Income Statement Analysis for Different Companies - Essay Example

Income ment Analysis for Different Companies Income ment Analysis for Different Companies Introduction Income mentsare essential in determining the financial status of a business, as well as, predicting the future growth. Income statements are prepared by accounting for all types of incomes, sales, revenues, expenses and costs. The net income is the most important value because it indicates the profit leftovers after deducting all expenses in a financial year. Net profit margins and qualities of earning can as well be prepared from the income statement values (Fridson, Alvarez and Finance Pro, 2011). This paper entails a comparison of five different companies where the profit margins and quality of earnings are evaluated and interpreted accordingly. Net Profit Margins Net Profit Margin can be defined as the ratio of the profitability calculated as net income accounting for all expenses and gains divided by revenue obtained from sales. In other words, we have; Net profit margin = Net Income/sales (given in percentage) The “profit margin” is a good indicator of how a company is able to manage costs in its operations, for example, selling stock. It does not mean that if the total earnings of a company are increasing, then, the profit margin improves. When the costs increase at a greater rate than the sales, then the profit margin reduces. The opposite of this statement is also true. Note that net income is a perfect indicator of the financial health of a company. Net income also indicates the performance of the of the core business operations. The net income is calculated by deducting the expenses from the sales revenue (Fridson, Alvarez and Finance Pro, 2011). As stated earlier, the net profit margin is computed from the net income and sales’ values indicated in the income statement and thus it is also important to discuss the income statement in this section. The income statement mainly includes the items directly or indirectly related to the companies’ activities. The activities can be primary or secondary. Examples of the items included in the income statement may include incomes, revenue, cost of goods sold, tax expenses and gross profit. With these items, we can therefore, compute the net profit margins, which are necessary in determining the profitability of a company from its operations. Comparison between the Net Profit Margins for the Companies Before comparing the profit margins for each company, it is important to look at how each company has prepared its income statement. Emaar Properties PJSC and Arabtec Holding PJSC have indicated the particular items included in their income statements. The other companies have indicated the specific items included in their income statements. For example, Emaar Properties’ income statement includes the cost of goods sold, revenue, gross profit, administrative cost profit before tax and tax expense. The company has eliminated other, operating expenses, other operating income, finance cost and income, as well as, shares from joint ventures. These items are not related to the core business activities and operations of Emaar Properties PJSC. A quick comparison between the profit margins of the companies shows that the profit margins for all the companies the favourable profit margins results from operating on the primary core business operations. The companies are all stable since they get considerably high profits from their sales. Emaar Properties PJSC is the leading company with a net profit margin of 27.69% for the year 2013. The new profit margin is obtained after removing all the previously stated items. Before removing the items, the profit margin amount to 24.6%. A net profit margin of 27.69% indicates that it has converted its revenues to profits adequately. The increase in profit from 24.6% to 27.69% occurs due to the increase in net income from 2,540,615 to 2,696,233. Al Mazaya Holding Company is the second leading company with a pure profitability of 26.7% and old profitability of 31.77%. The difference in both profit margins is very small and this indicates that the net income has also changed with a small margin. The net income reduces from 6,799,228to 5,573,418; indicating a less significant fall, which cannot affect the financial health of the business. The profit margin for year 2013 depicts that the company mainly obtains income from its core activities. Thus, it is evident that the business relies on the primary activities more than the secondary activities. Drake & Scull International PJSC, the real profit is determined by detecting all the gains and losses, which are not relevant to the core business operations. The company follows in the list with an old profitability of 3.7% and new profitability of 2.3%. The difference between the two profit margins equates to 1.4%. The small difference in profit margins indicates that the company has focused more on its core activities in 2013. Arabtec Holding PJSC is the fourth leading company with a net income of AED 468,259 thousands for the financial period that ended in 31st December 2013. The computed profit margins include an old profit of 6.35% and a new profit of 4.93%. This indicates that the company relies on its core business activities to generate revenue and thus gaining a lot of profit after deducting all the expenses. Dayaar Development PJSC is the last company in the list, with a net income of AED 182,030. Then, after excluding all the losses and gains that are not directly related to the core business, we get a net income of AED 188,353. The net profit margin for the company is 26.09% making it the last in the list financially healthy companies. Quality of Earnings The quality of earning is a vital method of evaluating the financial health of a company since it provides the true earnings of the company.The quality of earning can as well predict a company’s futures and give insights for creditors, investors and other financial statement users on how to go about in their investment plans (Fridson, Alvarez and Finance Pro, 2011). In addition, it shows how the company is gaining from its sales rather than the profits made during low rates of inflation. Good quality of earning is an indicator that the company is operating at a low cost. The formula for calculating the earning quality is given by; Quality of earning= (New net income – cash from operating activities)/sales The quality of earning is given as a ratio or percentage. Low percentages are more preferable than low ratios. Note that the operating activities are those actual activities, which are undertaken in the line of the businesses operation. The activities mainly involve the working capital and current liabilities and debts, which indeed consume revenue. Small ratios of qualities of earning are interpreted to be good indicators of a companies’ ability to earn from its primary activities. In other words, positive or negative ratios ranging around one shows that the firm obtains more revenue from its core business than from the subsidiary businesses. Usually the ratios are negative or positive. The negative sign shows that the cash from the operating activities is higher than the net income. Comparison for quality of earnings for the companies Generally, all companies have small ratios of qualities of earning except for Arabtec Holding PJSC. This indicates that they generate more revenue from their primary activities than the secondary subsidiary businesses. Emaar Properties PJSC has a ratio of -0.3762 as the quality of earnings for the year that ended on 31st December 2013. The ratio indicates that the cash from the operating activities were higher that the new net income made by the company. Emmar properties seem to have collected credit sales from its debtors and account receivables in the previous year. Accounting receivable can boosts the inflow of cash in a business and thus increasing the quality of earnings. This is the case for Emmar Properties, which has benefited from the actual operations of the business. In comparison with Al Mazaya Holding Company, Emaar Properties is performing well in terms of receiving cash from the operating activities. A ratio of –0.177 indicates higher cash inflow from the operating activities than the net income. However, the cash flow is lesser as compared to Emaar Properties PJSC. The small can as well mean that most of the debtors paid their debtors back assuming that the sales of the previous period were almost equal to the sales of the current period. Drake and Scull International PJSC is the next in the list because it has a negligible difference between its net income and the cash collected from the operating activities. A ratio of -1.1% signifies that either the sales made by the company are high or the costs are low. Additionally, the company could have collected its receivables from the previous financial period within a short time. The small ratio indicates that the firm is performing extremely well in its core business operations. Arabtec Holding PJSC indicates a percentage of 4.15% as the quality of earnings in 2013. The large percentage or ratio shows that the cash from the operating activities is far less than the net income. Also, the ratio of 0.415 could mean that the company is selling more, but, is not collecting cash from the debtors. Such high percentages in the quality of earnings can as well result from cancelling the bad debts from the previous and hence leaving the business with little cash for operations. Arabtec Holding PJSC is performing poorly and may eventually fail to earn from its operations in the future. Unlike Arabtec Holding PJSC, the other companies are performing well with Dayaar Development PJSC being the last in list comparing the level of quality of earnings It has ratio of -0.093 in the quality of earning indicating that the firm has received more cash from the operating activities that the net income in 2013. Additionally, the small ratio could mean that its core business operates brings more revenue than the subsidiary businesses. Conclusion and Recommendations Based on the income statement evaluation and analysis for different companies, it is evident that the net profit margins and quality of earnings are the key indicators of business performance. Income statement analysis allows the computation of the two indicators, which eases comparison among the five companies. As discussed in the essay, the net profit margins for all the companies show that they are performing well in terms of conducting the primary activities as well as making sales. When the old profitability is higher than the new profitability, then the business is performing well. A decrease in the net income also shows good financial performance of a business. The quality of earnings is also a parameter of measuring how a business is performing in terms of the cash received from the operating activities. When the cash from the operating activities exceeds the net income, then the company will be financially healthy with a small ratio (Fridson, Alvarez and Finance Pro, 2011). In order to improve the profit margins and quality of earnings, the five companies must take certain measures. Emaar Properties PJSC should concentrate much on the core business so as to increase the income in the coming financial year. In this way, the firm will have reduced the difference between the old and new profits and as a result improve the overall financial performance of the business. Similarly, the other four companies should improve the operations that take place in the business rather concentrating more on subsidiary businesses. The companies can as well boost their quality of earning by collecting debts from the debtors so as to increase the cash in the business operations. For example, Arabtec Holding Company should improve on the collection of debts and account receivables from the previous financial period instead of making more sales without getting cash immediately. References Fridson, M. S., Alvarez, F., & Finance Pro. (2011). Financial statement analysis: A practitioners guide, fourth edition. Hoboken, N.J: John Wiley & Sons. Read More