Question

Why do you need more than the income statement to judge a businesses financial well being?

Answer 1

Income Statement provides details and insights about the revenue, cost of goods sold, gross profit, operating expenses, other incomes and expenses and the resulting net profit. While Income statement helps the reader in identifying the profitability of the company along with other operational metrics such % of gross profit , % of other expenses to revenue, etc, income statement alone will not help the reader to complete analyse and understand the financial position and well being of a business.

To have a complete understanding of a business' financial well being, Balance Sheet with the notes should also be referred along with the Income Statement. Among many other information, Balance sheet provides the following information:

o Current Ratio = current assets / current liabilities which provides the liquidity position of the business

o Quick ratio = More conservative than current ratio (excludes inventory) and provides the liquidity position of the business

o Cash ratio = ratio of cash to current liabilities providing the cash position

o Debt-Equity ratio = ratio of source of financing the business

o Days Sales Outstanding/Days Inventory Outstanding/Days Payable Outstanding = provides insight on cash conversion cycle and how fast the business is able to use to convert its working capital into cash

While there are multiple other ratios and insights that can be understood from the balance sheet, the above are some of the key information available from Balance sheet which needs to be analysed to understand the financial well being of the business. Also notes to the balance sheet (with specific consideration to contingent liabilities) should also be referred to get an in-depth understanding of the financial well being.