Welcome to week two of the Husky Investment Tournament!
Accounting is the language of business; it allows companies to accurately convey important financial information to stakeholders. Accountants have many jobs, but among them is preparing the company’s financial statements, which show the financial position of a company.
There are three main financial statements: The income statement, balance sheet, and statement of cash flows. For the next three weeks, we will cover each one in greater detail, and give some investing tips regarding them.
Looking first at the income statement, it shows how much a company made during a period of time—revenues (earnings) minus their expenses.
Some ratios used by investors focus strictly on the income statement. Many start by looking at the gross margin percentage. This percentage is calculated by taking the gross margin and dividing it into the overall revenue. This shows what percentage of every dollar goes towards their gross income. It is important to look at what the company has done historically. Have they gotten better over time? How does it compare to its competitors? Similarly, you can look at their net profit margin. This is found by taking their net income and dividing it into their revenue. It tells us how much of every dollar goes towards their bottom line.
Another important part of the income statement is the earnings per share (EPS). This dollar amount shows us the amount of net earnings that is attributed to one share of stock.
As an example, let’s say XYZ Corporation had a net income of $150,000 and 50,000 shares of common stock outstanding. To calculate the EPS we simply take the $150,000 and divide it by the 50,000 shares. The answer in this example is $3. This company was able to generate $3 of earnings on every share of stock. So what does this do for investors? It is important to look at the historical trend of the company. If XYZ Corp. had an EPS of $0.50 last year, the increase in EPS is a good sign and should be considered when making your investments.