans)
The difference = their net worth

Cash Flow Statement = Bank Activity

Even if someone “earns” a lot, it doesn’t mean they always have cash.

The cash flow statement shows:

Where money is coming from (paychecks, side gigs)
Where it’s going (rent, investments, debt payments)

All three together give you the full story:

Are they living within their means? Are they building wealth? Or just scraping by despite a good salary?

Same with companies. The numbers only make sense when you connect the dots.

Quiz

Which financial statement shows if a company is actually generating cash?
a) Income Statement
b) Balance Sheet
c) Cash Flow Statement
What does the balance sheet show?
a) A company’s profits over time
b) A snapshot of assets, liabilities, and equity
c) How much the company spent on ads last month

See the answers at the bottom

Exercise: Match the Statement to the Metric

Match each item below to the correct financial statement:
- Net Income → ________
- Total Assets → ________
- Cash from Operations → ________
See the answers at the bottom

Summary and Key Takeaways

- Financial statements tell the story behind the stock. They show how a business earns, spends, and manages money.
- There are three key statements:
- The income statement shows profits
- The balance sheet shows what a company owns and owes
- The cash flow statement shows how money moves in and out
- They’re all connected. Understanding one helps you read the others better.
- Smart investors don’t rely on headlines; they read the numbers. This is how you find strong and healthy companies.
If investing is like buying a business, these statements are how you do your due diligence.

Answers to the Quiz and Exercise Questions

Quiz Answers:

1) Which financial statement shows if a company is actually generating cash?

Answer: c) Cash Flow Statement

2) What does the balance sheet show?

Answer: b) A snapshot of assets, liabilities, and equity

3) How are qualified dividends usually taxed?
Answer: a) At the long-term capital gains rate

Exercise Answers:

Net Income = Income Statement
Total Assets = Balance Sheet
Cash from Operations = Cash Flow Statement

Additional resources

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