Companies produce three major financial statements that reflect their business activities and profitabilityfor each accounting period. These statements are the balance sheet, income statement, and statement of cash flows. The cash flow statement shows how well a company manages cash to fund operations and any expansion efforts. In this article, we'll examinethe balance sheet and income statement and their differences.
Balance Sheet
Investors and creditors analyze the balance sheet to determine how well management is putting a company's resources to work. The balance sheet shows assets, liabilities, and shareholders' equity. Total assets should equal the sum of total liabilities andshareholders' equity. The liabilities section reflects how those assets are financed. Shareholders' equity isthe difference between assets and liabilities, or the money left over for shareholders for the company to repay all its debts.
To best analyze the keyareas of the balance sheet and what they tell us as investors, we'lllook at an example.
Example: Apple Inc.
Below is thebalance sheet for Apple (AAPL) at the end of its 2017 fiscal year.
Current Assets
The top section contains current assets, which are short-term assets typically used up in one year or less.
- Total current assets were $128.6 billion (highlighted in blue).
- Cash came to roughly $20.3 billion.
- Marketable securities(short-terminvestments) approached$54 billion.
- Accounts receivable is money owed to Apple for selling its products and services and came to $17.8 billion. A receivable could be due in 30, 60, or 90 daysdepending on the agreed terms. Investorswant to see receivables increase over time, as this indicates rising sales. Butwe don't want to seeaging receivables.
- Inventories of $4.8 billionmight be raw materials or supplies used in making products or finishedgoods waiting to be sold or shipped.
Long-term Assets
Next on the balance sheet are long-term assets.
- Long-term investments totaled $194.7 billion.
- Property, plant, and equipment (PPE) are calledfixed assetsbecause they're notconsumed within oneyear and they generaterevenue over the long term. Apple recorded $33.7 billion in PPE.
- Other assetsand intangible assets,which include trademarks and intellectual capital, round out the asset section.
- Total assets were $375.3 billion at the end of Apple's 2017 fiscal year.
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Current Liabilities
Current liabilities are short-term liabilities due within one year.
- Current liabilitiestotaled $100.8 billion (highlighted in purple).
- Accounts payable are short-term debt owed by Apple to suppliers, which came to$49 billion.
- Accrued expenses are expenses yet to be paid, but have a high probability of being paid. Apple recorded $25.7 billion in accrued expenses.
Long-term Liabilities
Not all of Apple's long-term liabilities are broken out,but they typically include:
- Debt includinglong-term debtandbank indebtedness, which totaled $97 billion for Apple.
- Rent, taxes, and utilities payable.
- Wages payable.
- Dividends payable.
Shareholders' equity
- Retained earningsare themoneynot paid out asdividends, but heldback to be reinvested in the business or pay offdebt. Apple recorded $98.3 billion in retained earnings.
- Shareholders' equity is the sum of total assets minus total liabilitiesand is helpful incalculating a company'sfinancial health. Shareholders' equity represents the net value or net worthof a company, whichfor Apple was $134 billion. This is the money left over for shareholders, assuming the company was to pay off all liabilities in the event ofliquidation.
Income Statement
The income statement, often called the profit and loss statement, shows the revenues, costs, and expenses over a period which is typically a fiscal quarter or a fiscal year.The income statement tells investors whether a company is generating a profit or loss. Also, the income statement provides valuable information about revenue, sales, and expenses.
J.C. Penney Company
Below is the income statement for J.C. Penny (JCP) for its fiscal year ending Feb. 3, 2018. The top section includes total revenue or sales for the period.
- Net sales (i.e. revenue) came to $12.5 billion. Sales and revenue are also called the top line due to their location at thetop of the income statement.
- Cost of Goods Sold was $8.17 billion. This represents the costs of producinggoods and services during the periods. COGS are direct costs and are only the expenses involved in the production process.
- Selling, general, and administrative costs are the other expenditures not directly involved in production. For J.C. Penney, SG&A was $3.4 billion.
- Total costs or expenses were $12.39 billion.
- Operating income was $116 million after subtracting total expenses from total revenue.
- Net interest expense of $325 million represents the cost of debt servicing and put J.C. Penney in the red for the year.
- Net income for the year was a loss of $116 million. Net income is also called net profitor the bottom line because it's the final number and located at the bottom of the income statement.
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J.C. Penney is a great example of the importance of looking at the complete financial picture. Although $12.5 billion in revenue appears impressive, debt servicing costs meant the company took a loss for the year. It's worth noting that examining the financials of any companyworks best when comparing over multiple periods and against other companieswithin the sameindustry.
The Bottom Line
The balance sheet displays what a company owns (assets) and owes (liabilities), as well as long-term investments. Investors scrutinize the balance sheet for indications of the effectiveness of management in utilizing debt and assets to generate revenue that gets carried over to the income statement.
The income statement shows the financial health of a company and whether or not a company is profitable. Both revenue and expenses are monitored closely. It's crucial for management to grow revenue while keeping costs under control. For example, revenue might be growing, but if expenses rise faster than revenue, the company may eventually incur a loss. Investors and analysts keep a close eye on the operating section of the income statement to gauge management's performance.
However, investors and analysts scrutinize the balance sheet just as closely, as both the balance sheet and income statement together provide a fuller picture of a company's current health and future prospects.
