Corporate Finance Explained: Analyzing Financial Statements
All right, so we both know that you're a pro when it comes
to corporate finance, but today we're taking
this deep dive into financial statement analysis. And the
twist is we're going way beyond just what you
see in a textbook. We're going to look at actual companies.
And we're going to use their financials to
understand how to spot opportunities, assess risks, the
whole nine yards, so you can ultimately make
smarter decisions. It's like a financial health checkup.
Yeah, exactly. It's like a financial health
checkup for some of the biggest names out there. For
some of the heavy hitters. Yeah. Yeah. Apple,
Tesla, Amazon. Oh yeah, we're talking big. Product-yums.
So, okay, before we get into the nitty gritty
of specific companies, let's just do a real quick recap
of what the three major financial statements
are all about. Sure. Income statement, balance sheet,
cash flow statement. You're probably pretty
familiar with these, but it never hurts to kind of refresh,
right? Absolutely. Yeah, always good to
have a refresher. Okay, so... The income statement, think
of it as like a company's report card. Okay.
It shows how they've been doing over a certain amount
of time, and it highlights things like their
revenue, their expenses, and then ultimately that bottom
line, the net income. Yeah, yeah. So, that
tells you how much profit or loss they've made. So if
you're thinking about investing in a company,
you're definitely going to want to look at that income
statement, right? Absolutely. So, that's the
goal they've been. Yeah. Okay, now we've got the balance
sheet, and this is always what I kind of
picture as like a snapshot in time. Right, right. It's
like we freeze everything and just get a glimpse
of what they own, which is the assets, and then what
they owe the liabilities. And the difference
between those two is basically what represents the
shareholders' equity. Right, right. Okay, so you
would look at a balance sheet to see if a company has
enough assets to cover its debts. Absolutely,
yeah. Which can give you an idea of like their financial
risk. It's a big one. Okay, and then finally
we've got the cash flow statement. Right. Which, as the
name suggests, is all about where the cash is
flowing in and out of the company. Exactly, and this one's
really important. Yeah. Because it shows you
how they generate cash from their operations. Okay. How
they invest that cash. Right. And how they're
financing their activities. Mm-hmm. So, it can tell you
a lot about their ability to generate cash, to
fund their growth, to pay dividends, all that time. So,
this is like the big point here. Yeah. These
statements don't just exist in isolation from each other.
No. It's when you start analyzing them all
together that you really start to see some insights, right?
That's where the magic happens, really, is
it's like putting together a puzzle, right? Yeah. Each
statement provides a piece, and when you combine
them, you get that full picture of how healthy a company
is financially. Yeah, yeah. And to really
unlock the secrets within these statements, and we have
to use things like ratio analysis. Ugh, yes.
Ratio, okay. So, ratios, these help us make sense of the
numbers by comparing them in different ways,
right? So, we can compare a company's performance over
time, maybe benchmark them against their
competitors. Right. Even spot potential red flags. Exactly.
Before they become huge problems. Yeah,
exactly. Like before they blow up. Yeah, yeah. One of
the most commonly used ratios is the debt to
equity ratio. Yeah. And this helps us assess a company's
financial leverage. Okay. So, let's take
Netflix, for example. Okay. They've relied a lot on debt
to fund all their content production. Yeah,
all those original shows. All those shows, right. So, back
in 2017, their debt to equity ratio was over
4.5x. Wow. Meaning, they had significantly more debt
than equity. So, they were really going all in.
They were going for it, yeah. But that amount of debt
has to come with some risks, right? Absolutely.
High leverage can be great for growth, but it can also
make a company really vulnerable, especially if
their growth slows down. Yeah. And that's exactly what
we saw with Netflix in 2022. They had that big
subscriber slump. Right. And that raised concerns because
when your revenue growth kind of stalls, it's
a lot harder to service all that debt. Right, right. That
makes sense. So, a high debt to equity ratio
that might be like a little warning sign. It could be,
yeah. That a company is taking on too much risk.
Especially in a fast changing industry like streaming.
Yeah, yeah, for sure. And that's just like one
example of how these ratios can help you really dig into
a company's financials. Yeah. But we also have
to consider trends over time too, right? Absolutely. Trend
analysis is crucial because it can show us
those patterns and you can kind of spot those turning
points. Okay. Let's look at Meta, you know,
formerly Facebook. Yeah. Their revenue growth looks amazing
on the surface. It went from $56 billion in
2018 to over $113 billion in 2022. That's incredible.
Right. That's huge growth. It is. But there's
always more to the story. No, I bet there is. So during
that same period, their costs and expenses also
shot way up. Really? And that's because of all their big
investments in the Metaverse and AI. Yeah. So
this raises an important question for investors. Okay.
Can they keep up this kind of revenue growth
while they're pouring billions into these new ventures?
That's a big question. Yeah. It's something you
really want to think about carefully before making any
investment decisions. For sure. Yeah. So, you
know, you see that even with a company like Meta, right?
Right. That seems like they can do no wrong.
You can't just look at like the top line revenue growth.
Exactly. Those ballooning costs. I mean,
whether it's for the Metaverse or AI, it really adds like
a layer of complexity. It does. And even with
like the straightforward metrics like revenue and
expenses, context is everything. Okay. Take
inflation, for example. If a company's costs are going
up because of inflation, that might not be a
sign of like bad management. Yeah. Might just be the
economy. So it's about connecting the dots, right?
Absolutely. We can't just look at these statements like
in a vacuum, right? You have to think about all
these other forces. You have to think, are these changes
because of something internal? Yeah. Or are
they driven by inflation, interest rates, what's going
on globally? It's like you're a financial
detective. Yeah. That's a great way to put it. You're
gathering clues, trying to piece together the
whole story. That's it. But, you know, detectives have
to be careful about like misleading information.
Oh, for sure. And companies, well, they can be a little
creative sometimes. Absolutely. They can be
accounting to try to make things look a little rosier
than they actually are. That happens all the
time. So what are some of those red flags we should be
watching out for? What could suggest that maybe
something fishy is going on? Well, you know, if a company
suddenly changes their accounting policies.
That's always a bit of a red flag. Yeah. Also, if their
revenue is growing way faster than everyone
else in their industry, that might be worth a closer
look. Yeah. Of course, like any unexplained
transactions or things that just don't seem to add up.
Right. So anything that's just too good to be
true or it doesn't make sense. Exactly. You always
got to be a little skeptical. Yeah. Trust but
verify, as they say. So speaking of decisions, let's
bring this back to the real world. How can we
actually use all this financial statement analysis to
make better decisions, whether we investors or
running our own business? So if you're thinking about
investing in a company, it's kind of like doing
your due diligence before you buy a house. You wouldn't
buy a house without getting it inspected. No
way. You want to make sure the foundation's good, no hidden
problems. You want to be sure you're making
a good investment, not like a gamble.
Exactly. And it can be
just as valuable if you're making
decisions inside a company.
So say you're a manager and you're trying to decide if
you should launch a new product or
expand into a new market.
Looking at your financials can really help you figure
out if you have the resources to do it. So it's
like using the numbers to kind of inform your strategy.
That's a great way to put it. Make decisions
that are backed up by data. And by tracking your performance
over time, you can really see what's
working, what's not and make changes as you go. It's
like having a financial GPS. I love that, a
financial GPS. Yeah, guiding you to success. But even
the best GPS can't predict everything, right?
That's true. There are things that the numbers can't
tell you. Right. We can't forget about the
qualitative side of things. Things like how good is the
management team? What's their reputation like?
What are their competitive advantages?
What's going on in the industry?
Even things like regulatory changes. Those
can all have a huge impact.
So it's like looking at a beautiful house, but not
realizing that the foundation is on shaky ground.
That's a perfect analogy. Yeah. A company could have
amazing numbers, but if they have a bad reputation
or their industry is going downhill, those numbers might
not be telling the whole story. So how do we
incorporate those qualitative factors into our analysis?
It's hard to put a number on things like
reputation or management competence. It's definitely
a challenge. There's no easy answer. It takes
research, critical thinking, and honestly a bit of intuition
too. So we really have to do our homework.
Read industry reports, talk to experts. Really try to
understand the company's position. And ask the
right questions like what are their strengths and weaknesses?
What opportunities are out there? What
threats are they facing? What's their strategy and are
they actually executing it? So it's about going
beyond just the balance sheet and getting a feel for
the company as a whole. And that's where
experience and judgment come in. There's no formula for
this part. It's more of an art than a science.
It's like an essential art. It is. If you want to master
this by combining the rigorous analysis with a
real understanding of those qualitative factors, you can
get a really complete picture. And that's what
makes a good analyst great, right? I think so. It's not
just crunching numbers. It's understanding the
story they're telling you and using that knowledge to make
good decisions. Okay. So we could talk about
this forever, but we are running a little short on time
for today's deep dive. But before we wrap up, I
do want to leave our listener with one final thought.
Okay. I'm all ears. What is it? Think of
financial statements like a window into a company's soul.
They show you their values, their priorities. Wow.
That's a powerful way to put it. Yeah. Their
strengths, their weaknesses. Yeah. And to read these
statements. We can understand not just their
financial health, but also their character. Exactly. And
that can be incredibly valuable. Not just for
financial decisions, but for just understanding how
business works. So let's all go out there and be
these master interpreters of financial souls, using
our knowledge to make the world a little bit
better. I love that. And on that note, I think
it's time to wrap up this deep dive.
All right. That's a wrap for today. Yeah. Thanks for
joining us. That was a really interesting point
you made about financial statements being like a window
into a company's soul. Yeah. It really makes
you think about how there's actual people behind all these
numbers. Exactly. And that kind of brings us
to another important part of doing this kind of analysis.
Okay. Understanding the people who are
actually running the company. So you're talking
about the management team. Yes. Exactly.
Ultimately, companies are run by people. And those people,
they make decisions that can make or break
the company. So even if a company's numbers look great
on paper, we should still be thinking about
how good is the leadership? Absolutely. You want to look
at their track record, their experience, their
vision for the future. Are they competent? Do they have
integrity? Do they have a plan for dealing with
all the challenges and opportunities that are out there?
It's like a ship with a great engine isn't
going to get very far if the captain
doesn't know where they're
going. Exactly. And it's not just the
top executives either. Oh, okay.
The quality of the whole workforce matters. Their
skills, their motivation, how well
they can adapt to change.
All of that stuff can affect a company's performance
even if you don't see it directly in the
financials. So we have to think holistically then, right?
Yes. Not just numbers. Not just numbers. But
the people too. Exactly. Okay. But there's one more piece
of the puzzle we haven't really talked about
yet. The broader economic environment. Right. Even the
most financially stable company can be hit by
things that are totally outside of their control. Like
what kinds of things? I mean, think about the
pandemic, supply chain problems, interest rates going
up. All of that can have a huge impact on a
company no matter how good their numbers look. So you're
saying we can't just analyze the numbers on
their own. We need to understand the big picture. You got
it. The macroeconomic stuff that's happening.
You have to think about inflation, interest rates, consumer
competence, government regulations. All of
that can affect a company's ability to succeed. And we
can't forget about competition either, right?
Oh, absolutely not. Like a company could have awesome
financials. But if they're up against some fierce
rivals or if their industry is shrinking, that's a problem.
You need to know who they're competing
with. Yeah. What their strengths and weaknesses are.
How do they stack up? Are they innovating? Are
they gaining market share? Are they keeping up with the
times? It's a lot to think about. That is. So
financial statement analysis is really like just the
beginning. It is the starting point. We need to
understand the company, the industry, the whole economic
landscape. We got it. It's a really smart
decision. I couldn't agree more. This whole deep dive
has been so eye-opening. I feel like I have a
much better handle on how to do this kind of analysis
and use it to actually make better decisions.
That's great to hear. And remember, this is a journey,
not a destination. Keep learning, keep asking
questions, keep getting better. The more you understand
about finance, the better equipped you'll be to
handle whatever comes your way. Well said. I think on
that note, it's probably time to wrap up this
deep dive. Sounds good. Thanks for
joining us on this journey
into financial statement analysis.
We hope you found it useful.
