How To Read Seedly Chicken Rice Limited's Income Statement
Why Do Stocks Analysis?
If you have read any of our stocks discussions, you will often see some variation of this line: “Please do your own due diligence before making an investment!”
So, what exactly is ‘doing my own due diligence’?
Does this mean that I have to read the financial statements of a company before buying the stocks? But what if I don’t know how to?!
And how do I even begin evaluating a company or analysing its stock as being worth buying?
In our pursuit of financial independence and freedom, it’s inevitable that we’ll eventually look towards investing in order to grow our wealth.
And since investing seems like a game which only people in the know can play, we decided to level the playing field by teaching you the really basic stuff in order to decide if a company or stock is worth investing in.
Disclaimer: we’re not experts but we just want to share the little that we know in hopes that it’ll help you to take the first steps in your investing journey and maybe even spark conversation in our Seedly Q&A!
In this first part of the series of ‘How To Analyse A Stock‘, we’ll show you how to read an income statement. A useful skill which should help you decide if you should invest in a company or not.
An Analysis Of Seedly Chicken Rice Limited
While having lunch (chicken rice) and thinking of which company I should use for my analysis, I thought: What better way to explain financial statements than linking it to chicken rice, our national favourite dish!
So for this exercise, I’ll be using a fictitious chicken rice company, Seedly Chicken Rice Limited – that has been in the chicken rice business for the past 10 years – to explain the basics of how to evaluate a company in simple, bite-sized terms.
First, let’s look at the company’s Income Statement.
Why Look At The Company’s Income Statement?
An Income Statement shows a company’s income, expenses, as well as the profitability over a period of time. Think of it as a report card which investors like you and me can use to determine if the company is doing well.
Here’s what Seedly Chicken Rice Limited’s Income Statement looks like:
* Note that these figures are for illustration purposes only.
Don’t worry, I’ll walk you through the definitions for some of the terms used in the above Income Statement.
The revenue is the Price x Quantity and it is the income received before deducting expenses. It’s basically how much the lao ban (Chinese for boss) of the chicken rice shop pockets from his business.
Assuming that Seedly Chicken Rice sells 200 plates a day, at $4 a plate, and the stall is open 6 days a week.
Revenue made in a year = 200 plates x $4 x 6 days a week x 4 weeks x 12 = $230,400
Running a business means that obviously, you’ll incur some expenses like:
- Cost of goods sold
- Staff costs
- Depreciation expense
- Interest expense
Cost Of Goods Sold
Cost of goods sold is the direct costs to produce the goods, sold. It is a variable cost which varies with the number of goods sold. Simply put, the more chicken rice you sell, the higher the cost of goods sold you will incur.
It is the cost of the materials you need to make the chicken rice:
- chilli sauce
- soy sauce
- oil to cook with, etc.
Assuming that the cost of these items works out to be $1.50 per plate of chicken rice.
Cost of goods sold in a year = 200 plates x $1.50 x 6 days a week x 4 weeks x 12 = $86,400
Rental, Utilities, And Staff Costs
Rental, utilities, staff costs, and depreciation expense are fixed costs. This means that they do not vary with the quantity of chicken rice sold. The owners of Seedly Chicken Rice Limited will generally pay a fixed amount regardless of how many plates of chicken rice they sell.
Depreciation expense is also another fixed cost.
Assuming that you buy an iPhone XR without a contract for $1,200.
You use it for two years and sell it off at $400. Depreciation expense per year, therefore, will be $400.
The same applies to Seedly Chicken Rice Limited. They have kitchen equipment and other fixed assets, like their stoves, cooking equipment and other miscellaneous equipment that have a lifetime – number of years before they spoil and have to be replaced.
Interest income is the amount of interest earned during a specific time period, for example, the interest you earn on a bank fixed deposit.
Interest expense, on the other hand, comes from loans which Seedly Chicken Rice Limited might have. Such as a bank loan for sufficient capital to start the business.
Profit After Tax
Profit after tax is the net income or net earnings. i.e. income minus all expenses and taxes. It is the actual profit which the owners of Seedly Chicken Rice Limited can pocket.
Sometimes you will also see EBIT or EBITDA used.
- EBIT stands for Earnings Before Interest And Tax.
EBIT = Net profit + Interest + Tax
- EBITDA stands for Earnings before Interest, Tax, Depreciation, and Amortisation.
EBITDA = Net profit + Interest + Tax + Depreciation/Amortisation expense
Profit margin = Net income / Sales = 58,428 / 230,400 = 25.4%
Note: This type of profit margin is very high and we seldom see it happening in real life. Don’t believe me? Here’s how much you need to be a hawker.
Evaluating A Company For Growth
We have now covered Seedly Chicken Rice Limited’s income statement for 2018.
The next step would be to compare the results against the income statement for 2019 to identify growth! Also, in 2018, Seedly Chicken Rice Limited did well and they have decided to expand by opening a new outlet.
Assuming that the new outlet sells 150 plates of chicken rice per day.
This is what Seedly Chicken Rice Limited’s income statement looks like for 2018 and 2019:
We can see that the expansion allowed for an increase in revenue by 75%, whereas profit after tax increased by 46%.
Using these indicators, we can conclude that the financial health of Seedly Chicken Rice is good and that there is good growth!
Next step, we have to look at the Balance Sheet to have a closer look at the company’s assets, liabilities, and equity.
Stay tuned for the next post!