In this article we will tell you how to analyze Balance Sheet and Income statement. Here are the complete details of it.
Financial statements are the important documents of any organization to know how their business strategies are transforming into profits. Similarly, investors would try to know the stability and prospects of the company that they wish to invest. Thus financial statements serve the purposes of profit making and new investment opportunities.
On other hand, financial statements are the original sources of inputs for preparation and submission of statutory returns that are mandatory as per the federal laws and applicable for all the entrepreneurs. These reports also required to be filed with the stock exchanges at which the companies are listed.
The most important financial statements are:
- Balance sheet
- Income statement
Now the question is how to analyze financial statements that are stated above?
Analysis of Balance Sheet
Any balance sheet contains two sides placed next to each other i.e. Assets and Liabilities. The simple inference that could be drawn from a balance sheet is:
Assets = Stakeholders money + Liabilities.
In other words, any company tries to increase the assets by rising debts (i.e. liabilities) and/or through accepting contributions from owners/stakeholders (equity). In the balance sheet both Assets column and that of Liabilities should match or balance. Otherwise there is something wrong with the calculation of the company. Another important aspect is the analysis of “Retained Earnings”. This part gives a hint about the financial stability of a company in a long run.
In nutshell a balance sheet does give the analysts a
broad sense of what is happening within an organization and where it stands now and in future. Balance sheet is the blueprint of how a company mobilized its finances to pull itself up in the market to increase profits.
Analysis of Income Statement
The popular name for this statement is the P&L statement i.e. Profit and Loss statement.
If we dub the income statement in to a simple mathematical equation it would look like:
Net income = Revenue – Expenses
“Bottom line” is the widely used jargon in the corporate circles and this bottom line could be seen in an income statement. Net income is the bottom line while Revenue or sales is called as the top line.
The analysis of income statement is also called as “margin analyses” as it tries to gauge the profitability gained by a particular company. A margin is the percentage of sales that becomes a profit after deducting all the expenses and overheads. In other words the “net profit” is called as the margin and income statement lets the readers to estimate the “margin” of profits of the company.
Expenses are of two types i.e. direct and indirect expenses. Income statement deducts the direct expenses from the total sales i.e. revenue and the resultant of this deduction are called as gross margin.
The indirect expenses or operating expenses would be deducted from the total sales to arrive at the ‘operating margins’. Later other expenses like discounts and taxes etc. would be further deducted from the total sales and with this the ‘net income’ would be calculated. This is the ‘bottom line’ that tells the readers about the financial stability of a company.