If you are wondering how to understand financial statements this course is for you. I am going to explain all of the necessary things you will need to understand how do to analyze financial statements. If you are just taking the very first steps in understanding how to invest in stocks, learning about financial statements should be very high up on your list of things to understand. For anyone that is trying to understand the stock market for beginners, the two big first building blocks will be understanding the fundamentals of what the stock market is, what stocks are, and then learning how to analyze a company. A perspective investor would want to understand the basics of a company and what the financials of the company show.
In this section I will break down gross profits. Gross Profits are an important part of the financial statement. Gross profits encompass three main lines of the first portion of the revenue statement. Understanding gross profits is the first step in understanding how well a company has performed. This is one of the first thing an analyst will look toward when determining how well a company has performed.
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What are Gross Profits
When you set out to determine how well a company has performed you will look within the financial statements. There are three sections of financial statements for a publicly traded company:
A company’s performance is determined by several metrics. The first is revenue and profits. This is followed by total equity which is shown in the balance sheet.
The Income Statement is broken down into smaller sections:
- Gross Profits
- Operating Profits
- Continuing Profits
These are the three sections of the income statement. But, within these three sections there are several other lines that break down how a company has performed during a period of time.
Top Line Revenue
The very top of the financial statement you will find the first segment of the financial statement that breaks down these three items:
- Gross Revenue
- Cost of Goods Sold
- Gross Profits
Revenue is all of the money that a company has earned during either a quarter, year, or the past Trailing 12 Months (TTM). When all of the items sold are quantified and the total value of the items sold is accumulated and added, this amounts to the revenue for that period.
This is termed top-line revenue because it is the very first item in the revenue statement, and it is positioned at the top of the revenue statement. And, this is also termed gross revenue.
It is important to note that revenue is all of the funds accumulated that the firm has earned in the period for the items sold that are part of the normal course of business.
If a company were to sell off assets, or sell something that brought in funds but, these funds were outside of the normal course of business, such as selling a building or other assets, these funds would show up in another line lower down in the financial statements.
Cost of Goods Sold (COGS)
Just underneath the top-line revenue number would be the cost of goods sold. This is exactly what it sounds like. Any costs incurred by the business to produce the item would be deducted from the total revenue line.
These items could be packaging costs, wages for productions employees, building rent that was used in producing the product, utilities and their costs, and potentially delivery costs for the products.
Gross Profits
After deducting cost of goods sold from top line revenue, or gross revenue, the remaining amount is gross profits. Keep in mind that all revenues that were derived from the sale of products during the normal course of business are the top line, and cost of goods sold are all costs related to the production of the products are COGS.
The end result is gross profits.
Gross Margins
As stated, the remaining portion of gross revenue after COGS are deducted are gross profits. And, if you were to take gross profits and mathematically divide that by total revenue you are left with a metric, a percentage, that is termed gross margins.
Gross margins are the percentage amount that remain after cost of goods are deducted from gross revenues. By understanding this metric, you can compare where one firm is versus another in determining which company is more financially competitive with from a metrics standpoint.
What to Look For Within The Gross Profits Section
As mentioned, there are three main sections of the first portion of the income statement. You will want to look toward gross revenues, cost of goods sold, gross profits and then gross margins. Here, I will explain what to look for within these sections to determine what you would want to be looking for.
Here, from Nasdaq website, you can see a complete breakdown of the financial statements for Apple (AAPL Stock).[1]Nasdaq AAPL Stock Financial Data In this video and posting, we are focusing on Total Revenue, Cost of Revenue, and Gross Profit.
As you can see above, for the period of 9/25/2021, Apple had total revenue of $365B, Cost of Revenue of $212B, and Gross Profit of $152B. These are the numbers we are focusing on within this section.
What to Look for With Gross Revenues
Looking at the above charts from Q2, 2022, from Tilray, Vibe Growth, & High Tide, we can see total revenue for each company. If you are someone who is starting out with analyzing each of these sections these three companies are at an excellent point for an example.
One of the things we are looking to do with a company is to put together a projection of what any company could be doing at any point. Companies tend to trend with their performance. And, notwithstanding any big changes to the company, if a company is performing on a certain pace, it is reasonable to assume this performance level is going to continue.
Vibe Growth
For instance, looking at Vibe Growth revenue, their revenue has been trending downward slightly. Understanding the factors that have occurred within the performance of the company will tell you if that respective company will continue forward performing at that pace. Without any kind of turn in performance, it may be reasonable to assume that Vibe Growth will continue to perform with a downward momentum. Again, this assumes no internal changes to move revenue higher.
Tilray
Lately, Tilray has been printing fairly flat-line revenue increases. However, future revenue projections for Tilray have revenue picking up. The revenue projections I use are generally brought in from analyst expectations. So, for now Tilray is slightly behind in their revenue print for this year. Given this, Tilray may be able to make up some of the revenue needed. For now, we can reasonably assume that revenue will continue to be flat over the future quarters, but eventually start to trickle higher.
High tide
If there is one thing you might be looking for it is consistently increasing revenue growth. Within that context, High Tide has been increasing their revenue quarter after quarter. If a company is looking to gain economies of scale by pushing more product through all of the various components of the company, such as the grow facility, processing facility, and ultimately the dispensaries, this will mean the cost of each of the facilities & dispensaries will be less on a per unit basis. This will mean the opportunity for higher profit margins.
What to Look For With Cost of Goods Sold
As I mentioned, cost of goods sold are the costs that are incurred by a firm to produce the products. There are several costs for the various companies for producing products but, they can be broken down into two groups; Fixed Costs & Variable Costs.
A company has its fixed costs for the rent on a processing facility or a dispensary. But, packaging for 1,000 units would cost a lot less than packaging costs for 100,000 units. Understanding this concept will help you understand the above cost of goods sold for the three charts.
As you can see with High Tide, as the company sold more units – increasing revenue – their cost of goods sold increased.
But, when you consider the rent on a dispensary, a fixed cost, if a dispensary were to sell 1,000 units, each unit would represent a much higher portion of paying the cost of the rent for the dispensary – along with the packaging costs and other variable costs – than if High Tide were to push 100,000 units through a dispensary.
Ultimately, however, cost of goods can be looked at on a percentage basis. Doing this allows an analyst to compare the rate of growth of revenue versus the rate of growth of cost of goods.
What to Look For With Gross Profits & Gross Margins
Gross Profits, of course, are gross revenues less cost of goods. This is a straight-line mathematical calculation. But, gross margins are a ratio. Gross margins are gross profits divided over gross revenues. This shows on a percentage basis how much of gross revenues were earned by any individual company.
Again, you are looking for trends here. And, again, you are looking for consistency to make reasonable assumptions. In the above, and surprisingly, gross margins are going in completely opposite directions for the above companies. This could be for various reasons. But, understanding cost of goods sold, looking at the percentages of each, this gives an analyst a much better understanding of what a company is achieving.
Looking for consistency so that you can make reasonable assumptions is such a key factor in analyzing stocks.
Understanding Gross Profits
When you can firmly grasp each segment of a financial statement and build upon your knowledge of what each metric reveals from a company you are better equipped at analyzing a company as a perspective investment and comparing this company to another.
Top line revenue, or gross revenue, less cost of goods sold for the production of this revenue, yields gross profits. Dividing gross profits over top of gross revenues yields gross margins metric.
From there, you can build your financial repertoire for understanding how to analyze financial statements.
References
| ↑1 | Nasdaq AAPL Stock Financial Data |
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