Every listed company publishes three statements. The income statement shows profitability over a period, the balance sheet shows what it owns and owes at a moment, and the cash flow statement shows the money that actually moved.
The income statement
Reads top to bottom, from money in to money kept:
| Line | What it is | Why it matters |
|---|---|---|
| Revenue | Total sales | The top line. Growth here is the healthiest kind of growth |
| Gross profit | Revenue minus direct costs | Gross margin reveals pricing power |
| Operating income | After running costs — wages, R&D, marketing | The cleanest measure of the core business |
| Net income | After interest and tax | The bottom line, but the most manipulable one |
| EPS | Net income per share | What per-share value the business generated |
The margins matter more than the absolute numbers. A company growing revenue 30% while its gross margin collapses is buying growth by cutting price — a fundamentally different story from one growing 15% with stable margins.
The balance sheet
A snapshot on one date, governed by one identity: Assets = Liabilities + Equity. Everything the company controls was funded either by borrowing or by owners.
- Current assets vs current liabilities — can it pay what is due within a year? The current ratio (assets ÷ liabilities) below 1 warrants investigation.
- Total debt — compare to equity and to operating profit. Debt is not inherently bad; debt that earnings cannot service is.
- Cash — the buffer. Companies rarely fail because of low profit; they fail because they run out of cash.
- Goodwill — the premium paid on past acquisitions. A large goodwill balance is a future write-down risk if those acquisitions disappoint.
The cash flow statement — the honest one
If you only read one statement, read this. Profit involves judgement calls about when to recognise revenue and how to spread costs. Cash is harder to dress up.
| Section | Covers | What you want to see |
|---|---|---|
| Operating | Cash from the actual business | Positive, growing, and comfortably exceeding net income |
| Investing | Capital expenditure and acquisitions | Negative is normal and healthy — the company is investing |
| Financing | Debt, equity issuance, dividends, buybacks | Context-dependent; persistent share issuance dilutes you |
Free cash flow
Free cash flow = operating cash flow − capital expenditure. This is the cash genuinely left over after keeping the business running: available for dividends, buybacks, debt repayment or reinvestment.
Many experienced investors treat free cash flow as the number that matters most, because it is the hardest to fake and the closest to what an owner actually receives.
Ratios worth computing
| Ratio | Formula | Reads as |
|---|---|---|
| Gross margin | Gross profit ÷ revenue | Pricing power and cost control |
| Operating margin | Operating income ÷ revenue | Core efficiency |
| ROE | Net income ÷ shareholder equity | Return generated on owners' capital |
| Debt-to-equity | Total debt ÷ equity | Leverage and financial risk |
| Interest cover | Operating income ÷ interest expense | Below ~3 is a warning sign |
| Current ratio | Current assets ÷ current liabilities | Short-term solvency |
Red flags
- Net income rising while operating cash flow falls
- Receivables growing much faster than revenue — sales made, cash not collected
- Inventory growing much faster than revenue — products not selling
- Repeated “one-off” charges that appear every single year
- Heavy reliance on adjusted or non-standard earnings measures in the presentation
- Frequent changes of auditor or chief financial officer
A twenty-minute routine
- 1Revenue trend, three years
Growing, flat or shrinking? Accelerating or decelerating?
- 2Margins, three years
Stable, expanding or compressing? Compression needs an explanation.
- 3Operating cash flow vs net income
Do they move together? If not, find out why.
- 4Debt and interest cover
Can operating profit service the debt several times over?
- 5Free cash flow
Positive and growing, or perpetually promised for next year?
- 6Share count
Rising steadily? Your slice is being diluted every year.