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Merchandising Financial Statement Analysis

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Source: Instrumental “Drops of H2O ( The Filtered Water Treatment )" by J.Lang (feat. Airtone),” Creative Commons, http://ccmixter.org/files/djlang59/37792

[MUSIC PLAYING] Hey everyone, and welcome to our video today, merchandising financial statement analysis.

So what is today's video all about? We are going to be looking at financial statements for a merchandising company and we're going to be performing analysis on those financial statements. We're going to look at two types of analysis, we're going to look at some income statement analysis techniques and some balance sheet analysis techniques.

So let's start with that first one, let's look at some income statement analysis that we can perform. So one type of income statement analysis is vertical analysis and that's expressing expenses as a percentage of gross revenue. Another type of analysis that we can perform is calculating the gross margin ratio which is net sales, minus cost of goods sold, divided by net sales.

So why is income statement analysis important? Why do we perform income statement analysis? Well it helps with trend identification so we can identify trends and it's helpful for assessing past performance and predicting future performance. It provides a complete picture so it helps us understand the relationship between expenses and revenues, the changing composition of expenses over time, and it helps measure the results of our expense management.

Now how often can this be analyzed? Well at least annually you should look at this for your business but it's typically done more frequently monthly, quarterly.

Now gross margin analysis and you. So you can do a personal expenditure analysis similar to what a business would do in terms of performing vertical analysis. So you can look at how much you're bringing in, how much you're spending, and you can categorize your expenses and that helps you understand where you're spending your money and businesses use it in the same way, to understand where they're spending their money.

So let's go ahead and look at an example of performing income statement analysis. OK so what we have here is our income statement analysis and we're going to be starting with performing vertical analysis. So what do we need? Well we need our income statement. OK and so what is vertical analysis? Well it's expressing our expenses as a percentage of our total gross revenue. So our total revenue in this case, our total sales 635,00 that's going to represent 100%, and now we take all of our expense items and we express them as a percentage of that total sales number. So we can see here that our cost of goods sold is 36% of our total sales, our salaries expense is 28% of our total sales and it helps us to understand again, the composition of our expenses, the relationship between expenses and revenues and then we can measure the results of any expense management if we're trying to bring our salaries down.

OK so now let's turn our attention to calculating the gross margin ratio. Now you'll see here we have some information that we'll need from our income statement and now the gross margin ratio formula is net sales, minus cost of goods sold, divided by net sales. So if we take our net sales right here the 612 500, subtract out cost of goods sold gives us 384,000 or our gross profit. Now if we divide that by net sales that's going to give us 63%, so this tells us what our gross margin is. So in this case our gross margin, our gross profit as a percentage of our net sales is 63%.

Great so now that we've seen how to perform income statement analysis for our merchandising company let's talk about balance sheet analysis. So we're going to focus on inventory turnover analysis which is how often a business buys, sells, and replaces inventory. So the periodic changes in the inventory, why is that important? Well, it's important for inventory management we need to understand the flow of inventory because as a business we don't want to have too much inventory. Increased costs associated with storing, protecting, and managing that inventory but then we also don't want to have the opposite, we don't want to have too little inventory which means we might not be able to meet our sales. So there's, what calculations can we perform?

So we're going to be looking at multiple calculations. The first one we're going to be looking at is the inventory turnover and then we're also going to look at days inventory on hand or it's also known as days in inventory. So let's look at these calculations.

So starting with our inventory turnover the calculation for inventory turnover is net sales, divided by inventory, but it can also be calculated by taking cost of goods sold and dividing by average inventory which is probably a better indicator because those are both period based items. So it's going to look at the entire period in terms of your inventory turnover rather than a point in time that that first formula would speak to. So the other formulas we talked about are days inventory on hand or it's also known as days in inventory and what we do there is we take the number of days in the period, so if we're looking at an annual period we would take 365, and divide it by that inventory turnover ratio that we just calculated.

So let's take these two analyses our inventory turnover and our days inventory on hand and let's look at an example of performing balance sheet analysis. OK so here we have our balance sheet analysis. We're going to start by calculating our inventory turnover ratios and there's two different ways that we can do that so I've pulled the information that we need here from the income statement and the balance sheet in order to perform these analyses. So the first inventory turnover calculation, we take our net sales from our income statement and we take our ending inventory from our balance sheet. OK so that gives us 4.9 times as the number of times the inventory was sold during the period, but if we take these more period based items so cost of goods sold from our income statement as well as if we average our inventory. So we take our beginning inventory and our ending inventory to calculate the average inventory for the period. We'll see that our inventory turnover ratio is 1.4 times, so that indicates that our inventory is only turning over 1.4 times, meaning we're only selling our inventory 1.4 times during the period.

OK so now we want to calculate our days inventory on hand or days in inventory and to do that we're going to need that inventory turnover ratio which we just calculated. So that's 1.4 times and so if we want to calculate our days inventory on hand we need to look at the number of days in the period and then divide that by our inventory turnover. So in this case, we're going to assume that we're looking at, going to look at the entire year so 365, and then divide it by our inventory turnover ratio of 1.4. So this tells us that every 259.6 days that's the number of days it takes us to sell our average inventory.

Great so that's our balance sheet analysis. Now let's summarize what we talked about today. So what did we talk about? In a nutshell we looked at financial statement analysis, we looked at some income statement analysis, we did vertical analysis, and calculated the gross margin ratio, and then we did some balance sheet analysis. We looked at inventory turnover calculations and then we looked at calculating days inventory on hand or days in inventory.

I hope everybody enjoyed this video and I hope to see you next time.