Understanding Financial Statements
Written by Bennet Grill for Gaebler Ventures
If you can't measure it, you can't manage it. The fourth article in this four-part series on financial statements focuses on financial metrics.
So far we've reviewed cash flow statements, balance sheets, and income statements.
So far we've reviewed cash flow statements, balance sheets, and income statements. While all of these documents reveal different information about a company, they are all related and contain information that enables you to calculate certain financial metrics used to evaluate a company.
What is the relationship between the different financial statements? A cash flow statement records all the cash going in and out of a company. This information can be used to calculate the revenue and expenses recorded on an income statement. The total amount of cash a company has is recorded in its balance sheet. When examining balance sheets, you can use horizontal analysis to compare the values of certain parts of assets, liabilities, and shareholders' equity as they change from year to year, or vertical analysis to compare the percentages of different components of assets, liabilities, and shareholders' equity as parts of the whole.
There are a large number of metrics derived from financial statement to effectively analyze the performance of the company. Below is an important list of commonly used financial metrics and their definitions:
- EBIT/EBITDA - Earnings before interest and taxes, and earnings before interest, taxes, depreciation, and amortization
- FCF - Free cash flow; the sum of operating cash flow, financing cash flow, and investment cash flow
- EPS - Earning per share; net earnings or profit divided by the total number of shares issued
- P/E Ratio - Price to earnings ratio; the price of one share of a company divided by its earnings per share
- Net Working Capital - Current assets minus current liabilities
- Debt Ratio - Total debt divided by total assets
- Debt/Equity Ratio - Total debt divided by shareholder equity
- Return on Assets (ROA) - Net earnings divided by total assets
- Return on Equity (ROE) - Net earnings divided by shareholders' equity
- Operating Margin - Operating earnings divided by total revenue
- EV/EBITDA - Enterprise value (price of the share times total shares issued) divided by EBITDA
Knowing these financial metrics allows you to evaluate your business and compare it to others in the industry, which is a valuable tool used in raising capital from investors (such as a venture capital firm).
It is also beneficial when trying to sell your company to a private equity firm or strategic investor, who will want to know not only the performance of your company, but how it stacks up to others in the industry.
Bennet Grill is a writer who has a passion for business and finance. He is currently an Economics major at Duke University in North Carolina.
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