How to Analyze Financial Statements: One Business, Three Reconciliations

Start with the reporting perimeter

Cedar Supply is an original fictional teaching business. All figures are USD for one 365-day year, with opening and closing balance sheets for the same entity. Net credit sales are $180,000 of $200,000 total revenue; the remaining $20,000 sales are cash sales. There are no acquisitions, exchange effects, asset disposals or other undisclosed movements. Interest and income taxes paid are operating cash flows here, with no change in their payables. This is a deliberately simplified US-style presentation, not a complete set of financial statements.

Use the Financial Ratios reference hub for definitions, and the grouped ratios calculator to reproduce this dataset. Its defaults use these input amounts. A real review also needs accounting notes, revenue policies, estimates, commitments and comparable prior-period data.

Read the annual income statement

Revenue less $120,000 COGS gives $80,000 gross profit. Subtracting $50,000 operating expenses gives $30,000 operating profit. Here EBIT equals operating profit because no other non-operating items exist. After $5,000 interest and $5,000 income-tax expense, net income is $20,000. Included D&A is $10,000, so EBITDA is $40,000. Rebuild that subtotal in the EBITDA calculator; do not add debt principal or add D&A twice.

Make both balance sheets balance

Opening assets $180,000 equal $110,000 liabilities plus $70,000 equity. Closing assets $200,000 equal $120,000 liabilities plus $80,000 equity. Cash equivalents are already in cash; the separate $5,000 investment line is not another copy of that cash. Non-interest-bearing shareholder loans are liabilities, but are excluded from the narrowly defined interest-bearing debt input.

Use period flows and average balances consistently

An opening-to-closing average uses two observations, not every daily balance. Seasonal swings can make it unrepresentative; use more frequent observations when available. A 90-day flow divided by an annual balance convention is not automatically comparable with this 365-day example. Do not assume missing opening inventory is zero.

Explain three different leverage answers

At closing, the equity multiplier is $200,000 / $80,000 = 2.50×. Total liabilities/equity is $120,000 / $80,000 = 1.50×. Interest-bearing debt/equity is ($10,000 + $50,000) / $80,000 = 0.75×. The first equals 1 plus the second because assets = liabilities + equity. It does not equal 1 plus the third because trade payables and non-interest-bearing shareholder loans are also liabilities.

Inspect these methods in the integrated leverage selector. A high ROE can reflect a smaller equity base and greater financing exposure rather than better operations. Negative equity makes a conventional positive-equity comparison unsuitable; it is not a strong score.

Reconcile $20,000 net income to $27,000 operating cash

Equipment purchases are $25,000, with no disposals. Net PPE therefore rolls forward as $125,000 + $25,000 − $10,000 depreciation = $140,000. Financing receives $10,000 additional non-interest-bearing shareholder loans and pays $10,000 dividends, net zero. Thus cash rises by $27,000 − $25,000 + $10,000 − $10,000 = $2,000, from $8,000 to $10,000. Equity rolls forward as $70,000 + $20,000 net income − $10,000 dividends = $80,000.

The $2,000 cash change is not the $20,000 profit or $40,000 EBITDA. Our operating cash flow guide and cash flow statement guide explain their separate cash classifications. Do not classify every current account as an operating adjustment or treat a new loan as sales.

Turn the reconciliation into questions, not a health score

Check receivables aging before concluding that $25,000 will be collected promptly. Ask whether inventory reductions reflect efficiency, shortages or a write-down; this fictional bridge assumes no write-down. Review loan terms and related-party repayment demands rather than treating non-interest-bearing financing as risk-free. Compare margins and turnover with the company’s own history and genuinely comparable businesses, including reporting policies and seasonality.

Common mistakes

Mixing total and credit sales in DSO, confusing total liabilities with interest-bearing debt, annualizing a short period silently, treating profit as distributions available and interpreting one ratio in isolation can reverse the decision. Follow the DSO method or the existing working-capital guide when those specific balances need investigation.

Sources and accounting boundary

The SEC’s financial-statement introduction distinguishes reporting-period flows, dated balance sheets and cash flows. BDC’s financial tools organize business-ratio questions. Cedar Supply, its statement amounts, the 19-measure reference and all reconciliations are original. This teaching example omits the full notes, disclosures and complexities needed for actual reporting or lending.