Chapter 1

An Introduction to Financial Statements

Imagine that you’re a banker, and you have to determine which companies to lend to, and on what terms. Or you’re an investor who wants to know which companies are likely to outperform the market averages over the next year or two. In short, where should you invest your capital? To answer this question, investors turn to corporate financial statements.

Financial statements exist to provide useful information on businesses to people who have, or may have, an economic stake in those businesses. These statements should help:

  • investors, to make more intelligent decisions on where to put their scarce capital;
  • bankers, to determine whether or not a company will be able to service its debts;
  • suppliers, to assess whether or not a potential customer is a good credit risk;
  • customers, to determine whether or not the company is strong enough financially to deliver on long-term promises of service and warranty coverage;
  • tax authorities, to determine whether or not a company is paying its fair share of taxes;
  • trade union representatives, in forming their negotiating positions with management;
  • competitors, to benchmark their performance;
  • courts of law, to measure, for example, the damage caused by one firm to another as a result of alleged unfair trade practices;
  • antitrust regulators, to measure market share and profits relative to competitors;
  • prospective employees, to determine whether the company is worth pursuing as a long-term employer.

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