What you need
- Balance Sheet — Snapshot of what company owns (assets), owes (liabilities) & shareholder value (equity)
- Income Statement — Revenue minus expenses = Profit. The movie of a company's performance over time
- Cash Flow Statement — Follow the actual money. Profit can be faked, cash flow cannot
- The Golden Rule — Assets = Liabilities + Equity. If it doesn't balance, something's wrong
- Red Flags Hide in Footnotes — Always read notes to accounts. That's where problems hide
- Ratios Need Context — Compare with peers, history, and industry averages
The 3 Financial Statements Overview
Every publicly traded company must publish three essential financial statements. Master these, and you'll understand any business on earth.
Balance Sheet
- Shows position at a specific date
- What company OWNS (Assets)
- What company OWES (Liabilities)
- What's LEFT (Shareholder Equity)
Income Statement
- Shows performance over a period
- Revenue (Top Line)
- Expenses & Costs
- Net Profit (Bottom Line)
Cash Flow Statement
- Tracks actual cash movement
- Operating Cash Flow
- Investing Activities
- Financing Activities
"Accounting is the language of business. If you don't understand the language, you can't understand the business."
— Warren Buffett
Balance Sheet = Photograph
A snapshot at a single moment. March 31, 2026 — what does the company look like on that exact day? It doesn't tell you the journey, just the current position.
Income Statement = Movie
The story of what happened during a period (quarter or year). How much did they sell? What did it cost? Did they make money? The full narrative.
Cash Flow = Bank Statement
The truth detector. Profit is an opinion, cash is a fact. This shows real money coming in and going out. Many "profitable" companies go bankrupt for lack of cash.
Contrarian Take
Everyone's worried about Meta's metaverse spending. They should be. But what they miss is that Meta's AI advertising engine is so far ahead, they can burn $10B yearly on moonshots and still dominate.
Balance Sheet Explained (With Visual)
The balance sheet follows one fundamental equation that ALWAYS holds true:
What you OWN = What you OWE + What's LEFT for shareholders
ASSETS (What We Own)
Resources that generate valueLIABILITIES + EQUITY
How assets are financedKey Balance Sheet Metrics to Check
- Current Ratio = Current Assets ÷ Current Liabilities — Above 1.5 is healthy. Below 1 means potential liquidity crisis.
- Debt-to-Equity = Total Debt ÷ Shareholders' Equity — Lower is safer. Above 2 needs investigation.
- Book Value Per Share = Equity ÷ Shares Outstanding — Floor value of the stock.
- Working Capital = Current Assets - Current Liabilities — Positive means company can pay short-term bills.
Income Statement Breakdown
The income statement (also called P&L - Profit & Loss) shows how revenue flows down to profit. Think of it as a waterfall — money flows from top to bottom.
Key Margins to Track
Cash Flow Statement Decoded
The cash flow statement is the ultimate truth-teller. Profits can be manipulated; cash cannot. It's divided into three sections:
Investing Activities
Cash spent on long-term assets
Financing Activities
Cash from/to investors & lenders
The Cash Flow Golden Rule
Operating Cash Flow should be HIGHER than Net Income. If a company reports ₹100 Cr profit but only ₹50 Cr operating cash flow, something's off. The profit is "low quality" — probably stuck in receivables or inventory. Consistently negative operating cash flow despite profits is a major red flag.
Free Cash Flow — The Ultimate Metric
This is the real money available for dividends, buybacks, debt repayment, or reinvestment
How the 3 Statements Connect
The three statements are deeply interconnected. Understanding these links reveals the complete picture.
Net Income → Retained Earnings
Profit from Income Statement flows to Balance Sheet's equity section as Retained Earnings (minus dividends paid).
Cash Flow → Cash Balance
Net change in cash from Cash Flow Statement updates the Cash balance on the Balance Sheet.
CapEx → Fixed Assets
Capital expenditure on Cash Flow increases Property & Equipment on Balance Sheet.
Debt Changes → Balance Sheet
New loans or repayments in Financing Activities change the Liabilities section.
"The balance sheet tells you what you have, the income statement tells you what you did, and the cash flow statement tells you where the money went. Together, they tell the complete story."
— Howard Marks, Oaktree Capital
Essential Financial Ratios
Ratios transform raw numbers into actionable insights. Here are the must-know ratios:
Red Flags to Watch For
Operating Cash Flow < Net Income (Consistently)
If a company shows profits but can't convert them to cash, earnings quality is poor. Revenue will likely be recognized aggressively, or receivables are piling up. Watch for this ratio being below 0.8x for multiple years.
Rapidly Growing Receivables (Faster Than Sales)
If receivables grow faster than revenue, company should be stuffing channels or struggling to collect. Days Sales Outstanding (DSO) increasing quarter after quarter is a major warning.
Inventory Building Up
Inventory growing faster than sales means products aren't selling. Could lead to write-downs, lower margins, or obsolescence. Check inventory turnover ratio trend.
Related Party Transactions
Excessive transactions with promoter-owned entities can be used to siphon money. Always check the "Related Party Transactions" note in annual reports. If complex or unusually large, be suspicious.
Auditor Qualifications or Changes
If the auditor flags issues or if the company frequently changes auditors, run. A qualified opinion or auditor resignation is a massive red flag indicating potential fraud or disagreements.
Pledged Promoter Holdings
If promoters have pledged shares as collateral for loans, they may be financially stressed. A share price fall can trigger margin calls, forced selling, and a death spiral. Check pledged percentage in shareholding pattern.
Frequent Equity Dilution
Companies that constantly raise equity capital (QIP, rights issues, preferential allotment) often have poor capital allocation. Your ownership keeps getting diluted. Check how shares outstanding has grown over 5 years.
Quick Analysis Checklist
FAQs
For Indian companies: BSE India (bseindia.com), NSE India (nseindia.com), Screener.in, Moneycontrol, or the company's Investor Relations page. For US companies: SEC EDGAR database, Yahoo Finance, or the company's investor relations website. Annual reports (10-K in US, Annual Report in India) have the most detailed information including notes and management discussion.
Start with the Income Statement to understand profitability and growth. Then check the Cash Flow Statement to verify earnings quality. Finally, review the Balance Sheet for financial health and asset quality. Many investors skip straight to cash flow because it's hardest to manipulate. Always read the Notes to Accounts for hidden details.
EBITDA (Earnings Before Interest, Tax, Depreciation & Amortization) shows operating profitability before financing and accounting decisions. Net Profit is the final bottom line after everything. EBITDA is useful for comparing companies with different capital structures, but it ignores real cash costs like CapEx. Warren Buffett calls EBITDA "bullshit earnings" because it excludes real costs.
Don't compare absolute numbers — compare ratios and trends. A 5% margin expect to be excellent in retail but poor in software. Always compare against industry averages and the company's own history. Use relative valuation (P/E vs sector P/E) rather than absolute metrics. Some industries are capital-intensive (low ROE normal), others are asset-light (high ROE expected).
Yes, within limits. Common tricks include: aggressive revenue recognition, capitalizing expenses instead of expensing, understating liabilities through off-balance-sheet arrangements, and "cookie jar" reserves. That's why cash flow is crucial — it's harder to fake actual cash. Compare earnings to cash flow, read auditor notes, check for frequent accounting policy changes, and watch for transactions with related parties.