[MUSIC] Hi everyone. But now you know that financial statements can tell a unique story about a company. Each company's balance sheet can tell readers about the company's position. Each company's income statement can speak to the company's performance. In this lesson, we're going to see how what we've learned about financial statements in our course can help us interpret the story. That is we'll see a problem arise when trying to interpret the company's story and then we'll discuss one solution to this interpretation problem. First, let's look at a few balance sheets. Here's a balance sheet A, here's balance sheet B, and finally, look at balance sheet C. I'm going to tell you that each balance sheet belongs to one of the three companies we were introduced to during our course. Missy's bakery, sweet indulgence, Jed's apparel store, body and sole or David and Ellen's dance studio, Regent ballroom. Now let's take another look at balance sheet A, you tell me which company this balance sheet belongs to. See there, just based what on what you've learned in this course, you can already distinguish between companies based on observing just a piece of the balance sheet. That's because companies from different industries often have quite different stories that result in quite different financial statements. You should be proud of your progress in understanding financial statements but you should also know that a challenge is looming. Let's say you have some cash you want to invest in a company and you've narrowed down to two companies. A newer, smaller company called TeachMeApps or an older, larger company called Learning Ware. Both companies develop applications for studying languages or reviewing for standardized college entrance exams. Your decision on which company stock to purchase comes down to your projection of each companies future performance. [MUSIC] So of course, we take a look at each company's income statement because that's the statement that answers the measurement question, how did you perform? [MUSIC] Because the two companies operate in the same industry, we notice that the income statements present the same line items just different amounts. Using logic, you presume that to project future performance you should compare each companies current performance. Low and behold, you see that Learning Ware reports net income of $150,000. Which is substantially larger than TeachMeApps income of $30,000. So that settles it, you should invest in Learning Ware or should you reconsider? You see Learning Ware's net income is a quite helpful number to assess its current performance compared to its own performance last year. Because Learning Ware likely is utilizing a similar set of assets to generate net income across the two years. But it's less clear when you try to compare Learning Ware to TeachMeApps. Because Learning Ware's larger net income might arise from differences in performance but also can arise from TeachMeApps simply having a smaller sized set of assets. Trying to make comparisons across companies of different sizes is the problem I mentioned earlier. But fortunately we have a solution and the solution is called ratios. Let's say that TeachMeApps average total assets during the year were worth $100,000 while Learning Ware held average total assets of $1,000,000. Now we want to measure performance by seeing how well each company utilized its assets. In other words, let's see how much net income was generated for each dollar of assets the company held during the year. Another profitability ratio and perhaps the most popular ratio is a company's earnings per share. Or EPS, calculated as net income divided by the average shares of common stock outstanding. EPS indicates the amount of net income earned for each share of common stock outstanding. Importantly, companies whose stock is sold on a public exchange are required to report earnings per share on their income statements. There are other ratios that provide information that allows better comparisons across companies or provides better information than just the values reported in the financial statements. For example, let's say TeachMeApps would like to secure a loan from Busey Bank. It wants to present the bank with evidence that the loan would likely be repaid. TeachMeApps might present a risk ratio, such as a current ratio which divides the company's current assets by its current liabilities. The result indicates its ability to meet its liabilities, giving Busey comfort that the additional liabilities could be satisfied using its current assets. So we've discovered that the financial statements can tell us quite a bit. They can tell us something about a company's story, as to its industry as they help us answer our measurement questions. We've also seen that we might run into trouble when using financial statements to compare companies that differ either by size or by industry or a host of other dimensions. But we also found that ratios can be used as part of the solution to this comparability problem. In fact, ratios are most useful when comparing the budgets, competitors, or prior periods. And with that we'll leave our lesson on a high note. Next time we'll wrap up the course with an overview of the high points of our time together, until then, be well. [MUSIC]
