1. What are some items on the Income statement, balance sheet, and cash flow statement that should be utilized to understand the financial health of a firm? Total Assets: This is the total value of everything a company owns, from factories and trucks, to inventory, right down to the pens and pencils in employees’ desks.
Total Liabilities: This is the total amount of money that the company owes to other people (or companies). Loans owed to the bank, bonds issued to investors, payments owed to suppliers, and taxes owed to the government are all liabilities that show up here.
Shareholders’ Equity: Take everything the company owns (Total Assets), subtract everything the company owes to others (Total Liabilities), and what’s left over is shareholders’ equity – the value of the owners’ stake in the company.
The income statement tells you how much money a company has coming in, how much is going out, and how much (if any) is left over. When examining an income statement, the three most important items are “Total Revenues,” “Total Expenses,” and “Net Income.” A quick summary:
Total Revenues: This is all the money the company receives in exchange for the goods or services it sells to customers. When a company sells a widget for a dollar, that dollar is revenue.
Total Expenses: This is all the money the company spends to produce and sell its goods and services. The costs of raw materials, employees’ wages, rent and other costs all show up here.
Net Income: This is a company’s profit. It is how much of their revenues are left after paying all their expenses, and paying taxes to the government. It is how much a company has left to reinvest in the company, or return to the owners through dividends or stock buybacks.
2. List and describe 4 profitability measures.
Profit Margin - A higher profit margin indicates a more profitable company that has better control over its costs compared to its competitors. Regular income doesn’t necessarily show how well a company is doing.
Return on Assets - An indicator of how profitable a company is relative to its total assets. ROA gives an idea as to how efficient management is at using its assets to generate earnings.
Financial Leverage - Financial leverage involves using fixed costs to finance the firm, and will include higher expenses before interest and taxes. The higher the degree of financial leverage, the more volatile EPS will be, all other things remaining the same.
Return on Equity - The amount of net income returned as a percentage of shareholders equity. Return on equity measures a corporation's profitability by revealing how much profit a company generates with the money shareholders have invested.