What you will learn to do: Describe how financial statements are used to analyze a business
Businesses publish financial statements to communicate information about their operating performance and economic health. The income statement shows the profitability of a business by presenting its revenue and expenses for a period of time and summarizes its profitability in one final result: net income. The retained earnings statement reports all of the profit a business has accumulated since it began operations. The balance sheet is a comprehensive summary report that lists a business’s assets, liabilities, owner investments, and accumulated profit.
Once the financial statements are available, the next step is to analyze them to glean useful information about a corporation’s performance over time and its current financial health. These insights help business managers and investors make decisions about future courses of action. Areas of weakness may be identified and followed up with appropriate measures for improvement. Elements of strength should be reinforced and continued.
Much of this financial statement analysis is accomplished using ratios that reveal how one amount relates to another. One or more amounts are divided by other amount(s), yielding a decimal or percentage amount. However, no ratio is particularly meaningful by itself; it needs to be compared to something else, such as desired or expected results, previous results, other companies’ results, or industry standards. This comparison lets you know where you stand in terms of whether you are doing better, worse, or the same as what you have expected or hoped for.
For this module on financial statement analysis, we’ll be using the following statements from a hypothetical company:
| Description | 2019 | 2018 |
|---|---|---|
| Sales | $994,000 | $828,000 |
| Cost of merchandise sold | 414,000 | 393,000 |
| Gross Profit | Single Line$580,000 | Single Line$435,000 |
| Subcategory, Operating Expenses: | ||
| Salaries expense | $77,000 | $64,000 |
| Rent expense | 63,000 | 52,000 |
| Insurance expense | 56,000 | 46,000 |
| Supplies expense | 49,000 | 41,000 |
| Advertising expense | 42,000 | 35,000 |
| Depreciation expense | 35,000 | 29,000 |
| Utilities expense | 28,000 | 23,000 |
| Total operating expense | Single Line348,000 | Single Line290,000 |
| Net income from operations | $232,000 | $145,000 |
| Subcategory, Other revenue and expenses | ||
| Gain on sale of investments | $137,000 | $186,000 |
| Interest expense | (55,000) | (50,000) |
| Income before income tax | $314,000 | $281,000 |
| Income tax expense | 66,000 | 50,000 |
| Net income | Single Line$248,000 Double Line | Single Line$231,000 Double Line |
| 2019 | 2018 | |
|---|---|---|
| Assets | ||
| Subcategory, Current assets: | ||
| Cash | $373,000 | $331,000 |
| Marketable securities | 248,000 | 215,000 |
| Accounts receivable | 108,000 | 91,000 |
| Merchandise Inventory | 55,000 | 48,000 |
| Prepaid insurance | 127,000 | 115,000 |
| Total current assets | Single Line$911,000 | Single Line$800,000 |
| Subcategory, Long-term investments: | ||
| Investment in equity securities | $1,946,000 | $1,822,000 |
| Subcategory, Property, plant and equipment: | ||
| Equipment (net of accumulated depreciation) | $87,000 | $42,000 |
| Building (net of accumulated depreciation) | 645,000 | 581,000 |
| Land | 361,000 | 361,000 |
| Total property, plant and equipment | $1,093,000 | $984,000 |
| Total assets | Single Line$3,950,000Double Line | Single Line$3,606,000Double Line |
| Liabilities | ||
| Subcategory, Current liabilities: | ||
| Accounts payable | $120,000 | $109,000 |
| Salaries payable | 244,000 | 222,000 |
| Total current liabilities | Single Line$364,000 | Single Line$331,000 |
| Subcategory, Long-term liabilities | ||
| Mortgage note payable | $83,000 | $83,000 |
| Bonds payable | 828,000 | 745,000 |
| Total long-term liabilities | Single Line$911,000 | Single Line$828,000 |
| Total liabilities | $1,275,000Double Line | $1,159,000Double Line |
| Stockholders’ Equity | ||
| Preferred $1.50 stock, $20 par | $166,000 | $166,000 |
| Common stock, $10 par | 83,000 | 83,000 |
| Retained earnings | 2,426,000 | 2,198,000 |
| Total stockholders’ equity | Single Line$2,675,000 | Single Line$2,447,000 |
| Total liabilities and stockholders’ equity | $3,950,000Double Line | $3,606,000Double Line |
| Description | 2019 | 2018 |
|---|---|---|
| Retained earnings, beginning of year | $2,198,000 | $1,987,000 |
| Net income | 248,000 | 231,000 |
| Less: Preferred stock dividends | 12,000 | 12,000 |
| Common stock dividends | 8,000Double Line | 8,000Double Line |
| Increase in retained earnings | 20,000 | 20,000 |
| Gross Profit | Single Line$2,426,000Double Line | Single Line$2,198,000Double Line |
