Accounting For Dummies®, 4th Edition

2.3. Gleaning Key Information from Financial Statements

The whole point of reporting financial statements is to provide important information to people who have a financial interest in the business — mainly its outside investors and lenders. From that information, investors and lenders are able to answer key questions about the financial performance and condition of the business. I discuss some of these key questions in this section. In Chapters 13 and 17, I discuss a longer list of questions and explain financial statement analysis.

2.3.1. How's profit performance?

Investors use two important measures to judge a company's annual profit performance. Here, I use the data from Figures 2-1 and 2-2 (the dollar amounts are in thousands):

• Return on sales = profit as a percent of annual sales revenue:

  $520 bottom-line annual profit (net income) ÷ $10,400 annual sales revenue = 5.0%

• Return on equity = profit as a percent of owners' equity:

  $520 bottom-line annual profit (net income) ÷ $2,470 owners' equity = 21.1%

Profit looks pretty thin compared with annual sales revenue. The company earns only 5 percent return on sales. In other words, 95 cents out of every sales dollar goes for expenses, and the company keeps only 5 cents for profit. (Many businesses earn 10 percent or higher return on sales.) However, when profit is compared with owners' equity, things look a lot better. The business earns more than 21 percent profit on its owners' equity. I'd bet you don't have many investments earning ...