Finance
The three statements
Income statement - revenue, costs, and profit over a period. Balance sheet - assets equal liabilities plus equity at a point in time. Cash flow statement - operating, investing, and financing cash movements. Profit is an accounting measure; cash is what keeps an organisation solvent.
Measures to know
- Margins: gross margin = (revenue − cost of goods sold) / revenue; net margin = net income / revenue.
- Liquidity: current ratio = current assets / current liabilities; the quick ratio excludes inventory.
- Leverage: debt-to-equity. Returns: ROE = net income / equity; ROA = net income / total assets.
- Capital budgeting: NPV discounts future cash flows at the required rate - positive means accept; IRR is the discount rate at which NPV is zero, compared against the hurdle rate; payback measures time to recover the outlay.
Traps
Profit is not cash - depreciation is non-cash and accruals shift timing. EBITDA ignores capital expenditure, interest, and tax, so it is not a cash flow measure. Payback ignores the time value of money and everything after the payback point. Only incremental cash flows matter; sunk costs are irrelevant to the decision. IRR can mislead when comparing projects of different scale.
Worked example
Fixed costs are $120,000, price is $40, variable cost is $25 per unit. Contribution per unit is $15, so break-even = 120,000 / 15 = 8,000 units. Every unit beyond that adds $15 of operating profit.