Analyzing an Income Statement

Published December 6, 2013 by Mayrbear's Lair

money

The goal of analyzing an income statement is to determine whether a company is operating effectively and making a profit.  Alvarez and Fridson (2011) suggest that to achieve this objective, the analyst must draw their conclusions by comparing the information from an earlier period as well as from examining statements of other companies in the industry. This helps give a better picture as to how well an organization is performing and how well they measure in terms of their competition (Alvarez & Fridson, 2011). To help us understand the concepts more effectively, we can examine the data provided from the Elf Corporation’s Income statement (see Exhibit A) to ascertain whether the figures reveal overall if they had better sales in 2010 than in 2008. For example, the statement shows that their sales figures increased 18% in 2009 from the 2008 figures and jumped another 8% in 2010. This means the company showed a total sales increase of 27% during that three year period. In the meantime, the cost of goods sold reflects the same percentage increases during that period. This indicates that the sales increase resulted from the amount of units sold, not due to a higher cost of goods. In addition, the statement shows that they decreased their advertising expenses. In 2008 for instance, the company invested 14% of their revenue to advertising costs that decreased to 11% in 2009 and dropped down to 7% in 2010. This may suggest that their brand may have become more recognizable and management decided to reduce advertising costs to maximize profit margins. The statement also exhibits that there was no change in the amount of expenses that were allocated for administrative costs which remained the same rate during that three year period. However, administrative costs expose a 4% decrease over that time because of the rising sales levels.

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Fraser and Ormiston (2010) explain that a company’s operating profit margin measures the overall performance of the company’s operations and provides the basis for determining the success of a firm (Fraser & Ormiston, 2010). The Elf Corporation’s income statement for instance, indicates a steady increase during that three year period with respect to their operating profits. This signals an increase from 18% of the company’s sales revenue in 2008 to 29% in 2010. This ratio suggests that the company experienced a steady strengthening in their returns. Other expenses incurred where interest amounts paid on the firm’s debts. For example, in 2008, the company paid 5% in interest expenses which rose to 8% in 2009 and 10% in 2010. This means that as profits rose, more funds were available for debt commitments. In addition, the statement also shows that the revenue the company collected before income taxes also reflected a steady increase during that three year period. For instance, in 2010 Elf’s earnings revealed an increase of 24% from that of 2008. Finally, the last item on the income statement shows the company’s bottom line, their earnings or the net income they profited after all revenue and expenses were deducted. These figures indicate a steady increase that began at 6% in 2008 and rose to 9% by 2010. My brief analysis of the Elf Corporation’s income statement concluded that the company continued to show a steady increase in profit from the 2008 to 2010 accounting period.

Exhibit A

Elf Corporation Income Statements for the Years Ending December 31

ELF

References:

Alvarez, F., & Fridson, M. (2011). Financial statement analysis: A practioner’s guide. Hoboken, NJ: John Wiley & Sons, Inc.

Fraser, L., & Ormiston, A. (2010). Understanding financial statements. Pearson Education

 

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