The complexity of financial statements continues to grow. (Photo: 123RF)
The Questions for My Accountant section is signed by accounting science students at the University of Quebec at Outaouais (UQO).
Financial statements are an integral part of the life of a business leader, investor or any other player in the world of finance.
Their complexity continues to grow. To navigate this jungle of financial information, here are the top five things to look for when reviewing a financial statement.
The net result
The first reflex is to see if the company has made a profit or a loss. It is the net profit figure (last line of the net income statement) that gives us this information. It results from a simple mathematical equation which consists in subtracting expenses from income. It can be positive indicating that the company was profitable or negative that the company was at a loss for the period.
The bottom line is important to look at because it tells us about the financial performance of the company: how the company fared after incurring all expenses, in other words, whether it is operating at a profit or a loss. It is also the basis (after adjustments) for the payment of taxes and for the investor a key source of information on the company’s recurring profit.
Assets refer to everything that a company owns or controls. It constitutes the economic resources that it uses for its exploitation and development. Assets include two broad categories:
- Current assets that generate value during the year such as bank account, receivables and inventory.
- Long-term assets that generate value beyond the next 12 months such as fixed assets (computer equipment, office equipment, cars and buildings).
Assets are essential to look into as they allow the manager to know his accumulated wealth, analyze the return on his investments and plan his future investment needs. It is also essential for the investor to estimate the value of the company and appreciate its size.
Debts represent the sums the company has contracted with its many creditors. These allow the company in particular to finance its assets and fulfill its obligations.
If debts often have a negative connotation, because they lead to an outflow of resources to the advantage of creditors, they also allow you to take advantage of the leverage effect. There are two categories:
- Short-term debts which are debts that the company has to pay in the next 12 months as suppliers or taxes.
- Long-term debts are debts due after the next 12 months such as bank loans and mortgages.
Thanks to debt, the company can finance the investments it needs. However, when it is too high, especially in relation to assets, it carries a risk of bankruptcy, i.e. the inability to meet one’s repayment obligations, hence the importance of examining the debt / total assets ratio.
The gross profit margin
The statement of net profit contains another data of fundamental importance, which is the gross profit margin. Represents the surplus of sales revenue after operating costs have been paid. In other words, for one unit, the profit margin would be equal to the selling price minus the cost price.
Gross profit margin is the first line that provides information on the financial performance of the company. By comparing this number with competitors or with the industry or industry average, it is possible to determine whether the company was effective in controlling costs or setting sales prices. Follows the adjustments to be made to costs or sales prices. All to improve competitiveness on the market.
Initially, the equity consists of the capital contributed by the owners and shareholders at the time of the creation of the business. Then, throughout the life of the company, equity is increased by annual results and other capital contributions and reduced by profit distributions (dividends). By mathematical deduction, equity represents the excess of assets (resources) over liabilities (debts).
The amount of assets is an essential indicator, especially for those who want to acquire the company, because it gives an idea of the value of the company and can help in its evaluation. The greater the equity, the greater the value of the company and vice versa.
Furthermore, by comparing the equity with the debt, we have an idea of the company’s financing policy: does the company finance itself more with debt or with its own capital (capital and reinvestment of profits)? This analysis makes it possible to assess the risk associated with the financing of the company.
A text by Ashkan Salehzadeh, student of accounting science, University of Quebec at Outaouais.
Ashkan Salehzadeh, accounting science student. (Photo: courtesy)