4.4: Key Information in Financial Statements
Learning Outcomes
- Identify important information found on key financial statements
As you have seen, the financial statements summarize a massive amount of raw data, turning it into information that is presented in a specific format.
The Income Statement, Revisited
A multiple-step income statement begins with Net Sales, which is Gross Sales less Returns and Allowances and net of Sales Discounts.
Cost of Goods Sold directly matches the cost of products sold against Net Sales. Often, a company then reports Gross Profit, which is Net Sales less Cost of Goods Sold. For instance, looking at The Home Depot, Inc. annual report ( http://www.homedepotar.com/financial-highlights.html ) for the fiscal year 2017, Net Sales were $100.9 billion (rounded to the nearest billion) and Cost of Sales (aka Cost of Goods Sold) was $66.5 billion, giving a gross profit of $34.4 billion. That remaining amount of $34.4 billion goes to pay operating expenses, income taxes, and other costs of doing business.
For The Home Depot, Inc., for the 2017 fiscal year, Selling, General, and Administrative expenses totaled $19.7 billion, leaving an operating income of $14.7 billion. Lowe’s, Inc. shows an operating income of $6.6 billion.
| Typical Statement of Earnings | ||
| (Income Statement) | ||
| Comparison of Home Depot to Lowe’s | ||
| For the 2017 fiscal year (all monetary amounts in billions) | ||
| Home Depot | Lowe’s | |
| Net Sales | $100.9 | $68.6 |
| Cost of sales | 66.51 | 45.2 |
| Gross profit | 34.4 | 23.4 |
| Selling, general, and admin | 19.7 | 16.8 |
| Operating income | 14.7 | 6.6 |
| Other income and expenses | 1.0 | 1.1 |
| Net income before taxes | 13.7 | 5.5 |
| Provision for income taxes | 5.1 | 2.0 |
| Net income | $8.6 | $3.5 |
Other income and expenses include interest expense and non-operating expenses. By separating out these non-operational amounts, operating income is more comparable across different companies. For instance, if Lowe’s borrowed very little money and was mostly funded by owner contributions, and if Home Depot borrowed heavily, operating income would not be affected, even though other income and expenses would be quite different, affecting the bottom line significantly.
The Statement of Owners’ Equity, Revisited
As discussed earlier, net income flows from the bottom line of the income statement to the statement of owners’ equity. For publicly traded companies like Home Depot and Lowe’s, the statement of owners’ equity can be called the Statement of Shareholders’ Equity or something similar. In any case, it shows changes in owners’ equity, as follows:
| Typical Statement of Owner’s Equity | ||
| Comparison of Home Depot to Lowe’s | ||
| For the 2017 fiscal year (all monetary amounts in billions) | ||
| Home Depot | Lowe’s | |
| Beginning equity | $4.3 | $6.4 |
| Net income | 8.6 | 3.5 |
| 12.9 | 9.9 | |
| Less: Dividends | 4.2 | 1.3 |
| 8.7 | 8.6 | |
| Repurchase of common stock and other equity transactions | (7.2) | (2.7) |
| Ending equity | $1.5 | $5.9 |
Publicly traded corporations like Home Depot and Lowe’s raise capital by either borrowing or selling stock on the open market. Distributions to owners are called dividends and are declared by the governing board of directors, rather than by individual owners. Note that ending equity for both Lowe’s and Home Depot was less than beginning equity, even though both companies showed positive net income. That is because both companies are buying stock on the open market, hoping to reduce the number of shares of stock outstanding. Dividends, stock repurchasing, and net losses reduce equity, while issuing stock and net income increase equity. See http://phx.corporate-ir.net/phoenix....-reportsannual for a copy of Lowe’s annual report.
The Balance Sheet, revisited
The balance sheet, also known as the statement of financial position, shows the company’s assets, liabilities and owners’ equity (net worth). The asset portion of the balance sheet is generally broken into three broad categories: current assets, fixed assets (property, plant and equipment), and other non-current assets.
Although each company is unique, every balance sheet shares one thing in common: total assets are always equal to the total of liabilities and equity. Below is a condensed version of the balance sheet for Home Depot for the fiscal year 2017.
The Statement of Cash Flows, Revisited
The statement of cash flows shows how changes in balance sheet accounts and income affect cash and cash equivalents, and breaks the analysis down to operating, investing and financing activities. Essentially, the cash flow statement is concerned with the flow of cash in and out of the business. The statement captures both the current operating results and the accompanying changes in the balance sheet. As an analytical tool, the statement of cash flows is useful in determining the short-term viability of a company, particularly its ability to pay bills.
The financial statements are augmented by an extensive set of footnotes. The notes typically describe each item on the balance sheet, income statement and cash flow statement in further detail. Notes to financial statements are considered an integral part of the financial statements and are audited along with the financials.
Practice questions