Financial statements communicate information that is useful to you. In Canada, public companies must issue annual financial statements every year and interim financial reports, also known as quarterly reports, for each three-, six-, and nine-month periods during its financial year. Once a year, a company must arrange for an auditor to audit its annual financial statements. The company’s board of directors must approve the financial statements.
Why is it Important to Review Financial Statements
Whenever a company issues annual financial statements or interim financial reports, it must also produce management’s discussion and analysis (MD&A), which provides an opportunity for management to discuss how it performed during the period covered by the financial statements or reports, along with its financial condition and future prospects. MD&A may also provide disclosure on additional areas, such as transactions with related parties and legal proceedings.
Note: Venture issuers have the option of providing a short discussion of quarterly highlights rather than the regular form of interim MD&A.
If you own shares in a company, it must send you any financial statements you request and may send you financial statements as part of their annual report, unless you choose not to receive these materials. You can also find the company’s financial statements on SEDAR and usually on the company’s own website.
What You Should Focus On
Below is a brief explanation of each statement and associated documents, along with suggestions for what to focus on as you review them.
Statement of Comprehensive Income or Income Statement or Statement of Operations
This sets out revenue and expenses for the period under review and the year-to-date. Focus on the significant components of net income/profit (or net loss) or net income/profit (or loss) attributable to common shares and compare this to the information for the prior period(s).
Statement of Cash Flows or Cash Flow Statement
Presents cash received and spent for the period and year-to-date for operating, financing, and investing activities.
- For operating activities, see if the company is bringing in more cash from operations than it is spending.
- For financing activities, see if the company raised money in this period by selling additional shares or borrowing money.
- For investing activities, see if the company spent money on new equipment or other long-lived assets (like property).
Statement of Financial Position or Balance Sheet
This presents what the company owns and owes on the last day of the period. The difference between the company’s total assets (what it owns) and its total liabilities (what it owes) is called equity or shareholders’ equity. Consider changes in the amounts for significant assets and liabilities. Also, consider whether the company will be able to settle its liabilities.
Statement of Changes in Equity
This shows the increase or decrease in the company’s net assets during the period resulting from the net income or loss generated by the company and from the transactions with owners (shareholders) of the company during the period. Any restatements to prior period amounts, whether due to errors or a change in accounting policy, are also reflected in this statement. Focus on whether the company issued shares during the period, and consider how the company used the funds raised. Also, consider if the company historically pays dividends back to shareholders.
These explain or disaggregate items presented in the individual statements. Notes describe certain items for which amounts do not appear in the statements, such as a contingent liability relating to litigation.
This accompanies the annual audited set of statements. The financial statements are the company’s records, not the auditor’s records. Check if the auditor’s report highlights any specific items in the financial statements or if it refers to a restatement. Read any notes to which the report refers.
Non-GAAP Financial Measures
When announcing financial results, or when discussing performance in the MD&A or on their website, many companies present both financial statement measures as well as additional measures we call “non-GAAP” or “non-IFRS” financial measures. These additional measures, which appear outside the financial statements, are not prepared in accordance with any accepted accounting standards. Common examples of non-GAAP financial measures include EBITDA (earnings before interest, taxes, depreciation, and amortization), adjusted earnings, or free cash flow.
Because there is no standardized meaning to non-GAAP financial measures, they can be misleading. If a company presents non-GAAP financial measures, accompanying disclosure should:
- clearly distinguish the non-GAAP measure from financial statement numbers.
- explain why the non-GAAP measure is useful.
- explicitly state that there is no standardized meaning.
- tie the non-GAAP financial measure back to a number presented in the financial statements.
Also consider whether a company presents the same non-GAAP financial measures over time – if they cherry-pick the measure to focus on every year, you may not be getting the full picture of the company’s performance.
During Your Review of the MD&A, Ask These Questions
- Does management’s explanation for any losses make sense?
- Does management have a plan to move to profitability over time and does it make sense?
If You Need Help, Consider These Options
- Ask your advisor to discuss your questions with you.
- Ask another trusted professional (your accountant, for example) to discuss your questions with you.
- Call the company and ask for a further explanation.
- Ask your question(s) at the company’s annual general meeting.