Key takeaways
- Financial statements tell three stories: how the company makes a profit, how it uses cash, and where it is exposed to risk.
- The useful way to read them is to compare two years and ask why each figure changed.
- In the example, revenue grows 25%, but profit falls, cash drops by THB 10 million and debt rises by THB 18 million.
The financial statements arrive on the owner's desk. The owner opens them at the net profit line, nods and closes the file. It is like receiving a multi-page annual health check and reading only the last line to see whether it says normal or not. The values that are starting to look abnormal, and their trend, which is the most valuable information, are skipped.
Owners do not need to be accountants. They only need to know what question each statement answers, and then ask the accountant targeted questions.
The three stories the statements tell
Story 1: How does the company make a profit?
Read this from the income statement. Look at growth, gross margin, expenses as a percentage of sales, and interest. The key question is whether profit comes from selling more or from selling better.
Story 2: How does the company use cash?
Read this from the cash flow statement. Separate cash from operations, investing and financing. The key question is whether the business can generate its own cash or depends on borrowing.
Story 3: Where is the company exposed to risk?
Read this from the statement of financial position. Look at receivables, inventory, short-term debt and equity. The key question is: if something unexpected happens, what does the company have to fall back on?
Notes to the financial statements
These give details that the numbers cannot, such as accounting policies, related-party transactions, commitments and litigation. Always read the last two first.
Example: revenue grows, but health worsens
A hypothetical trading company. Figures are in THB million.
| Item | Prior year | This year |
|---|---|---|
| Revenue | 80.0 | 100.0 |
| Cost of sales | 54.4 | 71.0 |
| Gross Margin | 32.0% | 29.0% |
| Selling and administrative expenses | 16.0 | 19.0 |
| Interest | 2.0 | 3.5 |
| Net profit after 20% tax | 6.08 | 5.20 |
| Closing cash | 14.0 | 4.0 |
| Trade receivables | 10.0 | 20.0 |
| Inventory | 9.0 | 17.0 |
| Trade payables | 6.0 | 8.0 |
| Interest-bearing debt | 30.0 | 48.0 |
| Equity | 40.0 | 42.0 |
Story 1 Revenue grows 25%, but net profit falls 14.5% because gross margin drops by 3 points and interest increases. Reading revenue alone would lead straight to the wrong conclusion.
Story 2 The cash flow in this example, assuming depreciation of THB 3 million, investment of THB 17 million and dividends of THB 3.2 million.
| Cash flow (THB million) | This year |
|---|---|
| Net profit + depreciation | 8.2 |
| Increase in receivables and inventory, net of payables | (16.0) |
| From operations | (7.8) |
| Investment | (17.0) |
| Net new borrowing 18.0 less dividends 3.2 | 14.8 |
| Change in cash | (10.0) |
Story 3 D/E rises from 0.75 to 1.14 times. EBIT to interest falls from 4.8 to 2.9 times. The collection period increases from 46 to 73 days, and inventory days rise from 60 to 87 days.
In short, the company is buying growth with borrowed money while the profit on each baht of sales is shrinking. Borrowing to invest is not wrong, but there must be an answer to when the THB 17 million invested will generate cash in return.
Five questions to ask the accountant
- Excluding one-off items, what is this year's normal profit?
- Did gross margin change because of price, cost or product mix?
- How much of the receivables are overdue by more than 90 days, which customers do they sit with, and has an allowance been made?
- Which inventory has not moved for more than six months, and what is it worth?
- Which debts or commitments fall due in the next 12 months, and what funds are there to cover them?
The statements of a property developer are read differently, because land and WIP are inventory, customer advances are a liability, and a loss before transfers begin may be a normal picture. Read them together with the sales report and the construction progress report.
A fifteen-minute reading order
Start with closing cash and debt falling due within 12 months, because these cannot wait. Then look at revenue and gross margin against the prior year, and open the cash flow statement to see whether cash from operations is positive. Next, check receivables and inventory against sales, and finish with the notes. If any figure has changed by more than ten percent, write it down as a question. You do not need to find all the answers yourself.
A good set of statements does not mean there are no problems, and an unattractive set does not always mean the company is in bad shape. In a year of heavy investment, cash may fall as planned. What to look for is whether the explanation is consistent with the numbers, and whether there is a plan to deal with the risks you can see.
Next steps
- Ask for comparative statements covering at least two periods, with the differences shown in baht and as a percentage.
- Set aside time once a month to review the statements with the accounting team, using these three stories as the agenda.
- Choose no more than six key ratios, and keep the same calculation method in every period.
- Always read the notes on related-party transactions, guarantees and debts nearing maturity.
- Record the answers and who is responsible, so you can follow up next month.