What do all these words mean? Are you making money? Do you owe taxes? Here’s Oxford Edge’s quick guide to your annual financial statement.
Statement of financial performance
Does my business operate well for the year? Does my business make profits or losses? What is the profit margin? What are the main sources of income and major expenses for the business? At the end of financial year, first thing you’ll want to know is profitability. How do accountants measure the profitability and find all the answers? Here we go!
Statement of financial performance (income statement) is our buddy to analyse the profitability of our businesses. It gives us all the income and expense figures we need to calculate profitability ratios. Below are some of the main ratios to measure profitability from your statement of financial performance.
Gross profit margin
The first profitability measure is gross profit – this gives us the percentage of profit made from total sales. Gross profit is the profit the company made on sales after you take away the cost of goods sold. We can find the gross profit in the trading accounts in the income statement. You can calculate your gross profit margin by dividing the gross profit by sales revenue.
Operating profit margin
The second profitability ratio is operating profit margin. The operating profit is the gross profit minus operating expenses. This is the same as earnings before interest and taxes (EBIT) as long as there is no non-operating income. We calculate the operating margin by dividing operating profit by total sales.
Net profit margin
Net profit margin measures how much profit your business makes for every thousand dollars of sales. It’s the percentage of revenue left after all expenses have been deducted from sales.
Return on assets (ROA) & return on equity (ROE)
These two important profitability ratios relate to your income statement and balance sheet. They assess costs and analyse in comparison to assets, so you can see how effective your business is at using assets to generate sales and profits. The return stands for the net profit of business, which is the value of earnings from sales after deducting all costs, expenses, and taxes.
ROA is calculated by dividing net income by total assets. The more assets the business owns, the more sales and potential profits the business may generate.
ROE measures the ability of a business to earn a return on its equity investments. Therefore, it is an essential ratio for shareholders. ROE can be calculated by dividing net income by shareholders' equity. ROE can increase without additional equity investments because the ratio can increase with higher net income, due to a larger asset base funded with debt.
Statement of financial position
Also known as the balance sheet, a statement of financial position tells you how things stand at a certain point. It shows your company’s ability to pay for its short-term operating needs, meet future debt obligations and make distributions to owners. If you are interested in the resources for business operation, the asset section will show you all kinds of resources in the business. Assets include both tangible (land, building, plant and equipment) and intangible assets (goodwill and trademark). Current assets are expected to be liquidated or used up within a year or an operating cycle while non-current assets are not. If you would like to know the sources of capital for the business, the liability and equity sections can give you an overview. Current liabilities are debts expected to be paid within a year or an operating cycle while non-current liabilities can be paid off later on. You can find the ordinary share capital, retained earnings and dividends paid in the equity section.
Statement of cashflow
The cash position is a key factor for the business. The ‘cash inflow’ indicates how much cash and cash equivalents are entering the business and ‘cash outflow’ describes how much cash and cash equivalents are going out of the business. The main activities are operating, investing and financing activities. For example, receipts from customers, salary, wages and rent payments are operating activities. Cash changes relating to equipment, assets, or investments are cash from investing activities. Dividend payments, stock repurchases, and the repayment of loans are financing activities.
So now you know about the reports on business profitability, position and cashflow. How do you know if the results are good? Talk to Oxford Edge’s business experts for analysis and advice.
