Chapter Two - Wiley

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64 CHAPTER 2 A Further Look at Financial Statements
STUDY OBJECTIVE
5
Identify and compute ratios
for analyzing a company’s
profitability.
USING THE INCOME STATEMENT
Best Buy Company tries to generate a profit for its shareholders by selling electronics
goods. The income statement reports how successful it is at generating
a profit from its sales. The income statement reports the amount earned during
the period—revenues—and the costs incurred during the period—expenses. An
income statement for Best Buy is provided in Illustration 2-12.
Illustration 2-12
Best Buy’s income
statement
BEST BUY CO., INC.
Income Statements
For the Years Ended March 3, 2001,
and February 26, 2000 (in thousands)
2001 2000
Revenues
Net sales and other revenue $15,363,723 $12,517,334
Expenses
Cost of goods sold 12,267,459 10,100,594
Selling, general, and
administrative expenses 2,454,785 1,854,170
Income tax expense 245,640 215,500
Total expenses 14,967,884 12,170,264
Net income $ 395,839 $ 347,070
From this income statement we can see that Best Buy’s sales and net income
both increased during the year. Net income increased from $347,070,000 to
$395,839,000. In order to increase net income, the company needs its sales to
increase more than its expenses. While this was the case for Best Buy during
this period, this is not as easy as it sounds. The consumer electronics business
is very competitive. New models are constantly arising, making old models obsolete.
Buyers are fickle, and sales are very susceptible to economic swings. Best
Buy’s primary competitor is Circuit City. Circuit City reported net income of
$160,802,000 for the year ended February 28, 2001.
To evaluate the profitability of Best Buy, we will use ratio analysis. Profitability
ratios measure the operating success of a company for a given period
of time. We will look at two examples of profitability ratios: earnings per share
and the price-earnings ratio.
Business Insight
INVESTOR PERSPECTIVE
Profitability matters. Recently, when the warehouse store chain Costco missed
its estimated earnings per share figure by 1 cent (earning 26 cents instead of a
projected 27 cents), its stock price fell by 25%. Although it isn’t unusual for a
company’s share price to react to earnings announcements, a move of this magnitude
is unusual. In addition, the share price of many other companies’ stocks
fell as a result of the news. In this case investors reacted so dramatically because
Costco’s financial health is viewed as a good indicator of the strength of the economy
as a whole. Investors feared that the economy was “headed south.”