One of the handiest skills that I learned from obtaining an accounting degree is to properly read a corporate financial statement. This article will help you to better understand why it is important to learn to read a financial statement. This skill can come in very handy if you would like to begin investing in stocks. In fact, reading a financial statement is extremely important if you want to invest in stocks.
To the untrained eye, a financial statement can seem very complicated and overwhelming. The first step to understanding a financial statement is to understand the numerous ratios, which can be used to interpret the financial health of a company. Each ratio has a specific purpose and is derived by dividing a defined set of numbers by another set of numbers.
The purpose behind the deciphering a financial statement is twofold. The first purpose is to compare the company's current performance compared to its previous performance. Also, deciphering the financial statement is useful in comparing companies of different sizes. A large company on paper can look much more impressive compared to the smaller company. However, once some calculations and ratios are compared, the smaller company may actually be a better investment.
Using ratios will help to negate the effect of the larger sales revenue or net income a larger company would probably have. In other words, a security company which had $6 billion in sales, at first glance, may look more impressive than a smaller company that only had $3 million in sales. However, digging deeper by using ratios, you may determine the smaller company is in better financial health than the larger company.
You probably won't find a large amount of ratios calculated for you in financial reports. In fact, a company which has publicly traded stocks is required by the SEC to disclose only one ratio. That ratio is known as the earnings per share ratio, also known as the EPS. Privately owned companies, generally speaking, do not have to disclose any type of ratio in their financial statements.
It's important to realize that ratios should only be used as a guide. There are good for indicating a company's current financial health. However, they shouldn't be relied on as a sole source of information, to make an investment decision with.
An extremely telling ratio about how profitable a company is, is the gross margin ratio. This ratio is calculated by dividing the gross margin by the sales revenue. The bad news is, no company includes margin information in any form of documentation outside the company. Margin figures for company are proprietary. This information is withheld to protect it from the competition.
One handy ratio, you can use to calculate the bottom line of the company, is the profit ratio. This ratio will show you how much net income was earned per $100 of revenue obtained. The standard percentage through most industries is 5% to 10%. Within extremely competitive industries, a profit ratio of 1% is an uncommon. A good example of this would be grocery store chains.
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