The Three Financial Statements Every Investor Must Understand
Financial literacy is the single most underrated life skill. There are three core statements. Each answers a different question.
The Income Statement: "How much money did we make?"
Revenue (top line) - COGS = Gross Profit. Gross Profit - Operating Expenses = Operating Income. Operating Income - Taxes - Interest = Net Income (bottom line). Key ratio: Gross Margin = Gross Profit / Revenue. Software companies: 70-85%. Retailers: 25-40%.
The Balance Sheet: "What do we own and owe?"
Assets = Liabilities + Equity. Current Ratio = Current Assets / Current Liabilities. Above 1.5 is healthy. Debt-to-Equity = Total Debt / Total Equity. Above 2.0 is heavily leveraged.
The Cash Flow Statement: "Where did the cash actually go?"
Operating Cash Flow — should be positive and growing. Investing Cash Flow — usually negative for growing companies. Financing Cash Flow — shows how the company funds itself. Free Cash Flow = Operating Cash Flow - Capital Expenditures.
Red Flags to Watch For
- Revenue growing but cash flow shrinking
- Accounts receivable growing faster than revenue
- Inventory piling up
- Frequent "one-time" charges
- Declining gross margins
How to Evaluate Any Public Company in 30 Minutes
- Pull the latest 10-K from SEC EDGAR
- Check revenue growth and margin stability
- Assess debt and current ratio
- Examine operating and free cash flow
- Compare 3 years of trends
- Calculate P/E ratio vs industry peers