Three statements, three questions
Company accounts revolve around three core statements. The income statement, also called the profit and loss account, answers "did we make money over this period?" It runs from revenue at the top, through costs, to profit at the bottom. The balance sheet answers "what do we own and owe at this moment?" It lists assets on one side and liabilities plus shareholders' equity on the other, and the two always balance. The cash flow statement answers "where did the cash actually come from and go?" It splits movements into operating, investing and financing activities.
Listed companies in the UK, the EU and many other countries prepare these statements under International Financial Reporting Standards, issued by the International Accounting Standards Board. US companies use US GAAP, set by the Financial Accounting Standards Board. The details differ, but the three-statement logic is the same everywhere.
Profit is an opinion, cash is a fact
The old accountants' saying overstates it, but the point stands. Profit follows accrual accounting: revenue is recorded when it is earned, not when the customer pays, and costs are matched to the period they relate to. Cash is simply money in and out of the bank. A fast-growing company can report healthy profits while running out of cash, because it is paying suppliers and staff before customers settle their invoices. That gap is working capital, made up mainly of stock, money owed by customers and money owed to suppliers. Managers who shorten payment terms or reduce excess stock release cash without selling a single extra item.
The margins worth tracking
Gross margin is revenue minus the direct cost of what was sold, as a share of revenue. It tells you how much each sale contributes before overheads. Operating margin, based on operating profit (often close to EBIT, earnings before interest and tax), shows how efficiently the whole business runs. EBITDA adds back depreciation and amortisation; it is widely quoted, but treat it with care because it ignores the real cost of replacing equipment. Comparing margins over time, and against close competitors, usually tells you more than any single year's figure.
How a budget gets set
Most companies run an annual budget cycle a few months before the financial year starts. Finance issues assumptions, departments submit plans, the executive team negotiates, and the board approves the final budget. During the year, results are compared with the budget each month and differences are reported as variances. Many firms also reforecast quarterly, because a budget fixed a year earlier quickly drifts from reality. When you present a variance, explain the cause, say whether it is timing or permanent, and state what you will do about it.
Judging an investment
Spending is split into operating expenditure, the day-to-day costs that hit the income statement straight away, and capital expenditure, longer-lived assets spread over several years through depreciation. Capital requests are usually judged with three tools. Payback period asks how long it takes to recover the outlay. Net present value discounts expected future cash flows back to today at the company's cost of capital; a positive figure suggests the project creates value. Internal rate of return is the discount rate at which NPV is zero, compared against a hurdle rate. Boards like to see all three, plus the assumptions behind them.
Learning from plain-English reports
If you want to see financial communication done well, read Warren Buffett's annual letters to Berkshire Hathaway shareholders, available free on the company's website. They explain results, mistakes and accounting quirks in language anyone can follow, which is a useful model for any manager writing a finance section in a proposal.