I’m gonna introduce to you, the key financial statements.
Key Financial Statements
There are two key financial statements we use for conducting financial ratio analysis.
First, income statement, also known as profit and loss account.
Second, balance sheet.
Accrual Basis of Accounting
For accounting, we apply accrual basis for reporting.
Accrual basis means, revenues and expenses are recorded when the transactions occur,
even though no cash flow may have occurred.
So, profit shown in income statement is not the amount of cash we earn.
In income statement, we have included some non-cash items as well, such as depreciation.
We don’t really pay for depreciation, that’s why, net profit is not cash.
Accrual basis can better measure the profitability of a company during a specific time period,
because it records the business activities based on the dates of transaction.
Key Financial Statements: The Income Statement
Alright, first, let’s look at the income statement.
The income statement provides a financial summary of a company’s operating results.
during a specified period.
All the figures shown in the income statement are on a one-year basis.
Revenue for one year, expenses for one year, and profit for one year.
For the format of the income statement, report revenues first, then deduct any expenses for
the period.
If we put it as an equation, it will be net income or net loss, equals revenue minus expenses.
If the end result is a net income, the company may have two options.
Either the company pays dividends to shareholders, or to keep the net profit as retained earnings.
This picture is a sample of the income statement.
The operations section of the income statement reports the firm’s revenues and expenses.
from principal operations.
It starts with sales revenue.
Less cost of goods sold, cost of goods sold is the direct cost of production, such as
material cost and labor cost.
Then you will get gross profits.
Less operating expenses, operating expenses are the indirect cost of production, including
selling expense, general and administrative expenses, lease expense, and depreciation
expenses.
Gross profits less operating expenses, you will get the operating profits.
Operating profits is also called earnings before interests and taxes, EBIT.
EBIT less interest expense,
you’ll get EBT, earnings before taxes or net profits before taxes.
ebt less taxes,
you’ll get EAT, earnings after taxes or profit after taxes.
EAT less preferred stock dividends,
the final item is earnings available for common stockholders.
Usually, we call this as net profit.
At this point, the company may decide how to use the net profits.
Either to pay out as dividend to shareholders, or keep it as retained earnings.
Next, let’s look at the balance sheet.
Key Financial Statements: The Balance Sheet
The balance sheet presents a summary of a firm’s financial position at a given point
in time.
We just mentioned the income statement is prepared only for one year, but for balance
sheet, it is for all years, which means it includes the records accumulated from the
first year the business started until current year.
Total Assets = Total Liabilities + Stockholder’s Equity.
The meaning of this equation is important.
For holding the assets, including inventories, receivables, and fixed assets, company can
generate sales.
When the amount of assets increases, at the same time, liabilities and equity will increase.
For buying the assets, the company may borrow money from the bank, the borrowing is a type
of liabilities.
The company may also issue shares to finance the company, that’s the part of equity.
Please take note, the transactions in balance sheet are recorded at cost price, which is
the original purchase price.
So, the book value of a firm may be very different from its current market value.
A company’s balance sheet is comprised of assets, liabilities and equity.
Assets are the things that a company owns and that have value, or something that will
be received and can be measured objectively.
It consists of current assets and long-term fixed assets.
Current assets include the short-term items, that are convertible into cash within one
year, such as cash, accounts receivable, and inventories.
Accounts receivable means the amount of money that you have not collected from the customers.
after selling the products.
Another part, the long-term assets or fixed assets are the items of a more permanent nature,
such as property, plant, and equipment.
Current assets + fixed assets, you will get the total assets…
Liabilities are the money that a company owes to others, such as creditors, suppliers, tax
authorities, and employees.
They are the obligations that must be paid under certain conditions and time frames.
Current liabilities are the short-term obligations due within one year, including accounts payable.
and short-term debt.
