Income statement Analysis and Key ratios.

              How to analyze Financial statement

 

The Financial statements come distinct in Three flavors. Those are: Income statement Balance sheet, and Statement of cash flow. An income statement displays the company”s quarterly and full year business performance. Which come along with a Balance sheet and statement of cash flow. 

These  reports consist of Revenue, expenses and gain, loss. How the company was in the specific account period that whether sales and profits are increased or decreased. If a company missed their sales and profit target. That helps management find out their achievements and in which areas need attention  in order to come up with better ideas. 

Who uses income statement

The two main groups overview this report. Those are internal and External. Internal groups include Managers and Board Members who would analyze their own report as well as peer groups reports too. 

The investor would look through all aspects of financial results especially ROE and EPS growth. 

 Then they can only make investment decisions, 

Creditors who look for  the company have enough cash flow and that the company is worthy to extend the loan further.

Subtle part of the income statement

The income statement does not only show the numbers of increase and decrease. And also Which contains many important aspects.  For example, we can find the competitive advantage through Gross margin, 

Likewise, SG&A items will show the management efficiency. Interest expenses may point out the company”s financial leverage   

 Net profit margin can help to weigh the shareholders EPS growth in the future. 

Major components of Income statement

The revenue and sales : this item represents in the first, typically which is divided into Operating and Non-operating revenue. A company generates revenue through their primary manufacturing and services - so called operating revenue. The Non-operating income generates from sale of assets and plant and Equipment which income is unsustainable and infrequent  for manufacturing companies in contrast,  banking and financials- they would earn considerably by other income.  

Cost of Goods sold : Raw material and semi- finished goods there goes into production and cost of labor for making each unit which direct cost  is called Cost of Goods sold.  Other overhead costs not to be added with it. The large volume producing companies keep their cost lower than smaller companies. This way calculate the COGS , 

Beginning inventory +  purchase - Ending Inventory = COGS

Gross profit : it is known as Total profit. Revenue - COGS = Gross profit, 

Gross profit Margin :  Higher the Gross margin means the company has a strong brand name reputation, producing a unique product and satisfied customer so that they can sell products at a higher margin , they procure the raw material and input at a low cost  and they could sell a product at a lower price than competitors. Economies of scale- keep leading the  company in a better position. 

The  Gross profit margins are above 40. That company has a competitive advantage if it is below 20 levels. That company is in a highly intensive industry. Low Gross margin companies unable to retain their profit during an economic burst.

Selling, General and Administration cost

Which items appear under COGS costs, it includes Management salary, Advertising, commission, Marketing, Traveling, and Office Expenses. This is unrelated to production that means Non-operative Expenses, which is the percentage of expenses with revenue that exhibit  the management efficiency.

 The advertising intensive industry spends a lot of money to deter new entrants to capture market share that needs to be sent over messages to consumers over many years. Typically, this kind of businesses like Advertising intensive industry, and R&D expenditure could elevate SG&A costs, the lavish management team could spend money for unrelated productive activities.    

This expenditure should compare with Gross profit margin and Net sales. If it compares with Net Sales that does not exceed 10 percent because during the worst scenario sale will fall and COGS will go together but SG&A cost will remain stable. So that could eat up Gross profit.

When it compares with Gross profit - SG&A should not exceed 40 percent. If it goes above 40 percent that company is in intensive competition that they would not survive in an economic downturn.  Some companies' ratios could surpass 80 percent, which means as soon as they might  go to bankrupt

Depreciation and Amortization

For example, A company is running .sugar factory. The machine's lifespan is 10 years and machine purchasing cost is 10 crore, if so, the company will assign 1 crore every year, later that amount to be used to replace that machine after a 10 years lifespan. 

Every financial year which depreciation number shows in the income statement as well as shows in the balance sheet that accumulation of every year depreciation amount is subtracted from the plant & Equipment section and added into the accumulated depreciation account in the liability section of  the balance sheet. 

Generally, The depreciation cost will be higher in capital intensive sectors, such as Automobile, oil & gas, and metal manufacturers. If it is less than 10 percent that company is good for long-term investment otherwise, higher percentage of the ratio when compared with Gross profit the management have to reinvest their money again and again reinstall new Equipment. Therefore, investors' returns will shrink. 

Interest Expenses

Most likely, cyclical industry and High capital intensive sectors would carry more debt than other industries that  money utilized  for short-term financial obligation and further, raise more debt to business expansion, which shows even in the balance sheet as a liability.

 firms are carrying more debt that need to repay more interest costs and principal amounts  during the quarter or year. This is called financial cost not an operating cost. It is measured through Interest coverage ratio that a company is consistently making a high profit margin that is able to manage its debts. But lower Operating margin companies may have to face financial constraints when piling up debt.

 Operating profit / Interest expenses = Interest coverage ratio. Which is lower below 15 percent is a normal level that goes far exceeding 50 percent that the company is going to trap in financial trouble.

EBITDA

EBITDA stands for Earning before income tax and depreciation Amortization. Which number comes after subtracting the COGS + SG&A then adding with D&A. This is typically used to measure a company's cash flow. In addition, Equity analysts use the Ratio of EV / EBITDA. Enterprise value divided by company”s operating income to compare with peer group industry. 

EBIT

It stands for Earning Before tax. Tax slabs might vary from industry to industry. Some industries could get low tax benefits from the Govt.  Capital-intensive industries are usually carrying high debt that turns out  fixed assets that are financed by debt,  therefore a certain portion of the money might go to interest expenses. That debt, if managed properly, helps to long-term growth. It is known as Operating profit margin, which number comes in after subtracted all expenses. 

Net Profit

This item is displayed in a final column in the income statement, after deducting all expenses of the operation then  remaining amount called Net profit. To know, the  percentage of profit from revenue used to net profit margin ratio. Which calculated Net profit / Total revenue. Durable competitive advantage  companies would produce a constant profit margin despite an economic downturn. Contrast, fierce competitive industry profits are being low in unfavorable economic conditions. Usually, Non-cyclical industry profit margins will be higher than cyclical industry- especially commodity based industries.