What to read in a Financial Statement

Like every Year December is the time for companies to release their Quarterly financial results and in few days you will be seeing the results of different companies for last quarter, i.e.. from October 2014 to December 2014. Since the stock which you own has its value tied to the financial health of the company so it is important to follow financial results. Because if the company grows, so will your stock's price. 

Remember, these income statements are not just about profits and losses, it's about how healthy your stock will remain in future.

Here are few things which you should read in a financial or 'Profit or Loss' statement:

Cost of Goods Sold:

What is profit? It is simply the total revenues subtracted by the total costs. One of the key costs for a company is the amount it takes to build its product or service. This includes raw material prices, labour costs, warehousing and so on. A rise in this cost has a direct impact on your profit. So, while reading a financial statement, look at the 'Cost of Goods Sold' section. Have costs risen in proportion with revenues? If yes, then you have nothing to worry. However, if costs have increased greatly, then it means your company is facing financial pressure. This could translate to lower profits in the coming quarters if the trend continues.

Operating Income:

A company can also earn money from investments and other means, like selling a plant or old machinery. Similarly, it also spends for activities other than production of the good or service. These costs and revenues often fluctuate. Hence, it is important to understand just how much profit the company makes from its core operations. This can give an idea about the real profitability of the company. This is why you must look at the 'Operating Income' section. It is also called as 'Earnings Before Income, Taxation, Depreciation and Amortization'. Operating income is a difference between the sales revenue and costs of production. It is also called as 'Operating Profit'.

Interest Expense:

Companies need capital to produce goods and services. Once it earns money from selling the same, it pays back the money borrowed. However, it has to pay an extra interest for the capital borrowed. This is called interest expense. It also eats into profits. A high or rising interest expense is detrimental to profits. It shows that the company is paying more and more to service its debt. It is better to compare with the growth in profits and revenues. If the rise in interest expense is greater, then it is quite likely that profit growth will slow down in the long run.

Pre Tax Income:

Just like you pay income tax to the government, every company has to pay a portion of its income as tax. Looking at the pre-tax income and comparing with the final net profits will give you an idea about the company's tax liability. Similarly, compare growth in both the pre-tax and after-tax profits. This could tell you the rise or fall in tax payments. This too affects profits in the long run

Extraordinary Income/Expense:

Sometimes, companies post a larger-than-anticipated profit or loss. This could be because of a one-time extraordinary expense or income. For example, if a company buys another company, it has to shell out money. This would be reflected in the 'Extraordinary Expenses' section. Not all such activities may be announced by the company. So, keep an eye on this section. The laws mandate that the company clarify what has been classified as extraordinary income or expense. This would be printed lower down in the income statement. If a company is regularly selling old plants and machinery, it may indicate that it is winding down its operations. As an investor, you should then look for the company's long-term outlook.

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