HOW TO READ AND CALCULATE FINANCIAL STATEMENT; TOP POINTS

How to read and calculate financial statements; top points 

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  This article taken from financial express



How to read and calculate financial statements; top points to know

financial statements help an investor understand the direction in which a company’s business is moving.


As an investor, some of you may be wondering why companies publish their financial statements apart from their annual reports. Of course, it is mandated by the law of the land and, most importantly, as per listing agreements with the stock exchanges, all listed companies need to disclose their  financial results within 45 days from the end of the quarter in a specified format. Annual reports help investors measure the direction and consistency in the financial performance of a company, whereas financial reports gives an indication on its capabilities to achieve its long-term projections. Let us see some of the important parameters that you need to look at and what they mean.

 Focus on sales

Two types of sales figures are reported in the financial report. One is gross sales and other one is net sales. Gross sales are popularly known as top line or total sales. A consistent increase in gross sales signals the growth in business. Net sales are calculated by deducting sales return, sales allowance, discount amounts from gross sales. Any unusual increase in sales returns and discounts are not really a good sign.

 1  How to calculate GROSS SALES

2  How to calculate NET SALES

HOW TO CALCULATE GROSS SALES AND NET SALES

In accounting terminology, "gross" means "before any deductions." So, when you calculate gross sales, all you're doing is looking at the overall sales for your business that haven't been adjusted to include discounts or customer returns. The metric is significant for retail businesses that need to file a sales tax return.

• Gross sales usually refers to a company's revenue before subtracting discounts and returns.

Assume restaurant chain XYZ made 1 million rs in sales for the year. The company would record this as gross sales.

Gross sales are not the same as net sales. If  the chain also offered 30,000 rs worth of discounts throughout the year to senior citizens, student groups and people who redeemed a certain coupon, and it also refunded 5,000 rs to unhappy customers during the year, restaurant chain XYZ's net sales are:

1,000,000 rs - 30,000 rs - 5,000 rs = 965,000 rs

Typically, the company’s income statement would show 1 million rs of gross sales, then 35,000 rs in coupons and discounts, and then 965,000 rs of net sales.

NET SALES

Net sales  is total revenue, less the cost of sales return, allowances, and discounts. This is the primary sales figure reviewed by analysts when they examine the income statement of a business.

For example, if a company has gross sales of 1,000,000,rs sales returns of 10,000,rs sales allowances of 5,000,rs and discounts of 15,000,rs then its net sales are calculated as follows:

1,000,000 rs Gross sales - 10,000 rs Sales returns - 5,000 rs Sales Allowances - 15,000 rs Discounts

= 970,000 rs Net sales

Operating profit

Operating profit is computed after deducting all operating expenses from net sales. These are the expenses which arise during the normal course running a business. This includes salary and wages to employees, rent, office supplies, electricity bills etc. Operating profits are also known as earnings before interest, tax, depreciation and amortization (EBITDA). Operating profitability reflects the prevailing business conditions and shows how efficiently the management is running the business.

Operating profit

is a measure of income that tells investors how much of revenue will eventually become profit for a company.

Operating Profit = Revenue - cost of goods sold, labor, and other day-to-day expenses incurred in the normal course of business                                                                            

Profit after tax

Profit after tax is popularly known as bottom line, which exhibits the company’s net earnings or losses made during the period. This is derived by deducting all expenses such as interest on loans, depreciation and amortization on assets and tax. The point to be noted is that though items such as depreciation and amortization are expenses there is no cash outflow for the company.

The success of a business is determined by how profitable that business is over time. After you calculate your gross profits, you must then deduct all associated expenses for your business. This leaves you with your net profits. However you still have to deduct the taxes you have to pay Uncle Sam. NOPAT, or Net Operating Profit After Taxes, will let you know exactly how much money you are making in your business. The NOPAT answer can then be plugged into even more complex equations to gain a more detailed look of the health of your business.

Using this information and the formula above, we can calculate that Company XYZ's NOPAT is:
NOPAT = 150,000 rs x (1 - 0.36) = 96,000 rs

Analysts often adjust operating income to convert accrual accounting to cash accounting or will capitalize some expenses (i.e., removed them from the income statement and pretend they were recorded on the balance sheet instead).

NOTE .  THAT NOPAT USES ONLY OPERATING SYSTEM.

Earnings per share (EPS)

EPS is the amount of earnings made by a company per outstanding share. Outstanding share means those shares which are available in the market for trading. EPS is computed by dividing profit after tax by numbers of share outstanding. You could observe two types of EPS in the quarterly/annual financial statements, i.e. basic EPS and diluted EPS. Basic EPS is the total earnings per share based on the number of shares outstanding, whereas diluted EPS is computed if all convertible securities were exercised. Convertible securities refer to all outstanding convertible preference shares and convertible debentures. Unless the company has no additional potential shares outstanding, the diluted EPS will always be lower than the basic EPS. In the normal course of business, rising EPS is a good sign of a profitable company.

EARNING PER SHARE (EPS) is the portion of a company’s profit that is allocated to each outstanding share of common stock, serving as an indicator of the company’s financial health. In other words, earnings per share is the portion of a company's net income that would be earned per share if all the profits were paid out to its shareholders. EPS is used typically by analysts and traders to establish the financial strength of a company, and is often considered to be one of the most important variables in determining a stock’s value. In fact, it is sometimes known as "the bottom line" – the final statement, both literally and figuratively, of a firm's worth.

The Significance of EPS 

• A higher EPS means that a company is profitable enough to pay out more money to its shareholders. For example, a company might increase its dividend as earnings increase over time.  
• Investors typically compare the EPS of two companies within the same industry to get a sense of how the company is performing relative to its peers. 
• Establishing trends in EPS growth gives a better idea of how profitable a company has been in the past and may be in the future. A company with a steadily increasing EPS is considered to be a more reliable investment than one whose EPS is on the decline or varies substantially.
• EPS is also an important variable in determining a stock’s value, since it provides the “E” or earnings portion of the P/E (price-earnings) valuation ratio. The P/E ratio is one of the most common ratios utilized by investors in determining whether a company's stock price is valued properly relative to its earnings. 
• It's important to note that some companies (especially in the technology sector) reinvest their profits to grow the business. However, investors still look to EPS as a gauge of a company's profitability.

• HOW TO CALCULATE EARNING PER SHARE

EARNING PER SHARE = NET INCOME / AVERAGE                                                                                                     OUTSTANDING COMMON SHARE  

Example

Quality Co. has net income during the year of . Since it is a small company, there are no preferred shares outstanding. Quality Co. had 5,000 weighted average shares outstanding during the year. Quality’s EPS is calculated like this.

Earnings Per Share Formula =     rs 10  =                rs 50,000-rs 0/5,000

 As you can see, Quality’s EPS for the year is . This means that if Quality distributed every rupees of income to its shareholders, each share would receive 10 rs

Interest expenses

It is the total sum of the interest paid on different loans taken by the company. Broadly, a company can avail short-term loan which is meant for managing the day to affairs such as working capital loans and may avail long-term loans which are meant for procurement of land, building, machinery etc. However, an increase interest expense depicts that the company has increased its debt. However, proper use of both short and long term debt is important along with rise in sales and profit otherwise rising interest will erase the profitability of a company.
          

Interest Expense formula

Interest expense is an expense you incur when you borrow money. Your lender charges you a specific interest rate that is stated in your loan document. As time passes, you are charged interest on the amount that you borrowed. You may need to calculate simple interest or compound interest on your loan, depending on how the loan is structured. If your loan is for business, you will post interest expense to your accounting records.

             

Here is the formula to calculate interest on the income statement:

Interest Expense = Average Balance of Debt Obligation x Interest Rate

For example, a company has borrowed rs 85,000 at a 6.5% interest rate. The controller issues financial statements each quarter, and wants to know the amount of the interest expense for the past three months. The calculation is:

rs 85,000 Principal x .065 Interest rate x .25 Time period

= rs 1,381.25 Interest expense

Comparison helps

Investors should not only look at the profit-related figures but also other details such as growth in sales on quarterly basis, changes in the debt equity structure, profit margin and whether company is able to contain the cost of goods sold and interest expenses. Generally, quarterly financial statements help you understand the direction in which a company’s business is moving.

Making a statement

A consistent increase in gross sales signals the growth in business Operating profit is computed after deducting all operating expenses from net sales Profit after tax is popularly known as bottom line, which exhibits the company’s net earnings or losses made during the period

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