Accounting 101: How to Analyze Financial Statements with Gross Profit & Liquidity | Reap Global

Accounting 101: How to Analyze Financial Statements with Gross Profit & Liquidity


2 min read

Last time, Reap has introduced basic accounting knowledge or must-know 101, so it’s easier for you to manage your accounting reports. Many of you maybe consider to outsource an accounting firm, then just submit your finalized financial reports to the Company Registry. However, what else can we learn from those financial statements? Reap has consolidated various accounting ratios for you.

Accounting ratio #1 — Analyze gross profit

When it comes to understanding your company’s financial status, company income is always our main concern. You can just look at the net income in your financial statement, but when it comes to operating a business, you need to consider other factors such as the company’s purchase costs and taxes as well. Firstly, the gross profit can be seen in the income statement, and the gross margin represents how much revenue your products generating, in which the formula is (revenue – the cost of sales) / revenue x 100%, noted that sales revenue means your income generated by selling. The cost of sales is the cost that rises in proportion to the number of pieces produced, such as raw materials and packaging. The cost of labor salaries and rent that spend the same amount of money regardless of how many products are sold are not included. In fact, you only need to compare the gross profit margin within the company itself. Every calculating models involved in every single company are different, and the reference value of comparing gross profit margin with competitors is not recommended. In other words, if everyone’s gross profit margin is very high, which means it is a good business and worth investing more. The owner should also pay attention to the trend of gross profit margin. If it starts deteriorating, which means that there is an issue with the cost control. You should pay extra attention to the circumstance that gross profit margin only calculates product-related costs without calculating salary. It is conceivable that the gross profit margin is not the best choice for analyzing the profitability of the service industry.

Accounting ratio #2 — Analysis of liquidity

Then, we will proceed to learn more about other analysis methods. Take a look at the horizontal format, which is the balance sheet. On the balance sheet, you can read more different types of company data. You can exploit various accounting ratios to see if the company’s operations are effective or not. You can use the current ratio, quick ratio, and capital in order to calculate the company’s liquidity. The current ratio represents the company’s solvency, and the formula is, current ratio = current assets / current liabilities. Current assets refer to assets that are easily converted within one year, such as cash, account receivable, and inventory. Non-current assets such as office equipment, automobiles, and goodwill are not included. Current liabilities are debts to be repaid within one year, such as short-term loans and accounts payable, etc. Non-current liabilities such as debts and bonds payable over a year are not included. Therefore, what is the calculated answer to be considered a great current ratio? After calculation, it is already satisfactory if the answer is over 200%. The higher value the number is, the better it is. It also represents the company is easier to repay short-term debt. The quick ratio, as its name implies, requires higher liquidity than the current ratio. It is because the current ratio includes inventory, the problem is, whether the inventory can still be sold in a few months. The quick ratio deducts the inventory and prepaid expenses to turn current assets into quick assets. The formula is Quick Ratio = Quick Assets / Current Liabilities. If the answer is over 100%, then it is satisfactory. Similarly, if the company’s quick ratio is higher, which means that corporate debt is not necessarily becoming a bad sign. The most significant thing is that the cash flow ability, especially small and medium enterprises and, start-ups are more prone to a poor turnover. Hypothetically, if your company lacks cash for a while and is in urgent need of capital turnover, you might need to consider using Reap Pay to pay your salaries, rents, and cost of goods with credit cards, without waiting for approval. You can use your own personal or company credit card to activate the funds immediately to enjoy up to the repayment period of 58 days, which makes your company’s turnover easier.