What is financial reporting and what is it for

2024 Author: Malcolm Clapton | [email protected]. Last modified: 2023-12-17 03:44

It is enough to study a few lines.

Why should an investor watch financial statements

When a person is just starting to invest, he often wants to invest in companies after articles by journalists or reviews of friends. However, investing on emotions without relying on facts is not the right approach. It is important not to collect stocks of well-known brands, but to find sustainable and fairly priced businesses.

Financial reporting helps with this. On its basis, you can determine the current position of the company, the prospects and difficulties that it faced. For example, if profit has turned into a loss, and debt has increased, they will write about this in the report.

Finding the data you want is not that hard. Laws require public companies to regularly publish information about their finances. And although usually such reports are complex documents of one hundred or even two hundred pages, it will be enough for novice investors to look at a few lines for an initial business assessment.

What reporting standards are there and what to look at

A private investor should be aware of the three main reporting standards: RAS, IFRS and GAAP. Here's what to look for in each.

What an investor should look at in a RAS report

All public domestic companies comply with Russian accounting standards. It is not quite suitable for an investor, because calculations and data calculation features are needed rather by accountants or tax auditors. But sometimes there is no choice.

Suppose an investor wants to take a closer look at the Magnit retailer. The company publishes several reports, we need "Accounting Statements" for the last full year. The investor will find almost everything he needs on the first three pages.

In the balance sheet, the investor will find mainly accounting indicators, but they can be useful to him too:

• Cash and cash equivalents. Shows how much money the company has on the accounts - if you can't buy goods, pay off contractors or renovate a store, you will have to borrow. This will reduce the potential profit of the firm and the investor.
• Balance. Reflects all assets that are: from intellectual property and deposits in the bank to debts to counterparties. This is an estimate of everything that the firm owned during the year.
• Capital and reserves. Demonstrates where the company gets its own funds from. From the financial point of view, there is only "retained earnings", the rest is more about accounting movements of money on paper.
• Long term and Short-term liabilities. List of external funding sources - from loans to tax deductions.

But the financial report on the third page is closer to the interests of the investor:

• Revenue. Indicates how much the firm sold goods for the year.
• Interest receivable. Reflects how much the retailer earned on loans to other legal entities. For example, for agreeing to pay a logistics company in advance for six months.
• Percentage to be paid. Debts of the firm, for example, for deferring payments to suppliers of goods.
• Profit before tax. Shows how much the corporation earns before taxes; a measure of the net business performance.
• Net profit. Reflects how much real money the firm received after all mandatory payments.

It is useful for an investor to know about depreciation - shops, equipment and warehouses decay over time, so you need to take into account their future repair or resale. Information about this is in a separate block of explanations to the reporting.

What an investor should look at in an IFRS report

The International Financial Reporting Standard is the best option for an investor, because it was invented just for him. The data are basically the same, they just calculate them a little differently - it turns out a little closer to reality.

Sometimes even Russian companies publish a report in English, but all the main lines and indicators remain in the same places. Let's say an investor decides to study Gazprom's business. He looks for a report on the company's website and again takes all the data from three pages.

The downside is that sometimes it is not easy to find the required string. For example, the oil and gas company refers to “interest receivable” as “finance income” and “depreciation” as “capital investment”.

What an investor should look at in a GAAP report

Generally accepted accounting principles - in fact, the same RAS, but for American companies. It makes sense for an investor to understand this too, because the US stock market is strong and many people around the world are investing in it.

It is not easy to understand it, if only because not all companies publish their reports in a prominent place. And those that are published are sometimes not so easy to understand. Let's say an investor wants to add a few cars to his portfolio - and immediately reads a report from the electric car manufacturer Tesla. To do this, look at the Consolidated Financial Statements section (English consolidated financial statements), and in it there are three already outwardly familiar tables.

The investor will see two features of American reporting that are atypical for RAS and IFRS:

• The fiscal year is not equal to the calendar year. If you want to look at the annual results, then you have to wait for spring. For example, the fiscal year 2020 ended on March 31, 2021.
• Data is published creatively. It is sometimes convenient to analyze metrics between quarters, but most investors will have to add numbers from four columns before they see the totals.

What to do with data from financial statements

First of all, they should be put in order. Any table will do for this: even in a paper notebook, even in Excel. Collecting metrics from different companies in one place makes it easier to compare them.

	"Magnet", RAS	Gazprom, IFRS	Tesla, GAAP
Cash and cash equivalents	2.86 million rubles	1034, 92 million rubles	$ 19.38 billion
All assets	234.17 billion rubles	23 352, 19 billion rubles	$ 52.15 billion
Capital	127.74 billion rubles	14,804.73 billion rubles	$ 52.15 billion
Commitments	106.42 billion rubles	8547, 45 billion rubles	$ 28.42 billion
Revenue	0.76 billion rubles	6321.56 billion rubles	$ 3.15 billion
Interest receivable	6.66 billion rubles	747.4 billion rubles	$ 30 million
Percentage to be paid	(5, 60 billion rubles)	(1,365.52 billion rubles)	($ 75 million)
Profit before taxes	28.26 billion rubles	133.47 billion rubles	$ 1.15 billion
Net profit	28.13 billion rubles	162.40 billion rubles	720 million dollars
Depreciation	0.03 billion rubles	1522.57 billion rubles	620 million dollars

Assess the state of the business

When you have data on a business, you can calculate its effectiveness - calculate the multipliers. These are special indicators with the help of which it is realistic to compare firms of different sizes. You just need to find out the market capitalization of the company: this data can be easily found in the broker's application or on a special screener site like Yahoo Finance, Zacks or Investing.com.

Critically examine analysts' opinions

If an investor sees how much the company is earning or owed, then he can better understand the calculations of investment analysts. If you combine your own analysis with the opinion of professionals, it will be easier to judge whether the company is worth the investment.

Data can also help you avoid getting emotional when journalists talk about disruptive technologies or impending crises. With information on hand, it will be possible to deal with waves of heterogeneous information.

Understand how financial services work

It is not even necessary to bury yourself in reports before evaluating an interesting company. It is enough to do this several times to understand where the indicators are published and how everything looks in the original source.

After that, you can use special services, or screener sites that automatically collect data from reports in one place and even calculate multipliers. All this will save time, and the results can always be double-checked.

What is worth remembering

1. Public companies always share information with investors, but there are different reporting forms - RAS, IFRS, GAAP. If possible, it is better to look at IFRS.
2. It is not difficult to study the financial statements - all ten indicators important for a private investor are located on 2-3 pages, you do not need to read the entire 200-page document.
3. It is easier to take data from screener sites, but it is important to understand where they come from there - and, if necessary, double-check in the original source.
4. Financial indicators are useful for analyzing companies and assessing business performance using multipliers.