CFA topics - financial reporting and analysis (i)

The idea of financial reporting is to report a business activity (eg. sale of a good) on financial statements, in a format (eg. GAAP, IFRS, etc.) that is commonly understood among the readers of financial reports.

The idea of financial analysis, on the other hand, is to extract different numbers from a financial report and perform analysis in order to understand the operations of a company.

In order to do financial reporting and analysis, it is important to first understand the three different financial statements that we come across daily as financial analysts:

Income statement (also called Profit and Loss Account): income statement records all the sales made and costs incurred during a particular financial period.

The bigger picture is revenue minus costs equals profits (or net income). Typically the topline is revenue (ie. sales), which minus costs of goods sold (“COGS”) to give us the gross profit of a company. Other operating expenses (excluding COGS) is then subtracted from gross profit to arrive at profit before tax. Finally profit before tax minus tax expense will give us net income.

To recap the different elements within an income statement:

Restaurant ABC	FY 2016
Revenue	1,000
Less: Costs of Goods Sold (“COGS”)	(500)
Gross Profit	500
Less: Sales and General Admin expense (“SG&A)	(120)
Less: Interest expense	(100)
Profit before tax	280
Less: Tax expense	(40)
Net income	240

Let’s assume the above is the income statement of Restaurant ABC. COGS represents the costs of buying the raw materials – in this case, costs of buying raw food. SG&A represents salaries, rentals, utility expenses, admin expenses, marketing expenses, etc. Interest expense represents the financing costs – for example, if Restaurant ABC has taken out a loan from a bank, then it has to pay this interest expense. After COGS, SG&A, interest expense, and tax are being deducted from the topline revenue, we get the net income – ie. how much Restaurant ABC makes in profit after paying for all the operating costs.

I will discuss balance sheet and cashflow statement in the next post.