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Understanding 4 Types of Company Financial Statements

To be able to assess the performance of both operational and financial, the level of health, as well as the growth potential of a company, it is very important that we can understand The Financial Statement.

A company’s financial statement generally consists of 4 types, namely:

    1. The Income Statement
    2. The Balance Sheet
    3. The Statement of Shareholders’ Equity
    4. The Statement of Cash Flows

These four types of reports are essentially related to each other and provide a comprehensive picture of a company’s operational performance and financial health.

Benefits of Understanding a Company’s Financial Statements

  • If you are the CEO of a company (or at least aspire to be a CEO 🙂 then understand the financial statements are mandatory. By understanding the financial statements you can take the right strategic business decisions to improve the company’s financial performance, among others by analyzing the following financial health conditions: 
    • Is your company’s cost structure efficient? How about your company’s sales revenue growth? Is the increase in costs higher than the increase in income or vice versa? Can the cost of goods sold or operating expenses be reduced again without reducing productivity? How about your company’s net profit margin compared to competitors?
    • Have company assets been used effectively to generate profits? If your company’s return on assets ratio (ROA) is relatively small, it could be that most of the company’s assets are less productive assets. Or it could be that the capacity of your factory is much larger than market demand or the amount your company can sell.
    • Is the company’s current debt excessive? Or vice versa? Can debt still be increased (optimized financial leverage) and invested in high-yield projects to pursue company growth?
    • What about capital (equity), is it time to increase the company’s capital with an IPO (initial public offering) or issue new shares?, or simply by issuing a corporate bond and or adding new debt.
    • Is the Company’s cash flow in good health?, is the company’s term of payment policy to attract customers balanced enough, between increasing competitiveness on the one hand and ensuring the Company’s cash flow is maintained on the other hand. How is it compared to the terms of payment that you can get from suppliers? So how does the company’s collection receivables perform? Or maybe your company hoards too much cash, so you miss the opportunity to spin the money in the company’s machines to make more profit.
    • As well as various analyses of financial ratios and other business decisions.
  • If you work for a company (in this case, you are not a CEO yet 🙂 ), understanding the financial statements of the company you work for can help you align your role and contributions to your functions/departments with the company’s financial goals or targets. Or, if you’re in a position to decide to work with another company, whether it’s in terms of selecting a vendor (especially for a large project), making a sale on credit, or a business decision such as a merger or acquisition , of course you must know the financial health condition of the company you will cooperate with (through its financial statements).
  • If you work in banking, or you are in a lender/creditor position, understanding the Company’s financial statements is crucial in making a decision on whether you will provide new or additional debt to the Company. And even if you decide the Company is worth the debt, what interest rate you will charge depends, among others, on the business risk and credit-rating of the Company (which is reflected in its financial statements).
  • Or, if you are a stock investor, in deciding which stocks you will buy, of course, understanding the financial health and growth potential of a company (through its financial statements) will make your choice wiser.

Unfortunately, for some people who do not work as accountants, or do not work in finance, reading a company’s financial statements is like reading a foreign language that has never been heard, or maybe like reading the language of another planet. 🙂

In this article, I try to describe how to read the Company’s Financial Statements in an easy-to-understand explanation—accompanied by examples and analysis and insight into the meaning of the numbers in the Financial Statements. So that I hope it will be helpful to help make it easier for readers to understand them well.

To facilitate understanding, below I will present an example of financial statements from a company imaginer “danieel.id Company” engaged in manufacturing.

This article is quite long, consisting of 4 pages, (and I have also prepared the sequel), so please prepare coffee and snacks, while enjoying the story slowly :-). 

If you are a student, who landed in this article either from Google or friend recommendations, and hope to get an A in your finance courses, you are on the right page, please read carefully these articles page by page. 

Or, if you’ve ever dreamed of becoming the CEO of a company, you can continue your career with more confidence after completing this series.  

Or maybe you are a beginner stock investor, (who getting frustrated, buying and selling stocks based on daily sentiment and losing more than profiting. 🙂 ), after reading the entire article and understanding the company’s financial statements, You can choose the better stock, over the long term, based on the company’s fundamentals and future growth potential.

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This is the first of my three articles on the Company’s Financial Statements, the other two are  :

Let’s start discussing one by one of the 4 types of Company Financial Statements:

 

1. The Income Statement

income statement
“danieel.id Company” Income Statement 2019

Income statement provide an overview of a company’s financial performance over a period of time (generally one year).

Income Statement starts from Revenue then reduced cost costs until finally get a net profit (or loss).

In its presentation, in each component in the Income / Loss statement is also included figures from the previous period, this is to make it easier for readers to assess and compare the performance of the company over time.

As we can see in the example of the picture above, the income statement structure of a company generally consists of the following components:

  • Revenue is the total income of the company, obtained from sales volume multiplied by price (or service, if the company is engaged in services).
  • Cost of Goods Sold (COGS) is the cost directly related to the production of a product, such as raw materials, labor in factories, and overhead costs for production facilities.
  • Gross Profit: this is obtained from reducing revenue with the cost of goods sold
  • Operating expenses (OPEX) are expenses that are not directly related to the production of goods or services, such as sales costs, general and administrative costs, office equipment costs, workers’ salaries (other than direct labour in production facilities) and the like.
  • Operating Profit or often referred to as EBIT (Earnings Before Interest and Tax), this is the result of a reduction in Gross Profit with Operating expenses.
  • Net Profit Before Tax is obtained by deducting Operating Profit / EBIT with interest expense
  • Net Profit After Taxes (NOPAT) or net income is certainly obtained by reducing Net profit before taxes with taxes 
  • EBITDA (earnings before Interest, taxes, Depreciation and Amortization) as the name implies is calculated by adding back Net Profit After Tax (NOPAT) with Interest, Taxes, Depreciation and Amortization.
  • Earnings Available for Common Stockholders is the amount of income available to common stock holders, this figure is obtained by reducing Net Profit After Tax (NOPAT) with dividends allocated to Preferred Stock Holders
  • Earnings Per Share (EPS) is the amount of earnings per share common stock, this figure is obtained by dividing earnings available for common stakeholders by the number of common stock outstanding (number of common stock outstanding)
  • Dividend Per Share is the amount of dividends earned by ordinary shareholders for each share, of course this figure is obtained by dividing the total dividend by the number of common shares outstanding.

Analysis

From the “danieel.id Company” Income Statement we can see that in 2019 the company managed to record sales revenue of $ 6,115,000, this figure is up 12% from the previous year’s revenue.

However, the cost of goods sold was increased higher than the increase in revenue (15% vs. 12%), so that gross profit only increased by 5%.

This could be due for example by the high increase in the price of raw materials and or direct labour on the one hand, but on the other hand the company cannot charge an increase in the cost of goods sold completely to the selling price because of the tight competition in the market.

Or another possibility, the company has tried to charge the increase in COGS earlier to the selling price of the product, but this has an impact on sales volume, so that in the end the increase in revenue is smaller than the increase in COGS.

The good news, in terms of operating expenses (OPEX), the company managed to withstand the rate of increase in operating costs at a rate of 5%, much lower than the increase in revenue. 

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While interest expense increased by 6% (this is an indication that the company is adding debt, we can later see in the balance sheet whether the debt that increases is short-term debt for operational needs, or long-term debt for investment needs). 

With the increase in revenue and the realization of costs as mentioned above, the company managed to record net profit after taxes of $ 560,000, up 4% compared to the previous year.

then after deducting the dividend for preferred stock of $ 30,000, earning available for common stakeholdersdanieel.id Company” 2019 is $ 530 (up 5% compared to the previous year)

One more interesting thing, if we look at the structure of this Income Statement; Depreciation, Amortization and Interest expense are located before net profit before taxes, this means that the three components of the cost are tax deductions (legally).

Therefore, it is very important to calculate depreciation and amortization appropriately and in accordance with applicable provisions.

For interest expense, this provides insight on how to optimize company financing (both working capital and investment).

At some optimal limits, for companies, financing from loans is more profitable rather than from the capital market (issuing shares), in terms that the interest on the loan is a tax deduction.

Returning to the company’s profit, even in nominal terms, the profitability of the danieel.id company in 2019 (gross profit, operating profit, and net profit) increased compared to the previous year. However, when viewed relatively compared to sales revenue, it will be seen that the ratio of gross profit margin, operating profit margin, and net profit margin has decreased compared to 2018.

Comparison of Profitability “danieel.id Company” nominally vs. in ratio (divided by its sales revenue), can be seen in the table below :

Profitabilitas nominal vs ratio
Profitabilitas “danieel.id Company” 2019 nominal vs ratio

If you look at the Income Statement above, as we discussed earlier, this is because costs, especially cost of goods sales (COGS) increased (15%) higher than the increase in sales revenue (12%). This can be caused, among other things, due to tight competition, where the Company cannot raise the selling price as high as the burden of increasing cogs costs.

The profitability of a Company can also be analysed with a Return On asset (ROA) ratio, to measure the relatively large profit earned compared to the total assets of the Company, and Return On Equity (ROE) to measure the relatively large profit compared to owners’ equity.

These two measures are most often used to measure profitability, as ROA can compare the effectiveness of the use of company assets and ROE measures the effectiveness of the use of equity in generating profits for the Company.

More details about financial ratios, including profitability ratios, can be read in the following article : 

Understanding Financial Ratios for Company Performance Analysis 

But before discussing more deeply about ROA and ROE, it will be easier if we understand first the second type of company’s financial statements, namely The Balance Sheet, because in this report will be listed the value of assets and equity of the company.

Let’s continue studying The Balance Sheet on the next page (page 2) 

This post is also available in: Indonesian

Daniel
Danielhttps://danieel.id
Lahir di Palembang pada bulan November 1981, saya menyelesaikan S1 di Jurusan Teknik Kimia Universitas Sriwijaya, dan S2 Master of Business Administration (MBA) di Sekolah Bisnis Management Institut Teknologi Bandung (SBM-ITB). Bekerja di salah satu BUMN dan tinggal di daerah Jakarta Selatan.

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