If you want to buy a used car, you don't just kick the tires; you check the engine, the mileage, and the service history. In finance, we do this by reading Financial Statements.

Many of you fear accounting. You think it is boring. I am here to tell you that accounting is the language of business. As Warren Buffett says, if you don't know the language, you can't understand the story.

In India, every listed company must release these "medical reports" every quarter (Q1, Q2, Q3, Q4). They tell us if the company is healthy, sick, or dying.

Let’s open Chapter 6.

Chapter 6: The Three Financial Statements – The Trinity of Truth

1. The Income Statement (The Movie)

Also known as the Profit & Loss (P&L) Statement.

Think of this as a video recording of what happened over a period of time (e.g., "For the year ending March 31st"). It answers one question: Did the company make money or lose money this year?

We read this from Top to Bottom:

• The Top Line (Revenue/Sales): How much chai did Tata Tea actually sell? This is the raw money coming in.
• The Middle (Expenses): We start deducting costs.
  • COGS (Cost of Goods Sold): Raw materials.
  • Employee Costs: Salaries.
  • Depreciation: The wear and tear of machinery.
  • Interest: Money paid to banks.
  • Taxes: Money paid to the Government of India.
• The Bottom Line (Net Income / PAT): Profit After Tax. This is what is left for the shareholders.

The Indian Trap: Always check "Other Income." Sometimes, a company shows a huge profit not because they sold good products, but because they sold a piece of land or earned interest on cash. That is low-quality profit. You want profit from Operations.

2. The Balance Sheet (The Photograph)

While the P&L is a video, the Balance Sheet is a snapshot. It freezes time at a specific second (e.g., "As of March 31st"). It tells you what the company owns and what it owes.

The Golden Equation:

$$Assets = Liabilities + Equity$$

• Assets (What we have): Factories, cash in the bank, inventory (unsold goods), and brand value.
• Liabilities (What we owe): Bank loans (Debt), money owed to suppliers (Payables).
• Equity (What is left): If you sold all assets and paid all liabilities, this is what belongs to the shareholders (Promoters + You).

Key Metric to Watch: Debt-to-Equity Ratio.

In India, high debt is dangerous because interest rates are high. If a company has a Debt-to-Equity ratio > 1, be careful. If it is > 2, be very afraid (unless it's a Bank or NBFC).

3. The Cash Flow Statement (The Truth Teller)

This is the most honest statement.

Profit is an opinion; Cash is a fact.

A company can legally "show" a profit on the P&L even if they haven't collected the money yet (e.g., they sold goods on credit). But you cannot fake cash in the bank.

We divide cash into three buckets:

1. Cash from Operations (CFO): The cash generated from the core business. This must be positive. If a company has positive Net Income but negative CFO, they are likely cooking the books (manipulating accounts).
2. Cash from Investing (CFI): Cash spent on buying new factories or machines (Capex). This is usually negative, which is good, it means the company is growing.
3. Cash from Financing (CFF): Cash from taking loans or issuing shares, or paying dividends.

The Golden Rule: Look for companies where CFO > PAT (Cash from Operations is greater than Profit After Tax) over a 5-year period. This shows the company actually collects the money it earns.

4. How They Connect

You cannot read these in isolation. They are a triad.

• The P&L tells you how much profit was generated.
• The Cash Flow tells you how much of that profit actually hit the bank account.
• The Balance Sheet tells you how that cash changed the company’s financial health (did they pay down debt? Did they buy more assets?).

Summary

When you look at a stock like Reliance Industries or Infosys, do not just look at the stock price. Look at the Trinity.

• P&L: Are sales growing?
• Balance Sheet: Is debt manageable?
• Cash Flow: Is real cash coming in?

If the answer to all three is "Yes," you have a potential winner.

Class assignment:

Go to our financial screener. Search for "Asian Paints".

1. Look at the Sales for the last 5 years. Is the line going up?
2. Look at the Borrowings (Debt) on the Balance Sheet. Is it high or low?
3. Report back: Is Asian Paints a "Cash Rich" or "Debt Heavy" company?