Report Analysis – How to Read the Statements

Learn how to read and understand the basic financial reports used by all businesses. From the balance sheet to the profit and loss statement, understand why the reports are organized in this fashion. Find out how a cash flow statement works and the value it brings to the reader of this report. Finally, understand how the equity section and the reports about ownership are used for a small business.

Operating Profit Margin – Formula and Understanding

Operating Profit Margin - Formula and Understanding

Operating profit margin refers to the value earned as a percentage of net sales.   The operating profit is often referred to as earnings before interest, taxes, depreciation and amortization, (EBITDA).   This is a misleading reference as operating profit is actually defined differently by industry sector.   EBITDA is used primarily in valuing businesses.

Debt Ratio

Debt Ratio

Every business buys on account whether it is a traditional vendor account like that found in retail or simply using a credit card.   A third party provides credit which creates debt for the business.    The debt ratio reflects the percentage of assets covered by debt. 

Fixed Assets Turnover Rate

Fixed Assets Turnover Rate

The fixed assets turnover rate is another activity ratio whereby an income statement financial characteristic is compared to a balance sheet asset section.    In this case, comparing adjusted sales against historical cost of fixed assets.   This financial business ratio is only effective for business operations that are fixed asset intensive.  So with service based industries like carpet cleaning, professional firms and medical practices this particular ratio is impractical.

Working Capital Turnover

Working Capital Turnover

The activity ratios measure performance of a current asset on the balance sheet against a corresponding area of the income statement.  The working capital turnover is the most encompassing of all the activity ratios; in effect, it is the most general of the activity ratios.   This particular ratio measures the ability of management to efficiently utilize net current assets. 

Cash Ratio

Cash Ratio

One of the liquidity ratios used in business is the cash ratio.  It is a much more effective tool for small business than the traditional current or quick ratio.  Although the cash ratio is more difficult to manipulate in small business, most entrepreneurs miscalculate the result

Accounts Receivable Turnover Ratio

Accounts Receivable Turnover Rate

One of the activity ratios in business is the receivables turnover ratio or rate.   This ratio measures the frequency of collecting the entire balance of accounts receivable during a standard accounting year.   The ideal turns rate is twelve with a higher value indicating an aggressive collection process.   A lower value is a warning about accounts receivable management.

Net Profit

Net Profit

No other business term is so misunderstood, misstated, misleading or deceiving as the words ‘net profit’.  Accounting defines net profit as the amount earned after all associated costs and expenses are subtracted from the associated sales.   The larger or more public the company the more reliable the dollar value as stated on the bottom line.  But in small business, the more likely the value is inaccurate as stated in the financial report.  

Current Ratio

Current Ratio

The current ratio is an inappropriate relationship to use or rely on in small business.  The ratio is best suited for large publicly traded organizations.  This article explains the basic formula for the current ratio, how to identify the ratio in reading financial statements, its purpose and the many drawbacks for its use with small business.

Business Ratios (Introduction)

Percentage of Completion

Ratios are used in business to compare companies of different sizes within the same industry. The goal is to discover the best investment for return on your stock purchase.  Business ratios essentially equalize different size companies within the same industry.  A common mistake is to compare two different industries within the same sector (explained below).

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