FAQs on evaluating financial statements of an IT services company
1) What are the key financial statements of an IT services company?
The key financial statements of a services company are the income statement, its balance sheet, and the cash flow statement. While the income statement shows the level of activity for a company during a period (usually a quarter or a year), the balance sheet shows the financial position of a company at a particular point in time (usually half-yearly or annually).
2) What are the important line-items in the income statement?
The income statement or P&L statement is the financial statement that shows the revenues, expenses, and net income generated by a company during a specific period. The important line-items of an income statement include revenue from operations (depends upon how many services the company sells), other net income, employee benefit expenses, cost of sub-contractors, travel expenses, cost of software packages, communication expenses, consultancy, and professional charges, depreciation as well as amortisation charges, finance cost along with other expenses.
3) What are the important items in the assets side of the balance sheet of an IT services company?
A company’s balance sheet, also called 'statement of financial position’, show the firm’s assets, liabilities, and owners’ equity (net worth). Assets in the balance sheet must always equal the liabilities plus the shareholders' equity. Under assets, we have the current assets and non-current assets. Current assets include cash and investments, trade receivables & loans. On the other hand, non-current assets are those assets that have a lifespan of more than one year. They are represented by tangible assets such as property, plant and equipment, right of use assets, and capital work in progress. There may also be intangible assets in the form of goodwill, patents, or copyright.
4) What are the important items in the liabilities side of the balance sheet of an IT services company?
On the other side of the balance sheet are the liabilities of a company. These represent financial obligations that a company owes to external parties. Current liabilities are the company’s liabilities that will come due and must be paid within one year. It includes short-term borrowings such as accounts payable, and the current portion of long-term borrowings. Long-term liabilities include lease liabilities, other financial liabilities, and deferred tax liabilities. Shareholders’ equity represents the initial contribution of the owners and other shareholders to the company. At the end of every fiscal year, a company may decide to re-invest its earnings after taxes into the company. The shareholders' equity will increase by the amount of re-invested earnings after tax.
5) What are the important items in the cash flow statement of an IT services company?
The cash flow statement of a company has three main headings i.e. cash from operating activities, cash flows from investing activities while the third one is, cash flows from financing activities. The main items under cash from operating activities include the net change in working capital and adjustments to reconcile net profit to net cash provided by operating activities. Under cash flows from investing activities, the main items are capital expenditure on plant, property, and equipment, interest & dividend received, along with payment towards the acquisition of the business, net of cash acquired as well as payments to acquire investments. The main items under cash from financing include the payment of lease liabilities, payment of dividends, and buyback of equity shares including transaction costs.