Reading Financial Reports For Dummies. Lita Epstein

types can test a company's viability.

      Gross profit

      The gross profit reflects the revenue earned minus any direct costs of generating that revenue, such as costs related to the purchase or production of goods before any expenses, including operating, taxes, interest, depreciation, and amortization. The gross profit isn't actually part of the Chart of Accounts. You calculate the number for the income statement to show the profit a company makes before expenses.

      Operating profit

      The operating profit is the next profit figure you see on the income statement. This number measures a company's earning power from its ongoing operations. The operating profit is calculated by subtracting operating expenses from gross profit. Some companies include depreciation and amortization expenses in this calculation, calling this line item EBIT, or earnings before interest and taxes.

      

Others add an additional line called EBITDA, or earnings before interest, taxes, depreciation, and amortization. Accountants started using EBITDA in the 1980s because it gave analysts a number they could use to compare profitability among companies and eliminated the effects of financing and accounting.

Interest is a financial decision. A company has the choice to finance new product development or other major projects by selling bonds, taking loans, or issuing stock. If the company chooses to raise money using bonds or loans, it has to pay interest. Money raised by issuing stock doesn't have interest costs. I talk more about this difference and the impact on a company's profits in Chapter 11.

      Believe it or not, taxes are also an accounting game. Most corporations report different tax numbers on their financial statements than they pay to the government because of various tax write-offs they're able to use to reduce their tax bill.

      

Companies don't actually pay out cash for depreciation and amortization expenses. Instead, depreciation and amortization are an accounting requirement that comes into play when determining the value of assets.

      Net profit

      Net profit is the bottom line after all costs, expenses, interest, taxes, depreciation, and amortization have been deducted. Net profit reflects how much money a company makes. If the company isn't incorporated, it can pay out the profit to shareholders or company owners, or it can reinvest the money in growing itself. Firms add reinvested money to the retained earnings account on the balance sheet.

Part 2

      The Big Show: Annual Reports

IN THIS PART …

       Discover the parts of an annual report and look at how to summarize financial information.

       Check out assets, liabilities, and equity, and see how to review and examine them to keep things in balance.

       Understand how to use income statements to determine whether a company has made a profit.

       Look at statements of cash flows to determine whether the company has enough cash to operate.

       Read behind the numbers and scour financial reports for red flags.

       Understand consolidated financial statements and look at ways companies buy other companies.