Managing Your Finances

 

Understanding How To Analyze A Financial Statement

For someone who may not be familiar with a financial statement, looking at it at first glance may give you a difficulty to understand or interpret what it contains, what with its many numbers and figures. One way to understand a financial statement is by ratio computation. In computing for the financial statement ratio, a particular number in the financial statement is divided by another number. Financial statement ratios are useful because it allows the reader to compare a business's current performance with its previous performance as well as that of another company’s no matter the change in its sales revenue or revenue over the years. Simply put, using financial statement ratios can call off bottom line differences in business sizes.

Ratios, however, do not guarantee definite answers.  While they may be useful an indicator in understanding a financial statement, these are not just the only factor to be considered and not the be-all and end-all in measuring a business’s value and profitability.

Financial statements do not have as much ratios.  Businesses that are publicly owned are only required to report one ratio, also known as earnings per share or EPS while those that are privately owned do not generally report ratios at all. The Generally Accepted Accounting Principles or GAAP also do not require ratios to be included in financial reports, except for earnings per share in the case of publicly owned businesses.

The gross margin ratio is one good example of a ratio that is helpful in indicating a business’s profitability. Gross margin ratio may also be gross profit percentage. In computing for the gross margin ratio, the gross profit amount is divided by the net sales amount. Most businesses, though, do not disclose in the external financial reports the margin information as this is said to be naturally business propriety and classified as a company secret that should always be kept confidential in order to protect from nosey competitors.

Another type of ratio, which is the profit ratio, is also important in assessing the bottom-line of a business. Profit margin is derived by dividing net income to net sales. The profit ratio shows how much net income was earned on each $100 worth of sales revenue. In most industries, the most common profit ratio is from five to ten percent, although in some highly priced and competitive industries such as supermarkets and retail stores indicate profit ratios of only one to two percent.