A Case for Understanding the Numbers

Small- and mid-sized businesses are faced with many demands on an ongoing basis. Some issues that require employee attention include keeping customers satisfied, ensuring that products are made with the highest quality and containing costs throughout the entire operation.

 

With such a focus, many employees don’t give too much thought to their company’s overall financial numbers. However, not only are more and more companies open to sharing their financial picture with employees, but they also want employees to understand what the numbers really mean. With this in mind, here is a brief summary of the more important financial numbers to help you understand how your company is performing. 

 

There are two main financial statements that contain a company’s critical financial information. The first is the Income Statement, which reflects how a company performed during the period (or periods) presented and shows whether that company’s operations have resulted in a profit or loss. The second is the Balance Sheet, which shows the financial position of the company based on what it owns and what it owes at a specific point in time. There are specific categories (line items) within each of these statements. The most critical are described below.

 

• Net Sales is usually the first item on the income statement. It represents the revenue earned by the company for goods and services sold, less returned goods and allowances for price reductions.

 

• Cost of Sales represents all the costs incurred to purchase and convert raw materials into finished products. The major components of cost include material, direct labor and overhead such as rent, electricity, equipment maintenance and others.

 

• Gross Margin is the difference between Net Sales and Cost of Sales.

 

• Operating Expenses are separate from Cost of Sales. These expenses include selling costs, such as advertising and salaries for sales personnel, and administrative costs, such as office employee salaries and travel expenses.

 

• Operating Income is the difference between Net Sales and the sum of Cost of Sales and Operating Expenses.

 

• Other Income/Expenses may be used to reflect sources of income or expense not covered in the line items above. Typical expenses include management consulting, amortization expenses (decline in useful value of an intangible asset like a patent), interest/dividend income and interest expense.

 

• Profit/Loss Before Tax is determined once all income and costs are considered.

 

• Provision for Income Tax is an estimation of what is owed to federal, state and local governments.

 

• Net Profit/Loss After Tax is determined once the provision for Income Tax is subtracted from the Profit/Loss Before Tax amount.

 

• Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA) is net profit with interest, taxes, depreciation and amortization added back to it. EBITDA simplifies analyzing a company’s profitability by eliminating the effects of financing and accounting decisions.

 

• Current Assets include cash and assets that will be turned into cash within a year from the balance sheet date.

 

• Property, Plant and Equipment consists of assets that are used to manufacture, present, store and transport the company’s products.

 

• Net Property, Plant and Equipment reduces the value of the property, plant and equipment by the cost of depreciation.

 

• Total Long-Term Assets is the sum of net property, plant and equipment and other long-term assets held by the company, including goodwill (the value of a company’s reputation) and intangible assets (such as a copyright).

 

• Current Liabilities are obligations payable within 12 months, such as accounts payable.

 

• Long-Term Debt represents notes payable after one year from the balance-sheet date.

 

• Total Long-Term Liabilities include long-term debt plus any capital equipment leases, deferred income taxes (such as from an accelerated write-off of equipment) or other long-term liabilities.

 

• Shareholders’ Equity (Net Worth) represents a company’s assets after subtracting all of its liabilities. Shareholders’ equity can include stock, warrants (entitlements to buy stock in the future) or retained earnings (the accumulated profits the company earns and reinvests in the company).

 

• Total Liabilities and Shareholders’ Equity is the result of adding all liabilities and shareholders equity together. This total should be the same as the total assets of a company.

 

Financial statements are not especially complicated, and a better understanding of their meaning can provide anyone with greater insight to a company’s performance.