Basics of Accounting - Income Statement Analysis | Robert Reed | Skillshare

Basics of Accounting - Income Statement Analysis

Robert Reed

Basics of Accounting - Income Statement Analysis

Robert Reed

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18 Lessons (1h)
    • 1. Course Introduction

    • 2. Intro to Key Terms

    • 3. Types of Financial Statements

    • 4. Where to Find Income Statements

    • 5. Net Revenue, COGS, and Gross Profit

    • 6. Operating Income SGA Expenses

    • 7. Interest Income and Interest Expense

    • 8. What is Net Income?

    • 9. Section 2 intro

    • 10. PE Ratio

    • 11. Times Interest Expense

    • 12. SGA and Other Research Ratios

    • 13. Introduction to Margins

    • 14. Margins Explained

    • 15. Gross Margin

    • 16. Operating Margin

    • 17. Profit Margin

    • 18. Conculsion cut 2

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About This Class


Income statement analysis is a field of study that determines a company's financial health by looking at publicly available information found on financial reports. Income statement analysis allows us to determine how efficient a company is as well as calculating different measures of profitability. Income statement analysis is typically thought of as an Accounting or Finance skill, but other business professionals such as managers and economists need this tool set as well.

There is nothing worse than trying to learn a new skill that you don't understand. As an Economics student, I found most of the courses in Financial Statement Analysis were geared towards explaining the concepts in a way that Accounting and Finance students could best understand, and the examples did not make sense to me. This course is specifically designed for non-experts who have no prior experience with accounting. I will do my best to explain all of the concepts in a simple, easy to understand way while still covering all of the important information.

Topics Covered

  • Where to find Income Statements and other Financial Statements

  • Compare and Contrast Three Measures of Profitability

  • Understand Key Income Statement Terms

  • Calculate Price to Earnings Ratio

  • Differentiate Earnings per Share vs Diluted Earnings per Share

  • Derive Commonly Used Financial Ratios

About the Instructor

Robert Reed is a current Masters of Business Administration candidate and veteran with four years of service in the 82nd Airborne Division of the United States Army. He holds a B.A. in Economics and has served as a student tutor for three years.

Meet Your Teacher

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Robert Reed


Welcome! I am a veteran and current MBA Candidate. Teaching and tutoring are passions of mine. My first job in college was tutoring other students. I love seeing the magical moment when an idea finally "clicks." When I am not working, I enjoy gardening, inline skating, and playing the harmonica.

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1. Course Introduction: hello. In this course, we're going to be using a company's income statement to assess the financial health and stability of the company. Now the income statement is a free, publicly available financial document that every single publicly traded company must publish. It's a treasure trove of financial information that we can use to understand the company. Now this courses for complete beginners. You don't need a background in economics, accounting or finance to understand the concepts in this course, we're going to divide the course into three separate sections in the first section will focus on the basics of an income statement. We'll go line by line and talk about the most important terms on the statement. In the second section, we get to talk about financial ratios such as earnings per share or the research and development ratio. Lastly, we'll talk about different measures of profitability, depending on how you want to evaluate a company. There are actually three different measures of profitability that we're going to discuss in Master. This course is a beginner's introduction toe, looking at financial statements and interpreting the results. It's going to be a perfect course for so long that must get started in accounting or just started in financial analysis, but doesn't really have a strong background in the area. I hope you enjoy the course. Let's start learning. 2. Intro to Key Terms: hello. Welcome to the first section of the course on income statement analysis. This first section is the key because it's laying the ground work for the rest of the course. It's imperative that you understand all the concepts in this section, But don't worry. I'm going to take it slow and explain everything in detail. This section will focus on things such as learning what cost of goods sold means what are selling general and administrative expenses will look at different types of income to the company can have. And then we're going to go line by line on an income statement from a real company and show you all of these things in real life from a real life income statement. I hope you find this section useful, and I am here to answer any questions that you may have 3. Types of Financial Statements: Hello. Welcome to the course in income. Stay analysis. Now, before we begin analyzing income statements, it's important to understand that there are four main types of financial statements. The first of these, which we will be focusing on, is the income statement. Now the income statement is so important to understanding a company that it is also called the profit and loss statement. What an income statement does is it summarizes the revenues and expenses in a given period . So let's use a personal example and suppose that you are working in the month of January and you make a salary of $1000. The cost of driving to work is $200 the gross profit of your work then becomes $800. So what the income statement is doing and there's a lot more that goes into an income statement. This is just a very, very, very, very simple example. But what an income statement does is it allows us to see over a given period. What are we doing? What are we making and what are we spending now? A balance sheet is a financial snapshot at a given time. So where's the income statement tells us, over the period of January, we made this much and we spent this much. A balance sheet is like going to the bank and getting a statement. It's telling you on this specific day at this specific time you had this much and assets you had this much in liabilities. So for a personal example, on January the first I might have $100 in cash, $300 worth of investments in my retirement account, and I might have $50 worth of bills and $50 that I owe to a friend because he mowed my lawn and I didn't really pay him yet. Now the statement of retained earnings shows changes in retained earnings between balance sheets. So if I am in January and I have retained earnings of, let's say, $300 then in February, I have retained earnings of $400. This statement of retained earnings explains why this change occurs and your pricing Wait, wait, wait, What are retained? Earnings. Well retained earnings are simply money that is left over after everything from the company has paid out. So if we make a sale and then we deduct the cost of goods sold, we have the gross profit. Then, after we take taxes and things like that, we have net profit. Even after we make net profit, companies will pay out dividends or other things that decrease their retained earnings. Retained earnings is after everything is said and done, taxes, cost of goods sold dividends after everything is completely paid out. This is how much the company actually retains of that money and then lastly, we have the cash flow statement. Now the cash flow is exactly what it sounds. It's where the cash is going in the business it's describing are operating activities. Operating activities are pure business activities. So this is US buying and selling products, investing activities. This is the purchase of stock or the purchase of capital equipment. So if we invest in a new factory or we invest in a new machine and then lastly, it discusses financing activities such as the issuance of debt, the issuance of bonds, the repayments of bonds and things like that now getting back to the purpose of this course . While you should be aware of the other types of financial statements, this specific courses going to look at the income statement, the profit and loss statement. We're going to be looking at a company and seeing the money that it's making the cost that it's taking to make that money. We're going to be looking at different kinds of financial ratios relating to how good the company does at turning inventory into sales, how good the company can do at turning sails into actual profit. I hope you found the video useful, and I will see you in the next lesson. 4. Where to Find Income Statements: Hello and welcome back to the course in income statement analysis In this lesson, we're finally going to be introduced to the income statement and we see here that this is an income statement for the Coca Cola Company. Now, immediately, we noticed that this income statement is prepared for the three months ended September 28 2018. What does this mean? What this means is that an income statement analyzes income and expenditures over a period of time. So it's not looking at a specific day. It's saying over the past three months over the past year, what were our incomes? What was our expenses? Now it also has here September 29th 2017. And this is for a comparison. If you were to pull up the September 29th 2017 income statement, it would be on the left and then September 29th 2016 would be on the right. So they just give us this historical context. Now we also see here that we have the nine months ended. So again, they're giving us these two different things to compare. But for our purposes, we want to focus on this Left most column this is the most current column, and we see that in this three months they did 8000 245 millions of sales. Now remember, this is just a number. This is the scale. So in this in this income statement, everything here is represented in millions so that they don't have to waste a lot of space with zeros and things like that. Now there's a lot of different terms here. There's net operating revenue, there's operating income, and we're going to cover all of this in some of the coming lessons. But for now, I just wanted to introduce you to the income statement, and I also wanted to show you where to find the income statement. Now, any company that is publicly traded is required to give filings to the Securities and Exchange Commission, and you can find this by simply googling SEC filings and going to company filings sec dot gov. So every company that is publicly traded is required to give these foot filings to the SEC , and you need to know how to find the statement so you can either search for the company names such as Coca Cola or, if you know the ticker symbol. You can simply enter the ticker. So for Coca Cola, the ticker is K O. If we were looking for a visa, it would be a V. Procter and Gamble would be PG, so it it speeds things up a little bit if you know the ticker symbol now, once we search for that, we have different filters. But we already see that it's giving this to us in a chronological format. So the most recent filing is from October 30th. So let's go ahead and find a tank you now a 10-Q is a quarterly report, so this is put out every quarter. If you were to find, let's see if we can find a 10-Q Here's a 10-Q statement. Now this is quarterly. Where's a 10-K? Oh, here we go. This is a 10-K So this is an annual report. So remember a que stands for quarterly and A K stands for annual. They're going to have a lot of the same things in them. But the quarterly statement is typically going to be a little bit more up to date because it's published every three months instead of every year. So let's go ahead and select documents. And then what we want to actually look at is this 10-Q statement. So we would click here and it would download. Now, if you don't want to search through all of this, you can also find this through a company website. So Coke investor relations. And if we go to the website, we're going to see a lot of different things. Now it's completely dependent on your choice. The SEC filings are a little bit more straightforward there a little bit easier to navigate . In my opinion, if you go to the actual company website, you're going to see a lot of things that can be confusing. So you see this, this information that it's giving you about the annual review and the production fax and you can you maybe think? Okay, I'm gonna click on stock information to find this, but then you're taken somewhere else so you can find all of this stuff through the company website. They do have it, but in my opinion, at least I would recommend joined directly through the SEC website because it's a lot quicker. You get exactly where you need to go. I hope the video's been useful and joined me in the next lessons when we actually start looking at the income statement when we actually start getting into the financial ratios and what everything means. I hope you found the video useful, and I will see you next time. 5. Net Revenue, COGS, and Gross Profit: Hello. Welcome back to the course in income statement analysis Today we're finally looking at the income statement and what all of these numbers mean. And we're starting off with the very first item on this list, which is net operating revenues now. Net operating revenues are a dollar for dollar sales amount from our primary business activity. What does this mean? Well, first off, it's our sales, but second, not every sale we make is counted in net operating revenue. It has to be from our primary business activity. So let's suppose that were a landscaping company. And you've seen these trucks where they put a lawnmower and a weed eater on the back. And then these guys go around and they cut grass or the plant, Gordon's or whatever. Now that is their primary business activity. But from time to time, people will want to use that big truck that they have. So if my lawnmower is broken down, I might call a landscaping company and say, Hey, I need you to transport my lawnmower. Since you have this big truck, can you please transport this lawn mower to a repair shop? And they might charge me $50 now they wouldn't count this $50 in their operating income. Why? Because this is a random amount of income. It's not related to their business. It's unpredictable income. Or let's suppose that I have a furniture store and I make money from selling furniture. But maybe once a month I order too much lumber, and I sell this to a scrap yard. Now I am making money. But remember, this isn't my primary business activity, so I'm not counting this now. Cost of goods sold is exactly what it sounds. It's the cost to produce a product now. One quick note. Coca Cola is producing a product, but some companies that offer a service like if you were a doctor or a lawyer, you wouldn't really have a cost of goods sold. So sometimes you might see cost of revenue or cost of sales. But in this example, we have cost of goods sold, and this is simply found by adding all the costs of production. So we have the metal that we're using to make our acts head is $25. That wouldn't handle cost US 10 and the labour to produce this ax costs us $5. So our total cost of goods sold is $40. And then what we can do to find gross profit is we subtract revenues minus the cost of goods sold, and you can even follow along with this example. In the balance sheet, 8245 minus 3000 and 59 gives us $5186. Now remember that this is expressed in millions of dollars on this particular income statement going back to our example of making an axe, it sells for $100. Cost of goods sold was $40 which means that we have a gross profit of $60 now, In summary, we've talked about net revenue, which is basically the total sales from our primary business activity. The cost of goods sold is how much it took us to make those products that we sold. And then when we subtract the cost from our total revenue, we get the gross profit and the coming videos. We're going to continue looking at the income statement and we'll look at some other types of expenses that we might have and will begin to talk about net operating income. I hope you found the video useful, and I will see you in the next lesson. 6. Operating Income SGA Expenses : Hello. Welcome back to the course in income Statement Analysis. Hello. Welcome back to the course in income statement analysis today we're continuing to learn about the income statement, specifically operating income. Now, if you remember from the previous video, we talked about how net operating revenues minus costs of goods sold gives us gross profit , and we talked about how we have to pay for the inputs of our product. We have to pay for labour, but there are other expenses that a business must make. For example, we have selling general and administrative expenses. These air required operating costs that are not used to produce a product. And what do I mean by this? Well, let's suppose that we are a tool manufacturer and we have a legal team that is to represent us in case we get sued. This legal team doesn't actually create a single product, but we have toe have this legal team so that we have defense in case we get sued or if we have a marketing team or a marketing budget. This marketing doesn't actually create a shovel or create an axe for us to sell, but it's essential in helping us generate revenue. So going back to the example that we had in the previous video, let's suppose that we're selling on acts and we put a $10 advertisement on the radio or in a Home Improvement magazine. Four R X. This $10 doesn't actually create an axe, but because it goes towards selling because it goes towards generating revenue, it is an SG a expense. Now we also have other operating charges, and in all honesty, these are very, very similar to SG A expenses. So sometimes these to get considered together, but they're basically things that are needed to keep the company in operation. Now, operating income is the income from the gross profit subtracting out all of the SG A expenses. So in this example, if we start with 5186 then we subtract the SG A and the other operating charges. We arrive at 2526. So it is the income from the operations. Let's suppose that we live in a vacuum and we don't have to pay income taxes. We don't have interest income. This operating income is the income solely from us selling a product and paying for all of the costs that go into not only creating that product, but all of the costs that are necessary to create that product all of the costs that are necessary to sell and market that product as well. So let's go back to the example of the tool company and remember that the sale price of our acts is $100 are cost of goods sold is $40. So this leaves us with a gross profit of $60. But now we subtract out the SG A expenses. Remember, we paid $10 for a newspaper advertisement, so we subtract another $10 which gets us to an operating income of $50. In summary, we have talked about gross profit, and we have seen how the companies have to provide other expenses other than the cost of goods sold. SG A selling general and administrative expenses account for this. Once we subtract thes out of growths profit, we arrive at the operating income. I hope the video has been useful and I will see you in the next lesson 7. Interest Income and Interest Expense: Hello. Welcome back to the course and income statement analysis, and today we're going to be talking about income before taxes, and I kind of get the sense that this can be a little bit confusing because we're talking about all this different income. We have net revenue, and we have gross profit operating income income before taxes. So let's just slow things down and see how this all fits together. At the very beginning, we have net revenue, and the easiest way to think of this is basically everything that we sell. So all of our sales R sales are the net revenue. Once we subtract out the cost of goods sold, the raw materials, the labour to produce those products that we sell, that is our gross profit. Now we don't have simply cost of production expenses. We have other expenses selling general and administrative. And once we subtract those, we get to operating income. This is the income from our business, our business model from our products, basically, but we have other things that we're doing as well. We have interest now once we factor an interest. This is where we have earnings before taxes and one more quick note before we move on. Depending on what balance sheet you're looking at, things can be said a little bit differently. They can be represented a little bit differently. So on the left in the red we have a Pepsi statement of income, and on the right we have one from Coca Cola. You will notice that Pepsi calls operating profit, whereas Coca Cola calls it operating income. You will also notice that the interest, income and interest expense equity income, other income are all under Coke. But Pepsi on the left simply says interest, expense, interest, income and other and one more thing under Pepsi. Look how they have other pension and retiree medical benefits, whereas on the right, Coke does not represent this. So if you were looking at a different balance sheet or an income statement, don't get confused because they use the words a little bit differently now, moving on to the actual lesson. The first thing we have is interest income, and this is income from our investments, just like a person a company can invest so they can invest in bonds or certificates of deposit. Let's suppose that robs tools, purchases a 5% bond, and this bond pays me $10 per year. This $10 would be interest income because its interest its income that I'm getting from interest. It's not income that I am getting through sales. We also have interest expense. Just as people can take out a loan, so can a company. And this interest expense is the payments that were making on loans and bonds. Think of this as paying your credit card bill or paying off a debt that you owe. And let's suppose that robs tools took out a loan from a local bank at 10% interest. And every year we have to pay back $400. This is our interest expense. We also have equity income companies can invest in other companies. So let's suppose that Robs Tools owns 500 shares of Mike's machine core. The income from these shares is our equity income. This is income that's coming from our ownership of a small piece of another corporation. Now we also have other income. Now, if you remember a couple lessons ago, we were talking about a furniture shop, and they make beautiful wooden furniture, but sometimes they order too much wood and they have to sell this would to a scrap yard. Now this is income. This is money that they're making. But it's not from their core business. So remember I said we can't count this sale as part of or original income. It has to become other income because it is not part of our business. So in summary, we have interest, income and interest. Expense income is money that we are getting from the bonds that we hold. The loans that other people owe us interest expense is what we are paying out and interest . This is paying towards our debts, paying towards the bonds that we have issued in the past. We have equity income, which comes from our stake of ownership in other companies. And then lastly, we have other income. This is income that we generate. But that isn't a function off our primary business. I hope you found the video useful, and I will see you in the next lesson. 8. What is Net Income?: Hello. Welcome back to the course and income statement analysis and this lesson. We are finally getting to net income now. Net income is what we commonly think of as profit. So let's go through a few more steps to show how we get to this net income. Now, As you remember, we're looking at the income statement for Coca Cola. And as we keep going down, we have income from continuing operations before taxes, net income from continuing operations. Now this is income that excludes discontinued operations. So what do I mean by this? What I mean is that let's suppose that robs tools is my business. And I also own a business called Rob's Workshops. Now Robs Workshops did make a little bit of money throughout the year, But for whatever reason, I decided that I'm not going to keep owning. This robs workshop business. So I end up selling. Rob's workshops now robs tools, owned Rob's workshops, but they were sold, so they they're not counting as regular income. They're not counting as the sales that we were talking about at the very beginning, because investors can't count on this money going forward because we're discontinuing this product line or this operation. Now, lastly, we have net income attributed Bull to shareholders of the Coca Cola Company. I'm going to be honest with you guys. Coca Cola's income statement is kind of one of the harder wants to understand. I'm going to be comparing it with a Pepsi statement so you can see that they're not all this hard. But I wanted to tackle one of the harder ones before we moved on to the easier ones, just so that you all understand that you can do it now. As we have here, The net income now consolidated means that this takes into account certain subsidiary companies. And let's look at how much simpler the Pepsi statement is on the left to Coca Cola on the right. You see that with Pepsi, we simply have net income. So when you are comparing two different companies, 1 may say net income, the other 1 may have consolidated in that income and net income attributable to shareholders of a certain company. Those were the two you want to compare. You don't want to compare net income to consolidated income or net income from continuing operations. You want to compare net income to net income attributable to Sharon knows of whatever company you're comparing. So in summary, we made it. We finally got to the portion of net income, which is known as profit. I know this was a short video, but I wanted to wrap everything up before we begin the next section, which is going to be actually looking at financial ratios and what they mean. I hope the video was useful and I will see you in the next lesson. 9. Section 2 intro: hello. Welcome to the second section in the course on income statement analysis. In this second section, we're going to be taking all of the key terms and basic information you learn in the first section and applying it to financial ratios. Well, look at things such as the price to earnings ratio, which describes the price of the stock in relation to its burning. We'll also talk about different types of efficiency measures, such as how much of a company's profit does it spend on research and development? How much of its profit is it spending on selling, general and administrative expenses? We'll learn how to use these ratios to determine not only the efficiency of the company, but also toe analyze how competitive of a mortgage that it operates. This is going to be a very interesting section with a lot of useful information. As always, if you have any questions at all, feel free to contact me. I will do the best to answer your questions 10. PE Ratio: welcome back to the course in income statement analysis. In this lesson, we're looking at the price to earnings ratio, and this is, quite simply, the price of the stock divided by its earnings. Now, this isn't really a course in stock analysis. It's more focused on the income statement. So why are we talking about a P E ratio? Will A P E ratio comes from the earnings per share and wears earnings per share found on the income statement. But since we're on the topic, the earnings per share is one of the most important financial ratios. In fact, many companies, such as market watch dot com, report earnings per share with the ticker symbol. So as you can see here on this graphic from Market Watch, they are giving us the most important information about the company. They're giving us the price. They're giving us the trading range, and they're even giving us the price to earnings ratio Now. First off, I want to show you that price to earnings ratio are so common and so important that they're typically calculated for you. So we have a price of $50.30 earnings per share is 65 cents, which gives us a price to earnings ratio of 77.38 Now, if you actually look at the P E ratio quoted on market watch dot com, you will see that it doesn't exactly line up to the actual division that we did. Why is that? Well, the P E ratio is not something that has to be calculated a certain way each time. It's always the price divided by the earnings, but what the price is and what the earnings can. Very so the price is the price that the stock is selling it. That's pretty standard. Now. Earnings can be where the differences come in. Sometimes the earnings per share will be from standard earnings per share. Other times analysts will use diluted earnings per share. If you don't understand the difference, stick with me because I'm going to do a little mini lecture at the end of this lesson that will clear all of that up for you. Additionally, sometimes they will use the past 12 months of earnings. So if you go back to this Coca Cola share here, you see that the earnings per share is listed as 65 cents. Now, if you go back to the Coca Cola income statement that we were looking at, we were not making 65 cents on in that specific quarter. So the earnings per share isn't a specific quarter. It's the average of the previous quarters that previous 12 months. Sometimes analyst will switch it up, and they will determine the price to earnings ratio off of predicted earnings for the next 12 months. In my opinion, I think you're better off sticking with the trailing earnings because a future prediction of earnings really is anyone's guess. Now let's look at this and go through some of the mechanics. We have the basic net income per share, and we have earnings off 44 cents and a price of $10 so our price to earnings ratio would be $10 divided by 44 cents, which gives us $22.72. Now let's let's think about the P E ratio, because whenever we start talking about ratios, people want to know what should this ratio be? What is a good P E ratio? What is a bad P E ratio and the thing that I want to point out is that it constantly changes so the earnings per share will be relatively constant because remember, they're calculated over a 12 month period. So the only time they're going to change is when we have a new income statement. But the price of a stock changes day today, our to our minute to minute. So a stock could be at a P E of 50 in the morning and then, by time lunch rolls around, it could be an A P e of 55. Now the MAWR earnings that a stock has. The lower the price to earnings ratio will be because earnings is the denominator. So as earnings go up, the P E ratio goes down. The less a company earns, the higher the P E ratio. So, generally speaking, a lower P E ratio all other things considered is better. But there's really no hard and fast rule for what a P E ratio should be. This varies depending on the industry, depending on the type of stock. So a technology sector could have a different average P E ratio than something that specializes in the production of food. For example, now deluded versus normal earnings per share is something that caused me a little bit of trouble when I was an undergraduate. But the way to think about this is that we have basic net income per share, and this is simply think about anyone that owns a piece of stock. We add up all of those stocks and we divide the earnings, buy these stocks, and that's our earnings per share. Now, diluted income per share refers to the fact that there are many people that are entitled to stock, but that don't actually hold it. So if I work for a company, they may tell, May you can buy ah 100 shares of stock at a certain price. Or I might have a bond that pays me a certain amount of interest. But I can exchange this bond for a certain number of shares of stock. So what this deluded net income per share does is it says okay if everyone converted all of these bonds into stocks, If everyone took their holiday bonus of a stock option, then how much stock would we have? Right. So it increases the number of shares of total stock, thereby lowering the earnings per share, and we can just work through an example really quick. Let's suppose we have a total of 100 shares. We have diluted shares of 10. So we have. Let's suppose to separate bonds that were issued, and each of those bonds can be redeemed. 45 shares of stock are trailing. Earnings are $5 so are normal. Earnings per share would be $5 divided by 100 which gets us about a nickel per share, and the diluted. We would add the normal shares. We would also add those 10 additional shares that could be converted from a bond, which would again increase the denominator. So it's going to lower our earnings per share now in summary, The P E ratio is not found on the income statement, but it is derived from the earnings per share, which are a critical portion of the income statement. I hope you found the video useful, and I will see you in the next lesson. 11. Times Interest Expense: Hello. Welcome back to the course in income statement analysis. Today we're looking at times interest earned, which is a measure of a company's ability to pay its debts. Now let's think about the worst case scenario for the stock market. The worst case scenario would be your company completely going bankrupt. Because, remember, stocks are pieces of ownership in a company. So the worst thing that can happen is that company goes bankrupt because as a stockholder, you are one of the last people to get paid. There is what's known as a payment hierarchy. So if a company goes bankrupt, what happens is it's liquidated and they sell company assets to meet the debts. Now the first people that are paid will be the people that hold bonds, then preferred stock, which remember preferred stock, is similar to common stock. But you you have a little bit less rights within the company. And then, lastly, common stockholders air paid. So when you're looking at a company, how can you ensure that this company is financially sound? One of the ways to do this is through the tie ratio, which is times interest and earnings, and let's think about this from a personal example. If you have $100 in credit card interest payments per month, but you make $1000 take home income, you can pay this interest amount 10 times over. So even if your credit card rate jumps up a little bit or you earn a little bit less one month because you had to take some sick days, you will still be able to pay this. And that's exactly what the tie ratio discusses for a business. Now this ratio is found by taking a bit, which is earnings before interest and tax, and dividing this by the interest expense as a side note. Sometimes you will also see this calculated as earnings before interest, tax, depreciation and amortization. So don't worry too much about that. But just know that if someone calculates the ratio with a bit and someone calculates it with EBITA that they are both correct now moving on to a real world example. In this example, we have a visa income statement provided by NASDAQ dot com, and we see that the earnings before interest and tax are about 13 million and we have the interest expense as $612,000. So dividing these two, we see that Visa can pay the interest more than 21 times over. So the reason this is important. Let's suppose that we can Onley pay our interest 1.5 times over. We're in a very real danger of not being able to make those payments if our revenue slump one month or if our interest rate hikes up right. So the higher this number is, the better it is because it's it's showing that we have MAWR ability to pay off our debts once we start getting into low numbers. And, you know, just think about this. If you have a credit card, if you're living paycheck to paycheck and every month your bill is $1000 you're only making $1100 you only have $100 to spare. If you take a sick day from work, you're not going to be able to cover those interest expenses. But if your bill is $1000 you're making $6000 a month, you can skip a few days of work or you can call in sick a few days and you're still going tohave mawr than enough money to cover that interest expense. That is the whole concept of the Thai ratio. Times interest expense. I hope you found the video useful, and I will see you in the next lesson. 12. SGA and Other Research Ratios: Hello. Welcome back to the course in income statement analysis. In today's lesson, we're going to be looking at two ratios that help us determine how efficiently a company is operating a and how competitive of a sector that a company is operating in. Now. The first ratio is the SG ratio. And remember from previous lessons, that s G A stands for sales, general and administrative expenses. These air the expenses that we use to market our product, advertise our product, distribute our products and, of course, pay for administrative expenses. But what this ratio does is allows us to say how efficient is our marketing and how competitive is our sector. And what I mean by that is let's suppose we have the Coca Cola income statement and we have SG A of 2505 and we have a gross profit of 5186. When we divine this, we get an SG a ratio of 51860.48 Now what does this mean? What this means is that of our gross profit. We're spending almost 50% on selling general and administrative expenses, so it's costing us almost 50% of our gross product to get that product into our customer's hands. Now it doesn't break down SG a by the different categories, perhaps were spending more on marketing or more on advertising or more on distribution. They just lump SG A all together. So for our purposes, we can simply say that almost 50% of our gross profit is spent on getting this product into customers hands. Now what we want to think about is what is what is the implications of this? How does this apply to us as an investor, as someone that's analyzing a company? Well, the higher this ratio is, it means the company is having to spend more money getting its product to consumers, which generally means that it is in a MAWR competitive industry. If we're in an industry, where were the lone supplier where we don't have to compete with other companies or corporations, then we can spend less money on our advertising on our marketing. We also have what's known as the research ratio, and Coca Cola didn't have a huge research budget. But some companies are constantly developing new products, especially if you think of a technology company or a drug company. They're always having to make new products. So the research ratio is found by dividing the research and development by the gross profit . And it's almost the same interpretation as the SG a ratio. It's basically saying of our gross profit. How much of that are we spending on developing new products now if we make one product that we've always made forever and doesn't really change? Like let's suppose that we've been making the same brand of hot sauce since 19 hundreds were not going to be spending a lot of money on research and development. We have a consistent product. Consumers know the product and they're going to buy the same product over and over. Now, the MAWR money we spend on research and development that shows us that we are in a fast paced, constantly changing industry. So we are facing Mawr competition. Just because we're selling Ah good product today doesn't mean that we're going to be profitable in five years from now because things are changing so rapidly. So in summary, we have two ratios that allow us to gauge how competitive a sector of that a company is operating in we have the SG a ratio which shows us what percentage of gross profits they're having to spend on marketing and distributing their product. And then we have the research and development ratio, which shows how much of their growth product they're having to spend on researching and developing new products. I hope you found the video useful, and I will see you in the next lesson. 13. Introduction to Margins: hello. Welcome to the final section in the course on income statement analysis in this section, we want to be looking at three different measures off profitability. Now, from a layperson's perspective, we simply think of profit as how much business makes. But in reality, profit for a business to be analysed in three different ways. We can talk about profit after accounting for simply the cost of goods sold. We can talk about profit after cost of goods sold and our administrative expenses or, in the war, common usage of the phrase we can think of profit as the money left over after the business has accounted for all of its expenses. Each of these different terms of profitability has a different meaning in a different interpretation. So I hope that this section does a good job of explaining the different types of problem, inability and the appropriate uses of each of them. As always, if you have any questions, feel free to contact me, and I will do my best to explain any confusion 14. Margins Explained: Hello. Welcome back to the course on income statement analysis in the coming lessons were going to be looking at different types of margins a gross margin and operating margin, and it's going to get a little bit confusing. So what I wanted to do is get a head start and clear up some of the confusion before you even get confused. Now the first thing I want to answer is what is a margin? And a margin is an amount by which a thing is one or falls short. That's the Google definition of a margin. And as we go through these income statements, what we're essentially going to be asking is how much money is left over after we account for X Y Z. So all in all, we're always thinking about how much money is left over. But different margins account for different expenses. So a gross margin says how much money is left after we account for the cost of goods sold, whereas a operating margin accounts for selling expenses as well. So let's just quickly summarize the three margins. We have gross margin, operating margin and profit margin, and gross margin is saying after we produce and sell a product. How much money do we have left over after covering the cost of the goods sold? So if I sell a product for $100 it cost me $50 to make it, I have $50 left over. Now there's more than simple raw materials that go into a product. There are selling and administrative expenses operating, Margin says. Okay, we know we sold a product for $100. It cost us $50 to make it, but we also had $10 of marketing expense. So after we cover not only the cost of the goods sold, but also the selling and administrative and other miscellaneous expenses, then how much money do we have left? And then profit Margin says OK, after everything is said and done after, we've accounted for the cost of the product, the administrative expenses, maybe even some of the other things in the company, like interest income or interest payments that we have to make now, how much money do we have left? And what I want to do is we're going to devote a whole video just to each one of these different margins But what I want to do now is show you just very quickly altogether how to interpret thes margins. So you see an orange Square and in this orange square is what this specific margin accounts for. So gross margin accounts for how much money is left over after we cover the simple cost of the goods, the simple basic cost of production, labor, raw materials. So what we have here is we have the gross profit and we divide this by the total revenue. So we see that we have a gross margin of 0.55 That means that we are. Let's suppose we make a dollar in revenue. Are gross profit is going to be 55 cents. So we're retaining just over half of that total revenue when we account for the cost of goods sold. But there are other expenses as well. When we talk about operating margin, we're still taking into account the orange cost of revenue. But we are also taking account of research and development, sales, general and administrative expenses. Both of these categories and orange are now being accounted for. So what we do here is we divide operating income by our total revenue and we see that we're going to have a much smaller margin. Why is this margin smaller? It's smaller because we're accounting four more of our expenses that are eating into that sales. And then lastly, we have the profit margin now. Profit margin accounts for everything it says. Okay, yes, we have cost of goods sold. Yes, we have selling general administrative expenses, but maybe we have interest payments we have to make. Maybe we have other things that the business has to account for. So after everything is said and done, how much money do we have left over? And we see that the profit margin is on Lee a 0.8 This means that remember, we started out with a gross margin off 0.55 We were keeping almost half of that revenue. After we started accounting for the sales and administrative expenses, we were still keeping almost 20 cents, and now we're down to just under a dime out of every dollar. In summary, the margin refers to how much money we have left after accounting for a certain thing, and generally higher is better now. Each of these margins are going to it be explained in a separate video. I just wanted to make this video to clear up any confusion you might have about the differences between these margins. I hope you found the video useful, and I will see you in the next lesson. 15. Gross Margin: Hello. Welcome back to the course on income statement analysis. Today we're looking at a valuable tool for determining the profitability of a company, and this tool is known as gross margin, and it uses two pieces of information found on the income statement. So let's start off with a practical example and suppose that I tell you there's a company Rob's Super Tool shop, and in the past year, they had a gross profit of $100,000. Now, at this point, you're probably thinking, Well, you know, $100,000 That's a good profit. They're not losing money, they're making money, so they look to be a very good company. However, I also tell you that robs serve shop supreme made a gross profit of $50,000 you're probably thinking, well, this company made quite a bit less money than the tool shop. So maybe it's not that good of a company. But this isn't a simple decision of $100,000 versus $50,000 because we also need to calculate the cost of goods sold. What we want to know is the gross margin gross margin is simply the gross profit divided by the revenue and what it's telling us is after after we take care of the cost of goods sold , how efficient are we at production? How much can we mark our product over the cost of goods sold? So let's let's go back to our example here. Why do we need gross margin? Well, right here we have the revenue of one company and the revenue of the other company, and we have Rob's Super Sheriff shop on the right and rob Super Tool shop on the left. Now what I want you to understand here is that on the left we have a gross profit of $100,000. However, we have revenue of $1 million so out of a $1,000,000 that we take in in sales, we have to spend 900,000 of that money just to cover our costs of production are cost of goods sold. So are gross. Margin is Onley 0.1, whereas rob super surf shop. The gross margin is 0.5 because we have $50,000 of profit, but we only have $100,000 of revenue. So with the surf shop out of the 100,000 that we make. We only have to spend half of that on paying for our cost of goods sold over well, half exactly of what we make is coming back to us as gross profit, whereas the tool shop has to spend a lot of money just to cover their costs of goods sold. So what is the interpretation of this? The surf shop. Remember it had the 0.5 gross margin. Is it more efficient? Yes, because we are able to make a product and over and half the sales are coming back to us as profit. Do we have a branding advantage? Yes, because let's go back here and look at this. We are able to charge double the actual cost of the good right? So we have a branding advantage where able to mark that product up, What else do we have? Can we charge a higher mark up? Yes, and lastly isn't more sustainable, and I really want to focus on this One isn't more sustainable because even though Rob's surf shop is making less in dollar for dollar profit, let's go back and look at this. It's It has a higher gross margin So let's suppose that the cost of goods sold increases at Rob's tool shop. We are operating on a thin margin. So if the price of our inputs, if the price of our labor, if the price of our storefront goes up, we might not be able to cover that with our profit. Whereas with the surf shop, if our prices of our inputs go up, if the cost of labor or the cost of materials to make surfboards goes up, we're going to be better able to absorb that cost and continue being profitable. Now let's look at some real world examples will go back to the Coca Cola Income statement. Remember, the gross margin is the gross profit divided by revenue. So we have 5186 divided by 8245 for a gross margin of 82450.63 In this example, we have the Dollar General Corporation, and we remember gross margin is gross profit divided by revenue. So we have about $7 million divided by about $23 million which gives us a gross margin of about 230.3. Now, what do we notice? This is considerably lower than Coca Cola. Remember Coca Cola WAAS 0.63 whereas Dollar General is only a 0.30 and the important thing that I want to make here is that gross margin can depend on the industry, that type of field the for example, the gross margin in a retail company might be different than the gross margin in something like a technology company. And there's a variety of reasons for this. It's not necessarily because one company is better or worse than the other, but as the decrease of the cost of goods sold. So let's suppose that we are a digital bookseller. We buy the rights to library books and then we rent them out. Our cost of goods sold is going to be very, very, very low, cause we have already paid for all of this. Almost everything that we're doing is coming back to us as gross profit. So that's because we're in a different industry now. Also, gross margin will increase as we increase our price so it doesn't do that much good to compare a dollar general to a Coca Cola. If we were considering investing in Coca Cola, for example, we would compare its gross margin to other beverage makers such as Pepsi. Or if we were considering investing in Dollar General, we would compare their gross margin to other other stores and of their same category. So we compared them to a dollar tree or a family dollar or something like that. In summary, we have talked about gross margin and gross margin is useful because it allows us to say off the revenue that we're getting. How much are we making after recover the cost of our goods sold its allowing us to see how efficient we are, a turning a product into profit. I hope you found the video useful and I will see you in the next lesson. 16. Operating Margin: Hello. Welcome back to the course in income statement analysis today we're looking at yet another type of margin, and this is the operating margin. Now I know it's starting to get confusing with operating margin and gross margin and everything like that. But today we're looking at operating margin, and I want to try to differentiate it from the gross margin. Gross margin, if you remember, is the margin above the pure cost of production. So we are using cost of goods sold and we are using total sales with operating margin. We are saying, How much are we above the extended cost of production? So we are including the cost of goods sold, the physical labor, the raw inputs, but we are also including the sales and administrative expenses. So let's look at this example from the Coca Cola Income statement, and we have net operating revenues of 8245 after we subtract cost of goods sold. We have a gross profit of 5186 and then once we subtract out as well this selling general and administrative expenses and some other charges we have operating income of $2526. This essentially is our business profit before we include income expense or taxes or equity income or anything like that. So this is our profit. This is our income just based on our business. So to find the operating margin, we divide 2526 by 8245 for a margin of 0.31 Now, if we were using the gross margin, we would be using the items in the red. Another example, And this one is a dollar general. We have total revenue, we have operating expenses and we have operating income. Now what we want to do is take operating income and divide by sales. So let's look for our operating income. We have $2,007,818 and our total revenue is 23,400 $70,967 which gives us an operating margin of 0.9 Now, remember, just as P E ratio is different justice, gross margin is different. Operating margin will also be different company to company, but in general it's better to have a higher operating margin. What this means is that we are were able to sell our product, were able to generate MAWR sales relative to the cost of goods sold and or selling and administrative expenses. So in conclusion, remember that gross margin takes into account the cost of goods sold on Lee. The physical labor, the raw materials operating margin also takes into account those selling, general and administrative expenses before we factor in income, taxes or equity income or interest income. We will get to that in the next section. I hope you found the video useful and I will see you in the next lesson. 17. Profit Margin: Hello. Welcome back to the course in income statement analysis today we're looking at the profit margin now. Profit margin seems the most intuitive out of gross margin and the different types of margins were talking about. And it is. That's because profit margin includes everything. If you remember from the previous videos, we talked about gross margin and how that represents how profitable well we are in relation to the cost of goods sold. We talked about operating margin and mentioned how operating margin also includes are selling general and administrative expenses. Lastly, we're adding interest tax equity income. Basically, we're looking at the whole corporation and saying OK, out of every single thing that this corporation does out of the cost of goods sold out of the tax out of the interest income, What is its profitability? And the way that we find this is by taking net income and dividing this by the total revenue. So we're saying out of this net income out of this total revenue, what are we actually profiting? And this is simple division, which we take 4,857,000 divided by 63,525,000 which gives us a profit margin of 0.0 76 Now remember, profit margin is going to depend on the type of company on the type of business. Different sectors will have different profit margins. But as with the gross margin, as with the operating margin in general, the higher profit margin is better because what this is saying is this is saying out of all the revenue that we take in we arm or efficient at converting that into profit for the company into profit for the shareholders. I hope the video has been useful and I will see you in the next lesson. 18. Conculsion cut 2: Congratulations. You just finished the course on the income statement analysis. It's taken a lot of hard work and dedication to make it through this course. You started at a very basic level, simply learning key terms and definitions. Then you moved up in large financial ratios. We finished the course by talking about different measures of profitability. I sincerely hope that this course has been useful to you and that you've learned much more about income statements and analyzing companies. It was an honor to join you on this learning voyage, and I hope that you will keep on learning. If there's anything you would like me to cover differently in the course, or there's something that I just didn't explain properly, be sure to let me know, and I will try to make additional material to clear up any confusion. Once again, thank you for taking the course and coupon