How to analyze company reports
A company report shows the financial health of a company. The jargons used may make the report look complicated for a novice. But having a basic knowledge about the terms used in the report can help a user in understanding the report. Here is brief information about the terms usually used in a company report
Profit and loss statement
A financial statement that summarizes the revenues, costs and expenses incurred during a specific period of time – usually a fiscal quarter or year. These records provide information that shows the ability of a company to generate profit by increasing revenue and reducing costs. The P&L statement is also known as a “statement of profit and loss”, an “income statement” or an “income and expense statement”.
Brief explanation about items in a profit and loss statement
Total operating revenue
Total operating revenue is the income company has made from its operations and other revenues like interest, dividends and proceeds from sales etc.
Operating profit before income tax
This is the basic profit of the company. It is the revenue – all the costs
These are the profit or loss that have an abnormal impact on the business, even though they happen during the course of a companies operation. Abnormals can be inventory write downs, bad debt loss or profit on the sale of interest in an associated company
Extraordinaries are different from abnormals . Abnormals are abnormal profit and losses happen in the normal course of the business, where as extraordinaries are something without the regularity of abnormals.
The accumulated net income that has been retained for reinvestment in the business rather than being paid out in dividends to stockholders. Net income that is retained in the business can be used to acquire additional income-earning assets that result in increased income in future years. Retained earnings is a part of the owners’ equity section of a firm’s balance sheet.
A Balance Sheet is a statement of the financial position of a business which states the assets, liabilities, and owners’ equity at a particular point in time. In other words, the Balance Sheet illustrates your business’s net worth.
All accounts in your General Ledger are categorized as an asset, a liability or equity. The relationship between them is expressed in this equation: Assets = Liabilities + Equity. The Balance Sheet is divided into these three sections.
Items in a balance sheet
Definition of Assets
An asset is any right or thing that is owned by a business. Assets include land, buildings, equipment and anything else a business owns that can be given a value in money terms for the purpose of financial reporting.
Definition of Liabilities
To acquire its assets, a business may have to obtain money from various sources in addition to its owners (shareholders) or from retained profits. The various amounts of money owed by a business are called its liabilities.
Non Current and Current
To provide additional information to the user, assets and liabilities are usually classified in the balance sheet as:
– Current: those due to be repaid or converted into cash within 12 months of the balance sheet date;
– Long-term: those due to be repaid or converted into cash more than 12 months after the balance sheet date;
A further classification other than long-term or current is also used for assets. A “fixed asset” is an asset which is intended to be of a permanent nature and which is used by the business to provide the capability to conduct its trade. Examples of “tangible fixed assets” include plant & machinery, land & buildings and motor vehicles. “Intangible fixed assets” may include goodwill, patents, trademarks and brands – although they may only be included if they have been “acquired”. Investments in other companies which are intended to be held for the long-term can also be shown under the fixed asset heading.
Definition of Capital
As well as borrowing from banks and other sources, all companies receive finance from their owners. This money is generally available for the life of the business and is normally only repaid when the company is “wound up”. To distinguish between the liabilities owed to third parties and to the business owners, the latter is referred to as the “capital” or “equity capital” of the company
In addition, undistributed profits are re-invested in company assets (such as stocks, equipment and the bank balance). Although these “retained profits” may be available for distribution to shareholders – and may be paid out as dividends as a future date – they are added to the equity capital of the business in arriving at the total “equity shareholders’ funds”.
Money which is owed to a company by a customer for products and services provided on credit. This is treated as a current asset on a balance sheet. A specific sale is generally only treated as an account receivable after the customer is sent an invoice.
A company’s merchandise, raw materials, and finished and unfinished products which have not yet been sold. These are considered liquid assets, since they can be converted into cash quite easily. There are various means of valuing these assets, but to be conservative the lowest value is usually used in financial statements.
An asset that is not physical in nature. Corporate intellectual property (items such as patents, trademarks, copyrights, business methodologies), goodwill and brand recognition are all common intangible assets in today’s marketplace. An intangible asset can be classified as either indefinite or definite depending on the specifics of that asset. A company brand name is considered to be an indefinite asset, as it stays with the company as long as the company continues operations. However, if a company enters a legal agreement to operate under another company’s patent, with no plans of extending the agreement, it would have a limited life and would be classified as a definite asset.
Profitability report of companies
EBIT margin = EBIT / sales revenue x 100
A profitability measure equal to EBIT divided by net revenue. This value is useful when comparing multiple companies, especially within a given industry, and also helps evaluate how a company has grown over time.
Earnings Before Interest, Tax and Amortisation
Earnings Before Interest, Tax, Depreciation and Amortisation
EPS (Earnings Per Share)
Represents the portion of earnings attributable to each ordinary share.
Net Profit Margin
Profit margin, net margin, net profit margin or net profit ratio all refer to a measure of profitability. It is calculated by finding the net profit as a percentage of the revenue.
Net Profit Margin = After Tax Profit x100 / Sales
The profit margin is mostly used for internal comparison. It is difficult to accurately compare the net profit ratio for different entities. Individual businesses’ operating and financing arrangements vary so much that different entities are bound to have different levels of expenditure, so that comparison of one with another can have little meaning. A low profit margin indicates a low margin of safety: higher risk that a decline in sales will erase profits and result in a net loss.
For example, a company produces a loaf of bread and sells it for $10. It cost the company $6 to produce the bread and it also had to pay an additional $2 in tax
That makes the company’s net income $2 (10 minus 6, before tax, then minus 2 for tax). Since its revenue is $10, the profit margin would be (2 / 10) or 20%.
Profit margin is an indicator of a company’s pricing policies and its ability to control costs. Differences in competitive strategy and product mix cause the profit margin to vary among different companies.
Return on Equity
Return on equity is the after tax profit as a percentage of shares holders equity .It is the measure of the rate of return on the equity investment in the company. The higher this ratio, the better for the company.
Ratios for measuring the financial stability of a company
Formula to calculate current ratio:
Current ratio = current assets / current liabilities.
Current ratio definition and explanation:
The current ratio is used to evaluate the liquidity, or ability to meet short term debts.
High current ratios are needed for companies that have difficulty borrowing on short term notice.
The generally acceptable current ratio is 2:1
The minimum acceptable current ratio is 1:1
Quick ratio = Current assets – Inventories / Current liabilities
cash, marketable securities , and accounts receivable divided by current liabilities. By excluding inventory, this key liquidity ratio focuses on the firm’s more liquid assets , and helps answer the question “If sales stopped, could this firm meet its current obligations with the readily convertible assets on hand?” Assuming there is nothing happening to slow or prevent collections, a quick ratio of 1 to 1 or better is usually satisfactory. Also called acid-test ratio, quick asset ratio.
Debt to equity ratio
Debt to equity ratio = Total devtx100 / Share holders equity
A measure of a company’s financial leverage calculated by dividing its total liabilities by stockholders’ equity. It indicates what proportion of equity and debt the company is using to finance its assets.
A company’s pretax operating income (or occasionally, cash flow) divided by its interest obligations, for a given period. Interest cover is regarded as a measure of a company’s creditworthiness because it shows how much income there is to cover interest payments on outstanding debt.
Interest cover – EBIT / Net interest payments
Other ratios to measure company performance
EPS ( Earnings per Share )
The term earnings per share (EPS) represents the portion of a company’s earnings, net of taxes and preferred stock dividends, that is allocated to each share of common stock. The figure can be calculated simply by dividing net income earned in a given reporting period (usually quarterly or annually) by the total number of shares outstanding during the same term. Because the number of shares outstanding can fluctuate, a weighted average is typically used. EPS can be calculated via two different methods: basic and fully diluted. Fully diluted EPS — which factors in the potentially dilutive effects of warrants, stock options, and securities convertible into common stock — is generally viewed as a more accurate measure and is more commonly cited.
The dividend yield is computed by dividing the annual dividend by the stock price. Older, slow-growth companies usually have a relatively high dividend yield, because they have fewer investment opportunities and thus tend to return more earnings to shareholders. Newer, high-growth companies usually have a low or no dividend yield, because most or all of their earnings are reinvested in their business. For a slow-growth firm with fewer prospects of substantial price appreciation, the higher dividend yield serves to make the stock more attractive and support the stock price. Dividend yield plays a key role in the Dogs of the Dow investment strategy, in which investors rotate into those blue-chips with the highest dividend yield. But beware: a high dividend yield is no sure measure of a safe, high-return investment. A stock may have a high dividend yield only because its price has fallen sharply on expectations that the company faces hard times and will cut its dividend.
Measure of a firm’s ability to pay its dividend. Higher the cover, the greater the possibility of earning the dividend and greater the chance of an even higher amount
Dividend cover = EPS / Dividend per share