This post includes topics addressed in further detail, and with a forest industry case study and summary financials, in the (virtual) Applied Forest Finance course on March 14^th, 2024.

Investment capital is constrained and limited in most industries, especially in forest products. Successful, profitable firms can accumulate capital for reallocation into new ventures and projects. Unsuccessful firms have their assets liquidated for reallocation by others. Ouch.

During these adventures, investors and executives monitor the economic performance of businesses with three reports: the income statement, the balance sheet, and the statement of cash flows. Here are a few observations about these tools and how to use them:

Income Statement

The income statement provides a snapshot of financial performance. It is not cumulative, but captures revenues received and costs incurred for a fixed period, such as during a quarter or fiscal year. The intent of the income statement is to quantify earnings generated from core operations of the business.

Observation: Cash, not net income, is the most important measure of value and performance. Interestingly, net income (profit) often takes the lead in discussions of financial performance. A friend and former client of mine used to remind us that “cash is a fact; profit is an opinion.” In other words, net income is an accounting number and may not reflect cash flow health.

Balance Sheet

The balance sheet measures cumulative performance. It also details the total investment (capital employed) in a business.

Observation:  Working capital is an important balance sheet item. It includes the short-term investment needed to operate the business day-to-day. Working capital plus fixed assets equate to capital employed.

Statement of Cash Flows

The statement of cash flows, also called the statement of changes in financial position, may be the most important and underappreciated financial statement. Taking the time to understand this statement will provide you with a clear picture of how much cash the firm generated during the period and how the firm used that cash.

Observation: Few things, if any, are more important for financial analysis than understanding cash flow.

Conclusion

Quarterly financial statements and annual company reports are the language of investors and executives, inside and outside of the forest industry.  At the end of the day, the results of managerial business and capital allocation decisions get translated through audited financial statements, which, like haikus and baseball box scores, require interpretation and translation.  While investors and analysts claim to like transparency, the reality is the reading and interpreting of financial statements requires practice and patience (and interest).