Why analyse a company’s income statement before investing?

Published on : 22 April 20203 min reading time

When you plan to buy shares in a company, you need to know its current financial condition to avoid making a bad investment. Is it in good shape at the moment? And what does the forecast say? Of course, financial analysis is an essential step in evaluating the company.

The income statement: what is it?

It is an indispensable accounting document in a legal company. It allows a detailed analysis of the financial situation, i.e. to determine the performance of companies. It details key figures and shows at the end the net result for a financial year. It is therefore easy to deduce whether the firm has made real profits or whether it is in the red. A profit and loss account summarises all income and expenses during a given period. It includes turnover, cost of goods sold, operating expenses (R&D¸ administrative expenses, selling expenses, etc.), interest expenses (which includes interest payable on loans) and income tax.

Gross profit = Sales – cost of goods sold

Operating or operating profit or REO = Gross profit – operating expenses

Pre-tax financial result or EFR = EOI – interest charges

Net income = EFR – income tax

If the net result is positive, the recipient company. If not, it is in deficit.

How do you determine whether a business is profitable or not?

A good financial analysis will allow you to determine whether the purchase of a share is worth it or not. But current results are not enough. You should also take a long-term view and take a look at the forecasts. For example, look at the operating and net margin results and the upward trend in EPS.

Note: It is recommended to analyze a company’s income statement over a period of at least five years. This makes it easy to determine whether the business is booming or falling!

What other ratios are important?

You should also calculate :

the gross margin to know the profitability of the firm before the operating cost (Gross margin = Gross profit / Turnover))

the operating margin: the ratio between operating income and turnover

and the net margin: after tax, you will get the final profitability of the company (Net margin = Net profit / Sales)

With these ratios, you will be able to easily evaluate the performance of the company and invest in businesses that are doing well.

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