MBA Boot Camp: Connecting the Statements & Key Ratios (2.5)
Concepts & Vocabulary
Profit Margin: A ratio showing how much of every dollar of sales a company keeps in earnings. (Net Income ÷ Revenue).
Current Ratio: A liquidity ratio that measures a company's ability to pay short-term obligations. (Current Assets ÷ Current Liabilities).
Liquidity: How easily an asset can be converted into ready cash without affecting its market price.
Core Lesson: The Unified Story
The three statements are not isolated. They are an interconnected loop.
Net Income at the bottom of the Income Statement flows into the Balance Sheet as "Retained Earnings" (under Equity).
That same Net Income is the starting number at the very top of the Cash Flow Statement.
The final Ending Cash Balance at the bottom of the Cash Flow Statement becomes the "Cash" number at the top of the Balance Sheet's Assets.
Once you understand how they connect, you can use Financial Ratios to analyze the company's health. Absolute numbers are useless without context. If I tell you a company made $10 Million in profit, is that good?
If they had $20 Million in Revenue, they have a 50% Profit Margin. (Amazing!)
If they had $1 Billion in Revenue, they have a 1% Profit Margin. (Terrible!)
Ratios allow you to compare a massive company like Walmart to a smaller competitor like Target on an equal playing field.
Application & Reflection
Here is an income statement from Target.
Their Net Income = $3,450,000
Their Total Revenue = $106, 377,000
Profit Margin is Net Income divided by Total Revenue. Target’s Profit Magin is 3.24%.
