3 Financial Problems Solved: How Financial Statements Reveal the Truth

Financial decisions can be daunting, especially when they involve significant investments or complex financial products. In this blog, we’ll explore three real-life financial problems faced by individuals and how financial statements reveal critical insights to solve them. Whether you’re investing in real estate, considering a pension fund, or looking at bank options, understanding how financial statements reveal the truth empowers smarter decisions. By the end of this blog, you’ll not only learn how to interpret financial statements but also discover resources to deepen your financial knowledge.

Problem I – Real Estate Investments

Kazim, a successful consultant in his early forties, found himself in a financial predicament due to a real estate investment. Kazim was no ordinary investor; his daily earnings surpassed the average monthly salary of a Pakistani citizen. He had invested a substantial amount in a local property company that promised a monthly return of 1% on his investment, along with a 15% annual capital appreciation. To Kazim, this seemed like a dream investment—his money was working for him even while he slept.

For the first six months, everything went as planned. Kazim received his monthly rent on time, with a reassuring message in his inbox: “Your monthly rent has been credited to your account.” However, things took a turn when the rent was delayed for the first time. The company blamed it on the financial year-end, and Kazim eventually received the payment at the end of the month. But from the 10th month onwards, delays became the norm. Sometimes the rent wasn’t credited at all, and when it was, it was often a month late. Exactly one year later, the payments stopped entirely.

When Kazim inquired, he was informed that the company was in financial distress. Not only would he not receive rent for the next year, but his principal investment would also be locked in for at least two more years. Kazim had no idea about the company’s financial health at the time of investment. He relied solely on the salesperson’s promises, never bothering to check the company’s financial statements.

When Kazim finally checked the company’s financial statements, they revealed:

• Unpaid rents to other investors
• Properties mortgaged to multiple lenders

By then, it was too late. His money was stuck, and he had no control over the situation.

Key Insight: Financial statements reveal what salespeople hide.

Problem II – Investment in Pension Fund

The second problem revolves around a pension fund investment offered to an academic institution. The fund promised an attractive annual yield and guaranteed the principal amount plus profits at maturity. However, the faculty members were hesitant to invest because of concerns about whether the investment was halal (permissible under Islamic law).

The debate among the faculty was intense. One group argued that the investment was allowed because it didn’t involve riba (interest), while others insisted it was prohibited because it did. The confusion stemmed from a lack of clarity about the fund’s sources of income and how the money was being invested. One professor, a close friend of mine, approached me for advice. He wanted to know whether the investment was halal and how he could determine its legitimacy.

I refrained from giving a definitive answer because I’m not a religious scholar. However, I was surprised to see how easily the faculty could have found the answers themselves. The information they needed was just a few clicks away—hidden in the financial statements of the pension fund provider.

Problem III – Short-term Investment at Bank with Regular Monthly Returns

The third problem involves a short-term investment in a bank’s term deposit certificate. The investor was attracted to the bank’s offer of regular monthly returns, reinvestment options, and the flexibility of premature withdrawal. However, he was concerned about the bank’s ability to honor its promises, given the country’s unstable economic situation.

In another conversation, two investors were comparing the returns on term deposits from two different banks. They couldn’t decide which bank was better because they lacked the tools to assess the banks’ financial health. Both investors were focused solely on the promised returns, ignoring the importance of the banks’ financial stability.

The Solution: Financial Statements

The common thread in all three problems is the lack of understanding of financial statements, and how financial statements reveal a company’s health. Financial statements are reports that detail a company’s financial activities and health. The four primary financial statements are:

1. Income Statement: Shows the company’s revenues, expenses, and profits over a specific period.
2. Balance Sheet: Provides a snapshot of the company’s assets, liabilities, and equity at a given point in time.
3. Cash Flow Statement: Tracks the flow of cash in and out of the business.
4. Statement of Equity: Details changes in the owners’ equity over time.

Let’s see how financial statements could have helped in each of the scenarios above.

Applying Financial Statements to Problem I – Real Estate Investments

Most real estate companies are private limited companies, which means they aren’t required to disclose their financial information to the public. This lack of transparency can be a red flag for investors. If Kazim had asked for the company’s financial statements before investing, he would have seen the company’s liabilities and cash flow issues. He could have avoided investing in a company that was already struggling to meet its financial obligations.

Applying Financial Statements to Problem II – Pension Fund

The faculty members’ concerns about the pension fund’s legitimacy could have been addressed by examining the fund’s financial statements. For example, the income statement would reveal the fund’s sources of revenue, such as premiums from policyholders and interest income from bank balances. The balance sheet would show where the fund invested the policyholders’ money—likely in government bonds and money market securities. While this information doesn’t provide a definitive answer on whether the investment is halal, it gives investors the data they need to make an informed decision.

Applying Financial Statements to Problem III – Short-term Bank Investments

When choosing a bank for short-term investments, it’s crucial to look beyond the promised returns. Financial statements can provide insights into the bank’s long-term prospects, including its cash flow, earnings, and net worth. As highlighted in the book Financial Intelligence for Entrepreneurs, Warren Buffett places great emphasis on cash flow when evaluating companies. A bank with consistent revenues, positive net worth, and healthy cash flows is more likely to honor its commitments.

Build Your Financial Capacity

Imagine being the person others turn to for financial advice. How would it feel to make investment decisions with confidence, knowing exactly what information to look for in financial statements? How would it feel to ask a salesperson for the numbers before agreeing to an investment? I can tell you from experience, it feels empowering.

I once had a pension fund representative try to sell me a plan, claiming it was the best investment opportunity on earth. My response was simple: “Can I see your audited financial statements?” He never got back to me. That’s the power of financial literacy.

Investment is not a short-term game. Those who achieve financial independence typically take about ten years to do so. One of the key ingredients of their success is their understanding of the companies they invest in. The first step on your financial journey should be investing in your knowledge.

If you’re ready to take control of your financial future, start by learning how to interpret financial statements.

By building your financial capacity, you’ll not only make better investment decisions but also gain the confidence to navigate the complex world of finance. Remember, knowledge is the best investment you can make.

Conclusion

Financial problems like Kazim’s real estate investment, the faculty’s pension fund dilemma, and the uncertainty around bank investments can all be addressed by understanding financial statements and how financial statememts reveal the truth. These documents provide a window into a company’s financial health, helping you make informed decisions and avoid costly mistakes. Whether you’re a seasoned investor or just starting out, learning to interpret financial statements is a skill that will serve you well throughout your financial journey. So, take the first step today—invest in your knowledge and take control of your financial future.