Overview of Financial Statements

In this module, we look at various financial statements. There is a three-step process to value securities – accounting analysis, financial and ratio analysis, and growth and forecasting analysis. The focus will be on income statements, understanding cash flows from operations, net earnings and return on capital invested.

Below Income Statement of Microsoft

Gross Margin = Total Revenue – Total Cost of Revenue

Operating Income = Gross Margin – Research and Development – Sales and Marketing – General and Administrative expenses

Operating Income is also EBIT === Earnings before interest and tax 

Microsoft Income Statement compares income statement for quarter ending September 30,  for a quarter on quarter comparison. Comparisons are q-o-q or y-o-y i.e. year on year are important to understand the growth in profit, revenue etc. Net Earnings are the earnings post the tax and interest expense. Organizations use net earnings to pay dividends to shareholders or buy back shares. Due to tax regulations, organizations tend to buy back shares in the US to increase the stock’s share price. Shareholders have a capital gain when they liquidate their shareholdings post buyback of shares as the stock price increases. Retained earnings are net earnings minus share buybacks and dividend pay-out. The company can use the proceeds to reinvest for growth, retire outstanding growth, and future dividends, buybacks, and M&A.

According to Microsoft financial statement ==> Basic earnings per share (“EPS”) is computed based on the weighted average number of shares of common stock outstanding during the period. Diluted EPS is computed based on the weighted average number of shares of common stock plus the effect of dilutive potential common shares outstanding during the period using the treasury stock method. Dilutive potential common shares include outstanding stock options and stock awards. Treasury stocks are used by company to buy back shares and reduces the outstanding shares. 

Invested Capital is the cumulative amount the business has invested in core operations, such as fixed cost (plant, machinery, etc.) and working Capital. The Return on Invested Capital can be calculated as below.   

Equity Simplified Balance Sheet 

Preferred Stock

Common Stock

Additional Paid-in Capital

Retained Earnings

– Treasury Stock (-)

Other Stock

Total Share Holder Capital 

Financial statements will be revisited, ahead solved worksheet problems to build on the topic covered.