This brochure is designed to help you gain a basic understanding of how to read financial statements. Just as a CPR class teaches you how to perform the basics of cardiac pulmonary resuscitation, this brochure will explain how to read the basic parts of a financial statement.
It will not train you to be an accountant just as a CPR course will not make you a cardiac doctor , but it should give you the confidence to be able to look at a set of financial statements and make sense of them.
We all remember Cuba Gooding Jr. They show you the money. There are four main financial statements. Balance sheets show what a company owns and what it owes at a fixed point in time. Income statements show how much money a company made and spent over a period of time.
Cash flow statements show the exchange of money between a company and the outside world also over a period of time. Assets are things that a company owns that have value.
This typically means they can either be sold or used by the company to make products or provide services that can be sold. Assets include physical property, such as plants, trucks, equipment and inventory. And cash itself is an asset. So are investments a company makes. Liabilities are amounts of money that a company owes to others. This can include all kinds of obligations, like money borrowed from a bank to launch a new product, rent for use of a building, money owed to suppliers for materials, payroll a company owes to its employees, environmental cleanup costs, or taxes owed to the government.
Liabilities also include obligations to provide goods or services to customers in the future. This leftover money belongs to the shareholders, or the owners, of the company. The following formula summarizes what a balance sheet shows:. A company's assets have to equal, or "balance," the sum of its liabilities and shareholders' equity. On the left side of the balance sheet, companies list their assets. Assets are generally listed based on how quickly they will be converted into cash.
Current assets are things a company expects to convert to cash within one year. A good example is inventory. Most companies expect to sell their inventory for cash within one year. Noncurrent assets are things a company does not expect to convert to cash within one year or that would take longer than one year to sell. Noncurrent assets include fixed assets. Fixed assets are those assets used to operate the business but that are not available for sale, such as trucks, office furniture and other property.
Liabilities are generally listed based on their due dates. Liabilities are said to be either current or long-term. Current liabilities are obligations a company expects to pay off within the year. Long-term liabilities are obligations due more than one year away. Sometimes companies distribute earnings, instead of retaining them. These distributions are called dividends. It does not show the flows into and out of the accounts during the period.
An income statement is a report that shows how much revenue a company earned over a specific time period usually for a year or some portion of a year.
An income statement also shows the costs and expenses associated with earning that revenue. This tells you how much the company earned or lost over the period. This calculation tells you how much money shareholders would receive if the company decided to distribute all of the net earnings for the period.
Select basic ads. Create a personalised ads profile. Select personalised ads. Apply market research to generate audience insights. Measure content performance. Develop and improve products. List of Partners vendors. Investing Portfolio Management. Learn about our editorial policies. Reviewed by Anthony Battle. Learn about our Financial Review Board. Key Takeaways When earnings are retained rather than paid out as dividends, they need to appear on the balance sheet. Retained earnings can be negative if the company experienced a loss.
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These choices will be signaled globally to our partners and will not affect browsing data. We and our partners process data to: Actively scan device characteristics for identification. I Accept Show Purposes. List of Partners vendors. Retained earnings are an important concept in accounting. The term refers to the historical profits earned by a company, minus any dividends it paid in the past. The word "retained" captures the fact that because those earnings were not paid out to shareholders as dividends they were instead retained by the company.
For this reason, retained earnings decrease when a company either loses money or pays dividends, and increase when new profits are created. The following options broadly cover all possible uses a company can make of its surplus money. The first option leads to the earnings money going out of the books and accounts of the business forever because dividend payments are irreversible. All the other options retain the earnings for use within the business, and such investments and funding activities constitute the retained earnings RE.
By definition, retained earnings are the cumulative net earnings or profits of a company after accounting for dividend payments. It is also called earnings surplus and represents the reserve money, which is available to the company management for reinvesting back into the business.
When expressed as a percentage of total earnings, it is also called the retention ratio and is equal to 1 — the dividend payout ratio. Though the last option of debt repayment also leads to the money going out of the business, it still has an impact on the business's accounts for example, on saving future interest payments, which qualifies it for inclusion in retained earnings. Profits give a lot of room to the business owner s or the company management to use the surplus money earned.
This profit is often paid out to shareholders, but it can also be reinvested back into the company for growth purposes. The money not paid to shareholders counts as retained earnings. The decision to retain the earnings or to distribute them among shareholders is usually left to the company management. However, it can be challenged by the shareholders through a majority vote because they are the real owners of the company.
Management and shareholders may want the company to retain the earnings for several different reasons. In the long run, such initiatives may lead to better returns for the company shareholders instead of those gained from dividend payouts.
Paying off high-interest debt may also be preferred by both management and shareholders, instead of dividend payments. On the other hand, when a company generates surplus income, a portion of the long-term shareholders may expect some regular income in the form of dividends as a reward for putting their money in the company. Traders who look for short-term gains may also prefer dividend payments that offer instant gains. Most often, the company's management takes a balanced approach.
It involves paying out a nominal amount of dividends and retaining a good portion of the earnings, which offers a win-win. Dividends can be distributed in the form of cash or stock. Both forms of distribution reduce retained earnings. Cash payment of dividends leads to cash outflow and is recorded in the books and accounts as net reductions. On the other hand, though stock dividends do not lead to a cash outflow, the stock payment transfers part of the retained earnings to common stock.
For instance, if a company pays one share as a dividend for each share held by the investors, the price per share will reduce to half because the number of shares will essentially double. Because the company has not created any real value simply by announcing a stock dividend, the per-share market price is adjusted according to the proportion of the stock dividend.
A growth-focused company may not pay dividends at all or pay very small amounts because it may prefer to use the retained earnings to finance activities such as research and development, marketing, working capital requirements, capital expenditures, and acquisitions to achieve additional growth. Such companies have high retained earnings over the years. A maturing company may not have many options or high-return projects for which to use the surplus cash, and it may prefer handing out dividends.
Such companies tend to have low RE. Both revenue and retained earnings are important in evaluating a company's financial health, but they highlight different aspects of the financial picture. Revenue sits at the top of the income statement and is often referred to as the top-line number when describing a company's financial performance. Revenue is the money generated by a company during a period but before operating expenses and overhead costs are deducted. In some industries, revenue is called gross sales because the gross figure is calculated before any deductions.
Retained earnings are the portion of a company's cumulative profit that is held or retained and saved for future use. Retained earnings could be used for funding an expansion or paying dividends to shareholders at a later date. Retained earnings are related to net as opposed to gross income because it's the net income amount saved by a company over time. For an analyst, the absolute figure of retained earnings during a particular quarter or year may not provide any meaningful insight. Observing it over a period of time for example, over five years only indicates the trend of how much money a company is adding to retained earnings.
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