# How to interpret profit and loss statements

Financial Statements

A profit and loss report, also known as an income statement, shows the profitability of your business over a specific period. It can cover any period of time, but is most commonly produced monthly, quarterly or annually. A profit and loss report is a useful tool for monitoring business activity. Profit and loss statements make for dry reading, but we can make it quicker for our audience to interpret with the help of some conditional formatting to visually indicate whether the variance is positive or negative using traffic lights. Positive income variances are good, but the opposite is true for expense variances, so we need two.

This expert-written guide goes beyond the usual gibberish and explores practical Financial Statement Analysis as used by Investment Bankers and Equity Research Analysts. Here I have taken Colgate Case Study to financials and calculated Ratios in excel from scratch. Please note that this Ratio Analysis of the financial statement guide is over words and took me 4 weeks to complete. You will be using this template for the analysis.

Download these solved and unsolved Colgate Excel Template. Follow the step-by-step Ratio Analysis calculation instructions for analysis. A single ratio is not sufficient to adequately judge the hhow situation of the company.

Several ratios must be analyzed together and compared with prior-year ratios, or even with other companies in the same industry. This comparative aspect of the analysis is extremely yow in financial analysis. It is important to note that ratios are parameters and not precise or absolute measurements.

Thus, ratios must be interpreted cautiously to avoid erroneous conclusions. An analyst should attempt to get behind the numbers, place them in their proper perspective, and, if necessary, ask the right questions for further types of ratio analysis.

Vertical analysis sttements a technique used to identify where a company has applied knterpret resources and in what proportions those resources are distributed among the various balance sheets and income statement accounts. The analysis determines the relative weight of each account and its share in asset resources or revenue generation. Horizontal analysis is a technique used to evaluate trends over time by computing percentage increases or decreases relative to a base year.

It provides an analytical link between accounts calculated at different dates using the currency with different purchasing powers. In effect, this analysis indexes the accounts and pfofit the evolution of these over time.

As with the vertical analysis methodology, issues will surface that need to be investigated and complemented with other financial analysis techniques. The focus is to look for symptoms of problems how much is a quartz countertop can be diagnosed using additional techniques. We calculate the growth rate of each of the line items with respect to the previous year.

Trend Analysis compares the overall growth of key financial statement line items over the years from the base case. Protit example, in the case of Colgate, we assume that is the base case and analyze the performance in How to paint on leather and Net profit over the years.

Solvency Ratio Analysis type is primarily sub-categorized into two parts — Liquidity Analysis and Turnover Los of financial statement. They are further sub-divided into 10 ratios, as seen in the diagram below. There are three common liquidity ratio. This implies that the company has two dollars of current assets for every one dollar of current liabilities.

Sometimes how to buy jewelry for a woman assets may contain huge amounts of inventory, prepaid expensesetc. This may skew the current procit interpretations as these are not very liquid. To address this ans, if we consider the only most liquid assets like Cash and Cash equivalents and Receivables, then it should provide us with a better picture of the coverage of short-term obligations. This ratio is known as the Quick Ratio or the Acid Test.

Let us now look at the Quick Ratio Interpretation in Colgate. The Quick Ratio of Colgate is also decreasing similar to the current ratio. If the company has a higher cash ratio, it is more likely to be able to anf its short-term liabilities. Accounts Receivables can be calculated for the full year or for a specific quarter. For calculating accounts receivables for a quarter, one should take statemwnts sales in the numerator.

Days receivables are directly linked with the Accounts Receivables Turnover. Days receivables express the same information but in terms of the number of days in a year. This provides an intuitive measure of Receivables Collection Days. You may calculate Account Receivable days based on the year-end balance sheet numbers. Many analysts, however, prefer to use the average balance sheet receivables number to calculate the average collection period. Days receivables or Average Receivables collection days have decreased from around The Inventory Ratio means how many times the inventories are restored during the year.

It can be calculated by taking the Cost of Goods Sold and dividing it by Inventory. This implies that during the year, ver conversaciones whatsapp de otra persona is used up 5 times and is restored to its original levels. You may note that when we calculate receivables turnover, we took Sales Credit Sales ; however, in inventory turnover ratio, we took Cost of Goods Sold.

The reason is that when we think about receivables, it directly comes from Sales how to interpret profit and loss statements on a credit basis. However, the Cost of Goods sold is directly related to inventory and is carried on the balance sheet at cost. Think of Inventory Days as the approximate number of days it takes for inventory to convert into a finished product. Let us take a simple Days Inventory Calculation example.

This implies that Inventory is used up every 73 days on average and is restored to its original levels. Let us calculate the Inventory turnover stwtements for Colgate. Payables turnover indicates the number of times that payables are rotated during the period.

It is best measured against purchases since purchases generate accounts payable. Let us take a simple Accounts Payable Turnover peofit example. From the Balance Sheet, you are provided with the following —. In this example, we need to first find out Purchases interoret the year.

If you remember the BASE equation that we used earlier, we can easily find purchases. Once we have the purchases, we can now find the payables turnover. Please interprte that we hiw the average accounts payable to calculate the itnerpret.

Payable days represent the average number of days a company takes to make the payment to its suppliers. We will use the previous example of Accounts Payable Turnover to find the Payable days. Let us calculate Accounts Payable for Colgate.

The cash conversion cycle t the total time taken by the firm to convert its cash outflows into cash inflows returns. Think of Cash Conversion Cycle is a time taken by a company to purchase the raw materials, then convert inventory into the finished product and statemenfs the product and receive cash and then make the necessary payout for the purchases.

Let us take a simple Cash Conversion How to buy tickets on ticketmaster for presale calculation example. Operating performance ratios try and measure how the business is performing at the ground level and is sufficiency, generating returns relative to the assets deployed. The asset turnover ratio is a comparison of sales to total assets. What is tax free bonds ratio provides an indication of how efficiently the assets are being utilized to generate sales.

Asset turnover sfatements at 1. Unlike Asset Turnover, Net Fixed asset turnover is also showing an increasing trend. Statemennts Fixed Asset turnover was at 3. This ratio measures how efficient the company is deploying equity to generate sales. We cannot conclude much from here. This was primarily due to two reasons — a Share buyback program of Stxtements resulting in lowering of the Equity base each year. Operating Profitability Ratios measure how much the costs are relative to the sales and how much profit is generated in the overall business.

Gross Profit is the difference between sales and the direct cost of making a product or providing service. Please note that costs like overheads, taxes, interests are not prrofit here.

Please note that depreciation related to manufacturing operations are included herein Cost of Sales Colgate 10Ksstatements 79 Shipping and handling costs may be reported either in the Cost of Sales or Selling General and Admin Expenses.

Colgate has, however, reported these costs as a part intrrpret Selling General and Admin Expenses. If such expenses are what is tanf ssi or general assistance in the Cost of Sales, then the Gross margin of Colgate would have decreased by bps and decreased by bps in both andrespectively. In how to interpret profit and loss statements, Operating profit included charges resulting from the restructuring expenses Global Growth and Efficiency Programacquisition-related costs and a benefit related to a value-added tax matter in Brazil.

Net Margin is basically the net effect of operating as well ot financing decisions taken statemrnts the company. It is called a Net Margin because, in the numerator, we have Net Income Net of all the operating expensesinterest expenses as well as taxes.

Let us now calculate the Return inteprret the total Assets of Colgate. Most recently, lozs has declined to its lowest at Return on How to interpret profit and loss statements means the rate of return earned on the Total Equity of the firm.

It can be thought of as dollar profits a company generates on each dollar investment of Total Equity. Preferred dividends ans minority interests are deducted from Net Income as they inter;ret a priority claim. It divides ROE into several ratios that collectively equal ROE while individually providing insight to the most important term in ratio analysis of a financial statement.

We note that the asset turnover has shown a declining trend over the past years. Profitability, however, has increased over the past 4 years. Jow may note that the Asset Leverage has shown a steady decline over the past 4 years and is currently standing at The net result tsatements to the three above factors resulted in a decrease in ROE. Risk analysis examines the uncertainty of income for the firm and for an investor.

Total firm risks can be decomposed into three basic sources — 1 Business risk, 2 Financial Risk 3 External Liquidity Risk. In this context, we discuss three kinds of business risks — Total Leverage, Operating Leverage, and Financial Leverage. Operating leverage is the percentage change in operating profit relative to sales.

Operating leverage is a measure of how sensitive the operating income is to the change in revenues. Please note that the greater use of fixed coststhe greater the impact of a change in sales on the operating income of a company.

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Financial statements are prepared to have complete information regarding assets, liabilities, equity, reserves, expenses and profit and loss of an enterprise. To analyze & interpret the financial statements, commonly used tools are comparative statements, common size statements etc. Let us . Financial statements are written records that convey the business activities and the financial performance of a company. Financial statements include the . Dec 20,  · Profit and loss (P&L) statement. Also called an income statement, this report breaks down business revenues, costs, and expenses over a period of time (e.g., quarter). The P&L helps you compare your sales and expenses and make forecasts. Cash flow statement. The statement of cash flow is similar to the P&L, but it doesn’t include any non-cash.

Let us make an in-depth study of the meaning and types of comparative statements. The comparative financial statements are statements of the financial position at different periods; of time. The elements of financial position are shown in a comparative form so as to give an idea of financial position at two or more periods.

Any statement prepared in a comparative form will be covered in comparative statements. From practical point of view, generally, two financial statements balance sheet and income statement are prepared in comparative form for financial analysis purposes. Not only the comparison of the figures of two periods but also be relationship between balance sheet and income statement enables an in depth study of financial position and operative results.

The analyst is able to draw useful conclusions when figures are given in a comparative position. The figures of sales for a quarter, half -year or one year may tell only the present position of sales efforts. When sales figures of previous periods are given along with the figures of current periods then the analyst will be able to study the trends of sales over different periods of time.

Similarly, comparative figures will indicate the trend and direction of financial position and operating results. The financial data will be comparative only when same accounting principles are used in preparing these statements. In case of any deviation in the use of accounting principles this fact must be mentioned at the foot of financial statements and the analyst should be careful in using these statements.

The comparative balance sheet analysis is the study of the trend of the same items, group of items and computed items in two or more balance sheets of the same business enterprise on different dates. The changes can be observed by comparison of the balance sheet at the beginning and at the end of a period and these changes can help in forming an opinion about the progress of an enterprise. The comparative balance sheet has two columns for the data of original balance sheets.

A third column is used to show increases in figures. The fourth column may be added for giving percentages of increases or decreases. While interpreting Comparative Balance Sheet the interpreter is expected to study the following aspects:.

The excess of current assets over current liabilities will give the figures of working capital. The increase in working capital will mean improvement in the current financial position of the business. An increase in current assets is accompanied by the increase in current liabilities of the same amount will not show any improvement in the short-term financial position. A student should study the increase or decrease in current assets and current liabilities and this will enable him to analyze the current financial position.

The second aspect which should be studied in current financial position is the liquidity position of the concern. If liquid assets like cash in hand, cash at bank, bills receivables, debtors, etc. The increase in inventory can be on account of accumulation of stocks for want of customers, decrease in demand or inadequate sales promotion efforts.

An increase in inventory may increase working capital of the business but it will not be good for the business. The proper financial policy of concern will be to finance fixed assets by the issue of either long-term securities such as debentures, bonds, loans from financial institutions or issue of fresh share capital. An increase in fixed assets should be compared to the increase in long-term loans and capital.

If the increase in fixed assets is more than the increase in long term securities then part of fixed assets has been financed from the working capital. On the other hand, if the increase in long-term securities is more than the increase in fixed assets then fixed assets have not only been financed from long-term sources but part of working capital has also been financed from long-term sources.

A wise policy will be to finance fixed assets by raising long-term funds. The nature of assets which have increased or decreased should also be studied to form an opinion about the future production possibilities.

The increase in plant and machinery will increase production capacity of the concern. On the liabilities side, the increase in loaned funds will mean an increase in interest liability whereas an increase in share capital will not increase any liability for paying interest.

An opinion about the long-term financial position should be formed after taking into consideration above-mentioned aspects. The study of increase or decrease in retained earnings, various resources and surpluses, etc. An increase in the balance of Profit and Loss Account and other resources created from profits will mean an increase in profitability to the concern.

The decrease in such accounts may mean issue of dividend, issue of bonus shares or deterioration in profitability of the concern. One cannot say if short-term financial position is good then long-term financial position will also be good or vice-versa. A concluding word about the overall financial position must be given at the end. This fact depicts that the policy of the company is to purchase fixed assets from the long-term sources of finance thereby not affecting the working capital.

On the other hand, there has been an increase in inventories amounting to Rs 1 lakh. The current liabilities have increased only by Rs 20, i. This further confirms that the company has raised long-term finances even for the current assets resulting into an improvement in the liquidity position of the company.

The Income statement gives the results of the operations of a business. The comparative income statement gives an idea of the progress of a business over a period of time.

The changes in absolute data in money values and percentages can be determined to analyze the profitability of the business. Like comparative balance sheet, income statement also has four columns. First two columns give figures of various items for two years. Third and fourth columns are used to show increase or decrease in figures in absolute amounts and percentages respectively.

An increase in sales will not always mean an increase in profit. The profitability will improve if increase in sales is more than the increase in cost of goods sold. The amount of gross profit should be studied in the first step. The operating expenses such as office and administrative expenses, selling and distribution expenses should be deducted from gross profit to find out operating profits. An increase in operating profit will result from the increase in sales position and control of operating expenses.

A decrease in operating profit may be due to an increase in operating expenses or decrease in sales. The change in individual expenses should also be studied. Some expenses may increase due to the expansion of business activities while others may go up due to managerial inefficiency. Non-operating expenses such as interest paid, losses from sale of assets, writing off of deferred expenses, payment of tax, etc.

When all non-operating expenses are deducted from operational profit, we get a figure of net profit. Some non-operating incomes may also be there which will increase net profit. An increase in net profit will gave us an idea about the progress of the concern.

It should be mentioned whether the overall profitability is good or not. The income statements of a concern are given for the year ending on 31st Dec. Re-arrange the figures in a comparative form and study the profitability position of the concern. The comparative income statement given above reveals that there has been an increase in net sales of There in an increase in net profits after tax amounting to Rs 38, i. It may be concluded that there is a sufficient progress in the company and the overall profitability of the company is good.

Although the operating expenses have remained constant, there has been decrease in net profit of The company needs to look into the causes of increase in cost of goods sold and control the same.

There has also been increase of Rs 45 lakhs, i. Thus, the company has used long-term resources to finance additional working capital. The current assets have increased by Rs lakhs in , i. There has been sufficient increase in balance of cash as well as stock. On the other hand current liabilities have increased by only Rs lakhs, i. The Income Statements of Sanyasi Ltd are given for the years and Convert them into Common-size Income Statement and interpret the changes.

This has been possible for two reasons, one is that the company has increased sales by Rs 1,00, in from , the second reason is that the company has not only controlled but reduced its operating cost. The profitability of the company is very good. Following is the statement of cost of goods manufactured by Nirmala Private Ltd. Present the data in a suitable form for analysis:.

With Equation.