Laypeople often believe that reading a complete financial statement is too complex to understand without a degree in finance. With some common sense, comprehension can come more easily than people realize.
A company’s Balance Sheet reflects a simplified, “right now” view of “money in-hand versus money out-of-hand.” It lists assets against liabilities, but it does not show the entire financial picture. Businesses might consider it an introduction to the financial picture.
The Cash Flow Statement compares the current year’s financial posture with that of prior years. An excellent tool for determining probable long-term, financial reliability and dependability, do not overlook or discount the Cash Flow Statement.
The Income Statement completes the triumvirate of a financial statement. This document outlines all income and expenses over time; that duration differentiates the Income Statement from a Balance Sheet. The more commonly known name for an Income Statement is a Profit and Loss Statement.
Understanding a few of the terms found in a financial statement can clarify the influence the terms have on the picture presented.
Amortization: Attributing the initial purchase cost on property or equipment over the time used to pay the full balance.
Depreciation: Parsing out the cost of an item over the useful lifetime of that item.
Gross Margin: Total sales minus the cost of goods sold. (For example, sales of an item may equal $10,000. The cost to produce the goods sold equals $6,000. The gross margin would be $4,000.00.)
Revenues: All sources of income for the company.
Net Income/Sales: Always annotated as a percentage. The figure reflects the total sales-to-expenses ratio.
While all the information portrayed in a financial statement is important, some ratios within the financial statement generate higher priority focal points than others.
Profitability ratios: Measure the business operations results and include gross profit and net profit ratios; expense ratios; net worth ratios; return on equity capital, shareholder investment, and capital employed ratios; and others.
Liquidity ratios: Measure the short-term solvency and include Current ratio and Liquid/Acid test or Quick ratio.
Activity ratios: Measures how efficiently the assets or resources within a business are utilized. (Also called turn over ratios.) They include inventory/stock turn-over ratio; receivables ratio; average collection period; creditors/payables turn-over ratio; working capital ratio; fixed asset ratio; and over and under trading.
Leverage or Long-term solvency ratio: Measures a company’s ability to meet payment schedules and interest accrual costs of long-term or “non-current” debts. These include debt-to-equity ratios; proprietary or equity ratio; fixed assets to shareholder funds ratio; interest coverage ratio; current assets to shareholder funds ratio; over and under capitalization ratio; and capital gearing ratio.
While a Financial Statement doesn’t reflect intangible assets that are important, such as brand recognition and public faith in a business, the information presented can help solidify impression into fact and can greatly influence the financial future of a business.
Houghton Mifflin Harcourt; “The American Heritage Dictionary of Business Terms,” ©2009; by David L. Scott.
South-Western, Cengage Learning; “Financial Accounting: An Introduction to Concepts, Methods, and Uses,”©2007; by Clyde P. Stickney, Roman L. Weil, Katherine Schipper, and Jennifer Francis.
John Wiley & Sons, “Wiley GAAP 2010: Interpretation and Application of Generally Accepted Accounting Principles,” ©2009. Barry J. Epstein, Ralph Nach, and Steven M. Bragg.