Question

You have only the balance sheet and the income statement of a firm. How does one evaluate a firm’s financial health?

Answer 1

An income statement summarizes the revenues, costs, and expenses incurred during a specific time frame by the firm. The company's income statement is usually broken into three parts that assists to analyze business financial health at three different points. It starts with revenue and the associated direct costs with revenue to compute the gross profit. Then it subtracts indirect expenses such as general costs, marketing costs, and depreciation to identify operating profit. Finally it ends computation of net profit which deducts taxes and interest. The profit margin on income statement helps to identify where a firm’s costs are low or high at different points of business operations; and reveals firm's ability to generate a profit

The balance sheet provides details as to how effectively the firm's management uses its resources. The firm's balance sheet is a snapshot of it's financial health at a single point in time as summarizes firm's assets, liabilities, and shareholders ‘equity. The Balance Sheet informs how much money a firm has (assets), how much firm owes (liabilities), and what is remaining when firm's calculate net the two together (book value, net worth, or shareholder equity).