An income statement is a financial statement that shows you how profitable your business was over a given reporting period. It shows your revenue, minus your expenses and losses. When a business makes an income statement for internal use only, they’ll sometimes refer to it as a Profit and Loss Statement (or P&L). Usually this statement is prepared annually, quarterly and monthly and compared to those of previous periods in order to get the full picture of the change.
Total amount of income generated by the sale of goods or services related to the company’s primary operations.
Cost of Goods Sold (COGS)
The cost of goods sold for a business is essentially the amount of costs in a given period required to manufacture and sell the business’s goods. These costs fall into the general sub-categories of direct labor, materials, and overhead. In the income statement presentation, the cost of goods sold is subtracted from net sales to arrive at the gross margin of a business. Here’s the formula for it.
COGS = Starting Inventory + Purchases – Ending Inventory
This number reflects the efficiency of a business in terms of making use of its labor, raw material and other supplies. The metric mostly considers variable costs—that is, costs that fluctuate with the level of output. In order to get gross profit we need to deduct COGS from revenues.
Administrative expenses include all of the non-selling expenses that contribute to the overall operations of the company and can’t really be directly related back to selling or making sales. Examples of this include: management salaries, accounting fees, overhead, etc. In short, these are the expenses you need to have in order to manage and run the business.
These are the costs that a company must make to perform its operational activities. It’s important to note that operating expenses do not include cost of goods sold, which means that materials, direct labor, etc are not taken into consideration when calculating it. Examples: marketing costs, property tax, rent, etc. Operational activities are a company’s key commercial activities in generating revenue. Basically, these are the costs you need to have in order for your business to be able to perform its operations.
This number tells us what amount of total revenue was generated by the business’s main operations. Per usual, investors pay considerable attention to this metric because it doesn’t include taxes and other one-off items that may skew a company’s profit in a given year and tells them how profitable its core operations. The higher the operating income, the more profitable.
This category refers to the various business expenses that are not related to the company’s core operations. In other words, it is the amount of money we spend on activities not directly associated with income generation. Some of the most commonly used non-operating expenses are interest expense and losses incurred on disposal or sales of assets.
Amount of money that’s generated from activities not related to its core business operations. It can include items such as dividend income, profits, or losses from investments, etc.
Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA)
EBITDA is a kind of operating income which excludes all non-operating and non-cash expenses. With it, factors like debt financing as well as depreciation, and amortization expenses are stripped out when calculating profitability. Thus, it can be used to analyze and compare profitability among companies and industries, as it eliminates the effects of financing and capital expenditures. It is also a useful metric for understanding a business’s ability to generate cash flow for its owners and for judging a company’s operating performance.
Depreciation and Amortization
Old plants, buildings, inventory, equipment, everything starts to break down after some time require to be either replaced or repaired. THis systematic decrease in value is depreciation. Amortization is the same, just for immaterial assets.
Earnings Before Interest and Taxes (EBIT)
This metric is almost the same as EBITDA. The difference being that EBIT includes non-cash expenses like depreciation and amortization. Thus you get EBIT by subtracting those expenses from EBITDA.
A non-operating expense which represents interest payable on any borrowings – bonds, loans, convertible debt or lines of credit.
This is also the amount gross income that the government deems subject to taxes. In other words this would have been the company’s net income if it didn’t have to pay taxes.
This is what you get when you deduct taxes and interest expenses from EBIT or just taxes from taxable income. Net income represents the amount of money that’s left after paying off all the costs.
Assets are items or rights purchased by a company that have financial value and are expected to be useful to the business. They can fall under several different categories, depending on their purpose and lifespan.
These are the resources that are not intended to be converted into cash quickly, less than a year, to fund the current business operations. Examples are: plants, buildings, equipment, etc.
Short term assets refer to assets that are expected to be converted into cash sometime during a year. For example, both accounts receivable and inventory balances are current assets. This is because inventory is quickly converted into products which in turn is also quickly turned into cash.
This is money that is owed to a company by its customers. If a company has delivered products or services but not yet received payment, it’s an account receivable.
Cash equivalents are any short-term investment securities. They include bank certificates of deposit, banker’s acceptances, Treasury bills, commercial paper, and other money market instruments.
Inventory includes goods available for sale and raw materials used to produce goods available for sale.
Prepaid expenses are future expenses that have been paid in advance. In other words, prepaid expenses are costs that have been paid but are not yet used up. This can be the money that has already been paid for some service or product and it hasn’t been delivered yet.
The cumulative depreciation of an asset up to a single point in its life.
Amount of money that company needs to pay in the future, whether it’s in return for already received service or to cover any other type of obligation. Also, the services that were already provided and hven’t been paid for are liabilities as well.
Liabilities that are to be paid off within more than a year. FOr example: long term debts and obligations.
Current liabilities are a company’s short-term financial obligations that are due within one year. Examples of it include accounts payable, interest payable, short term loans, accrued expenses, etc.
These are the liabilities that have built up over time and are due to be paid. They are considered to be current liabilities because the payment is usually due within one year. Examples include: salary and utility expenses.
A type of current liability that includes the money that you owe to any third party. The third parties can be banks, companies, or even someone who you borrowed money from.
This represent a portion of the profits a company decides to give to its shareholders as dividends.
There are payments a company makes to share profits with its stockholders. They’re paid on a regular basis, and they are one of the ways investors earn a return from investing in stock.
Sum of investments and retained earnings. It shows how the company has been financed with the help of common shares and preferred shares.
Cash Flow Statement
Cash from Operating Activities
Operating activities include any spending or sources of cash that’s involved in a company’s day-to-day business activities. Any cash spent or generated from the company’s products or services is listed here.
Cash from Investing Activities
Investing activities include purchases of physical assets, investments in securities, or the sale of securities or assets. Thus in this section you’ll see entries like, cash generated from the sale of a plant or cash generated from the sale of a car, etc.
Cash from Financing Activities
Issuing and selling of shares, applying for long-term loans, cashing or issuing obligations and issuing dividends are all financial activities. Cash generated from such happening is what goes in the financial section of the cash flow statement.
Fixed costs remain the same regardless of production output and include costs like lease and rental payments, insurance, and interest payments.
Variable costs vary based on the amount of output produced. They may include labor, commissions, and raw materials.
Debit (Technical Term)
An accounting entry that results in either an increase in assets or a decrease in liabilities on a company’s balance sheet.
Credit (Technical Term)
This accounting entry may either decreases assets or increases liabilities and equity on a company’s balance sheet.
Transactional Document (Technical Term)
Documents relating to transactions that have been made between businesses and their customers and clients. These include service statements and invoices to request payment for a service.
Chart of Accounts (Technical Term)
Listing of the names of the accounts that a company has identified and made available for recording transactions.
A type of transactional document issued by a seller to a buyer, relating to a sale transaction and indicating the products, quantities, and agreed prices for products or services.
The difference between the selling price of a good or service and cost. It’s added into the total cost of a good or service in order to cover the costs of doing business and generating profit.
General Financial Terminology
Break Even Point
The level of production or the price per unit at which the costs of production equal the revenues for a product, that is fixed and variable costs.
Break Even Point (Volume) = Fixed Costs / (Price per Unit – Variable Cost per Unit)
Break Even Point (Price) = (Fixed Costs / Product Volume) + Variable Costs per Unit
Compound Annual Growth Rate
The average growth rate of an investment over a specific period of time, assuming the profits were reinvested at the end of each year of the investment’s lifespan.
The percentage of sales that the company retains after covering direct costs associated with creating a service or product that was sold.
Gross Margin = (Sales – Cost of Goods Sold) / Sales * 100
Return on Assets
ROA, indicates how profitable your business is by comparing net income with your total assets. It measures the net income produced by total assets during a period by comparing net income to the average total assets. In other words, it measures how efficiently a company can manage its assets to produce profits during a period.
Return on Assets = Net Profit / Average Total Assets
Current ratio is a liquidity ratio which measures a company’s ability to pay its current liabilities with cash generated from its current assets. The ratio considers the weight of total current assets versus total current liabilities indicating the financial health of a company.
Current Ratio = Short-term Assets / Short-term Liabilities
The quick ratio is a liquidity ratio that measures a company’s ability to pay its current liabilities with cash generated from its current assets, excluding inventory. When we say current assets we mean the ones that can easily be converted into cash. The quick ratio is one of the fastest and easiest ways of measuring a company’s liquidity. It is majorly used by creditors and lenders to evaluate an entity’s creditworthiness and timely payments before approving their application for the loan.
Quick Ratio = Short-term Assets – Inventory / Short-term Assets
This number indicates a company’s capacity to pay off short-term debt obligations with its cash and cash equivalents. Compared to other liquidity ratios such as the current ratio and quick ratio, the cash ratio is a stricter, more conservative measure because only cash and cash equivalents are used in the calculation.
Cash Ratio = (Cash + Cash Equivalents) / Short-term Liabilities
It tells us what portion on company’s assets is financed by debt. A ratio greater than 1 shows that a considerable portion of debt is funded by assets. In other words, the company has more liabilities than assets.
Debt Ratio = Total Liabilities / Total Assets
Debt to Equity Ratio
Debt to equity ratio is a measure of the degree to which a company is financing its operations through debt versus wholly-owned funds. It also indicated how high the risk of not being able to pay off the debt is. THe higher the coefficient the higher the risk.
Debt to Equity Ratio – Total Liabilities / Total Shareholders Equity
Interest Coverage Ratio
This ratio tells us how easily a company is able to pay off the interest on its debt and for how long it can keep it up. The higher the number the longer the company can continue paying off the interest rate on its debt.
Interest Coverage Ratio=EBIT / Interest Rate
Asset Turnover Ratio
Which this rate we can tell how effective the company utilizes its assets. The higher the rate the better, because it tells us that the assets are adequately used to generate sales.
Asset Turnover Ratio=Sales / Average Total Assets
Inventory Turnover Ratio
This number tells us how effectively inventory is managed by comparing cost of goods sold with average inventory for a period. In other words, it measures how many times a company sold its total average inventory dollar amount during the period.
Inventory Turnover Ratio = Cost of Goods Sold / Average Total Inventory
Receivables Turnover Ratio
Which this coefficient we can tell how effectively a business extends credit and collects debts on that credit. The higher this ratio the better the company’s credit policy.
Receivables Turnover Ratio = Revenue / Account Receivables
Operating Margin Ratio
This ratio indicates how much profit a company makes from its operations before taxes and interest are deducted. While gross profit margin, operating profit margin, and net profit margin are all measures that analyze business operations, operating profit margin focuses on indirect business expenses.
Operating Margin Ratio = Operating Income / Gross Profit
Return on Equity Ratio
This ratio measures the profitability of a corporation in relation to stockholders’ equity. It is the rate of return that the owners of the common stock of a company receive on their shareholdings.
Return on Equity Ratio = Net Income / Shareholders Equity