How to Analyze Financial Statements in 5 [Stupidly Simple] Steps
If you don’t know what you’re looking for, trying to analyze financial statements can feel like swimming in a sea of numbers. By learning a few simple financial ratios, you can easily extract meaning out of what used to look like a jumbled mess.
This article outlines 5 simple steps you can use to analyze a set of financial statements and gain insight into any business.
Step 1 — Find the Company’s Balance Sheet in the Most Recent Form 10-k On EDGAR:
Then Copy and Paste it Into a Spreadsheet:
Step 2 — Find the Company’s Statement of Operations (Income Statement) in the Most Recent Form 10-k On EDGAR:
Then Copy and Paste it Into a Spreadsheet:
Step 3 — Calculate the Quick Ratio:
The quick ratio measures a company’s ability to pay its liabilities. Note that inventory is not included in the amount of current assets. Because it can’t be turned into cash quickly, inventory can’t help a company pay its bills.
A quick ratio of 1:1 means a company has exactly enough assets to pay its liabilities. A quick ratio greater than 1 means a company has more than enough assets to pay its liabilities. Anything below 1 means the company doesn’t have enough assets to pay its short-term liabilities.
In an empty cell, calculate the quick ratio using the following formula:
“=(Total Current Assets cell minus Inventory cell) divided by Total Current Liabilities cell”
Netflix doesn’t have an inventory balance, so that will be zero in our calculation. Netflix has a quick ratio of around 1.5, which tells us they have enough assets to pay their current liabilities (and then some).
Step 4 — Calculate the Return On Sales:
The return on sales tells you how efficiently a company is operating by showing how much of every dollar in sales is kept as profit.
In an empty cell, calculate the return on sales using the following formula:
“=Net Income cell divided by Revenues cell”
Netflix earned $0.08 in profit for every $1 of sales in 2018, and $0.05 in profit for every $1 of sales in 2017.
Obviously the higher the return on sales, the better.
Step 5 — Analyze the Trends
Looking at the changes in ratios over time can tell you more about a company’s condition than the individual ratios themselves.
A decreasing return on sales would be concerning, since that would mean the company isn’t operating as efficiently as it was in the past.
Looking at year-over-year changes is known as trend analysis. In our example, the $0.05 return on sales in 2017 compared to the $0.08 in 2018 means we have a $0.03 year-over-year increase, which would be a positive trend. It indicates that Netflix is operating more efficiently than it used to, allowing it to keep three more cents of every dollar of sales revenue.
Key Takeaways
Analyzing a company’s financial statements doesn’t have to be overwhelming and complicated. It’s much easier to find meaning in something when you understand how the different pieces fit together.
By following the five steps outlined above, you can perform a simple, quick analysis of any company’s financial statements.
