Reading Financial Statements with AI

Financial Statements Aren’t Scary

In the previous lesson, we explored stocks, bonds, and ETFs. Now let’s build on that foundation with the skill that separates informed investors from gamblers: reading financial statements.

Financial statements look intimidating. They’re full of terms like “amortization,” “deferred revenue,” and “EBITDA.” But here’s the secret: you only need to understand a handful of numbers to evaluate most companies.

AI makes this accessible. You can paste a company’s financial data into your AI assistant and get a plain-English analysis in seconds.

The Three Statements

Think of financial statements as three different answers to three different questions:

1. Income Statement: “Is this company making money?”

Revenue (what they sell)
- Cost of goods sold (what it costs to make/deliver)
= Gross Profit
- Operating expenses (rent, salaries, marketing)
= Operating Income
- Interest and taxes
= Net Income (the bottom line)

The analogy: Your personal income statement is your paycheck minus your expenses. What’s left is your savings (or debt).

2. Balance Sheet: “What does this company own and owe?”

Assets (what they own)
  = Current assets (cash, inventory, receivables)
  + Long-term assets (property, equipment, patents)

Liabilities (what they owe)
  = Current liabilities (bills due soon)
  + Long-term liabilities (loans, bonds)

Equity = Assets - Liabilities (the owners' share)

The analogy: Your personal balance sheet is your house, car, and savings (assets) minus your mortgage, car loan, and credit card debt (liabilities). The difference is your net worth.

3. Cash Flow Statement: “Where is the money actually going?”

Cash from Operations (running the business)
+ Cash from Investing (buying/selling assets)
+ Cash from Financing (borrowing, stock sales)
= Net Change in Cash

The analogy: Your bank account statement shows actual money moving in and out, regardless of what your income or expenses “should” be on paper.

Using AI to Analyze Statements

You don’t need to be an accountant. Use AI:

Here are the key numbers from [Company]'s latest annual report:

Revenue: $X
Gross Profit: $X
Operating Income: $X
Net Income: $X
Total Assets: $X
Total Liabilities: $X
Cash from Operations: $X

Please explain:
1. Is this company profitable? How profitable compared to its size?
2. Is revenue growing, flat, or declining?
3. Is the company financially healthy (assets vs. liabilities)?
4. Is it generating real cash, not just paper profits?
5. What concerns or red flags do you see?
6. Explain everything in plain language for a beginner.

The Five Numbers That Matter Most

You could spend weeks analyzing financial statements. Or you could focus on these five:

1. Revenue Growth

Is the company selling more over time?

Consistent growth = healthy business
Declining revenue = warning sign
Compare year-over-year, not quarter-to-quarter (seasonality)

2. Profit Margin

How much of each dollar in revenue becomes profit?

Gross margin = Gross Profit / Revenue
Net margin = Net Income / Revenue
Higher margins = more efficient, better pricing power

3. Debt-to-Equity Ratio

How much debt is the company carrying relative to what owners have invested?

Total Liabilities / Total Equity
Under 1.0 is generally healthy
Over 2.0 means the company is heavily leveraged

4. Free Cash Flow

Cash from operations minus capital expenditures.

Positive = generating real surplus cash
Negative = spending more than it earns
The most honest number on any financial statement

5. Return on Equity (ROE)

How efficiently does the company use shareholders’ investment?

Net Income / Shareholders’ Equity
Above 15% is generally strong
Compare within the same industry

Quick Check

A company reports $10M in net income (profit) but negative $5M in free cash flow. Should you be concerned?

See answer

Yes, this is a red flag. The company reports a profit on paper, but it’s actually spending more cash than it’s generating. Possible causes: heavy capital spending (could be good if investing in growth), customers not paying on time, or accounting practices that inflate reported profit. You’d want to investigate why profit and cash flow diverge before investing.

Comparing Companies with AI

The numbers mean more in context. Use AI to compare:

Compare these two companies in the [industry] sector:

Company A:
Revenue: $X, Growth: X%
Net Margin: X%
Debt/Equity: X
Free Cash Flow: $X
ROE: X%

Company B:
Revenue: $X, Growth: X%
Net Margin: X%
Debt/Equity: X
Free Cash Flow: $X
ROE: X%

Which company is:
1. Growing faster?
2. More profitable per dollar of revenue?
3. More financially stable?
4. Generating more real cash?
5. Using shareholder money more efficiently?

Which would you consider a stronger investment and why?

Where to Find Financial Data

Free sources for any public company:

Source	What You Get	Best For
Yahoo Finance	Summary financials, charts	Quick overview
SEC EDGAR	Official filings (10-K, 10-Q)	Complete data
Google Finance	Basic financials, news	Quick comparisons
Company IR page	Investor presentations	Company narrative
Macrotrends.net	Historical data and ratios	Trend analysis

Tip: Search “[Company name] investor relations” to find official financial data directly from the source.

Red Flags in Financial Statements

Watch for these warning signs:

Red Flag	What It Might Mean
Revenue growing but profits declining	Costs are rising faster than sales
Increasing debt with flat revenue	Borrowing to survive, not to grow
Cash flow consistently below net income	Aggressive accounting or collection problems
Frequent “one-time charges”	Recurring problems disguised as exceptions
Inventory growing faster than sales	Products aren’t selling

Exercise: Analyze Your First Company

Pick any company you’re curious about:

Find their financial data on Yahoo Finance or SEC filings
Extract the five key numbers (revenue growth, margins, debt ratio, free cash flow, ROE)
Ask AI to explain what the numbers mean for this specific company
Compare against one competitor using the same metrics
Form an initial opinion: is this company financially healthy?

This exercise takes 15 minutes with AI. Without AI, it would take hours.

Key Takeaways

Financial statements answer three questions: making money? (income), what do they own/owe? (balance), where’s the cash? (cash flow)
Focus on five numbers: revenue growth, profit margin, debt-to-equity, free cash flow, and ROE
Cash flow is often more honest than reported profit—watch for divergence
AI makes financial analysis accessible in minutes instead of hours
Always compare within the same industry—what’s healthy for tech differs from banking
Red flags include growing debt with flat revenue and consistent gaps between profit and cash flow

Up next: In the next lesson, we’ll dive into Portfolio Construction and Diversification.