Reading an income statement in 5 minutes
The income statement (P&L) tells a story in cascade: it starts from what you sell and goes down, line after line, until what is left for you. Five levels are enough: revenue, gross margin, EBITDA, EBIT, net result. Each one answers a precise question about the performance of your activity.
Revenue opens the dance: it is the sum of your sales over the period, excluding VAT. Important, but misleading on its own, because it says nothing about what these sales cost. The gross margin subtracts the direct cost of the products or services sold (purchases, materials, subcontracting). If you sell for EUR 1,000,000 and your direct costs weigh EUR 600,000, your gross margin is EUR 400,000, or 40%. It is the first health signal: what each euro sold leaves before paying for the structure.
The EBITDA then deducts the current operating expenses (salaries, rents, marketing) but not depreciation or interest. It approximates the activity's ability to generate cash. The EBIT, or operating result, additionally deducts depreciation: it measures the real operating performance, wear and tear of the equipment included. The net result, right at the bottom, arrives after financial interest and taxes. It is what goes back to the owners.
Reading a P&L in 5 minutes means going down these five floors and spotting where the money evaporates. A solid gross margin but a feeble EBIT betrays a structure that is too heavy. The next time you are presented with accounts, start from the top and ask at each line the question: what have we just subtracted, and why.
Understanding the balance sheet: assets, liabilities, equity
The balance sheet is a snapshot at a given moment: on the left what the company owns (assets), on the right how it financed it (liabilities). The two columns always balance. Within the liabilities, equity (FP) represents the shareholders' money; the rest is debt. The balance sheet answers a question: who paid for what.
Read it from top to bottom. On the asset side, we distinguish fixed assets (machines, buildings, software, what serves durably) from current assets (inventory, trade receivables, cash, what turns over within the year). On the liability side, equity and long-term financial debt normally finance the top of the balance sheet; short-term debt (suppliers, tax liabilities) finances the bottom. An imbalance, for example financing a factory with an overdraft, is an immediate warning signal.
Two ratios are enough for a first diagnosis. The gearing relates the net financial debt to equity: a gearing of 1.5 means EUR 1.50 of debt for EUR 1 of equity, which starts to become tight. Financial autonomy (equity / total balance sheet) says what share of the company truly belongs to itself; below 25 to 30%, the dependence on creditors becomes a governance risk as much as a solvency risk.
Concretely, when you look at the balance sheet of your BU or of a partner, do not stop at the total. Ask: is the long term financed by the long term, and does the company belong to itself enough to get through a rough patch. These two questions are worth more than a page of comments.
Working capital and cash: the vital difference
A positive net profit does not guarantee survival. A company can be profitable on paper and run out of cash the same month. The reason has a name: the working capital requirement (BFR). It is the money tied up in the operating cycle, between the moment you pay your suppliers and the moment your clients settle with you.
The formula is simple: BFR = inventory + trade receivables − trade payables. You have advanced the money for the inventory, you are waiting for your clients' payments (receivables), but your suppliers grant you a delay (payables). If your clients pay at 90 days while you settle your suppliers at 30, the gap widens. Net working capital (FRN), for its part, measures the stable resources available to cover this requirement. When the BFR exceeds the FRN, it is the cash that fills the gap, and it runs out.
Let us take an illustrative case. A company generates EUR 60,000 of net result, but its growth swells inventory and receivables by EUR 200,000 over the year. The income statement smiles; the bank account empties. Each new order consumes cash before bringing any in. This is exactly how profitable companies file for bankruptcy: not for lack of profit, but for lack of liquidity at the right moment.
Remember the distinction: the result says whether the activity creates value, the cash says whether it survives next month. As a manager, monitor the change in BFR as much as the profit line. Unfinanced growth is dangerous growth, and it is often the growth one is most proud of.
Building and defending an annual budget
An annual budget translates a strategy into committing figures. Two approaches build it: top-down, where management sets the objectives that the teams break down, and bottom-up, where each department feeds up its forecasts, consolidated afterwards. Most companies combine the two: a top-down framing, refined by field estimates.
The strength of a budget lies in its assumptions. A budget of EUR 800,000 based on sales growth of 15% is only worth something if this growth rests on something concrete: an order book, a sized sales team, a market that allows it. Always distinguish the volume assumptions (how many units), price assumptions (at what price) and cost assumptions (at what margin). An unquantified and unjustified assumption is a promise, not a budget.
The defence before the executive committee is prepared like a trial: you will be attacked on the weak link. Anticipate the three killer questions: what happens if revenue disappoints by 10%, where are the compressible costs, and what justifies the gap with last year. Present a low version, a target version, and the adjustment levers. A manager who arrives with a single scenario arrives unarmed.
In practice, defending a budget is not about justifying it line by line, it is about demonstrating that you master your assumptions and your room for manoeuvre. The executive committee does not finance spreadsheets, it finances a lucid reading of risk. Arrive with your figures, but above all with your plan B.
Evaluating an investment project (NPV, IRR)
Evaluating an investment means answering one question: does this project create value once time and risk are taken into account. Three tools answer it: the net present value (NPV), the internal rate of return (IRR), and the payback period. The first decides, the other two illuminate.
The NPV rests on a principle: a euro tomorrow is worth less than a euro today. You therefore discount each future flow, then subtract the initial investment. NPV = sum of discounted flows − investment. If you invest EUR 500,000 to recover flows whose total discounted value is EUR 560,000, the NPV is worth EUR 60,000: the project creates value. A positive NPV validates, a negative NPV invites you to give up. It is the most robust decision rule.
The IRR is the discount rate that cancels the NPV: if the project returns an IRR of 12% and your cost of capital is 8%, the margin is comfortable. The payback indicates in how many years the investment is repaid; useful for liquidity, silent on profitability beyond. The choice of the discount rate is decisive: for a manager, it reflects the cost of the company's money plus a premium for the project's risk. Too low, you validate bad projects; too high, you kill the good ones.
Concretely, never defend a project on its payback alone or its expected revenue. Present the NPV at the rate retained, say why this rate, and show from which assumption the project tips into negative. It is this transparency that gets a case through the executive committee.
The 7 ratios a manager must track
Seven ratios are enough for a non-financial manager to read the health of an activity without drowning. Three measure the profitability and efficiency of capital, two scrutinize the client-supplier cycle, two gauge financial solidity. Each is calculated in one line and interpreted in one sentence.
Do not track these seven ratios in isolation: it is their crossed evolution that speaks. A ROCE that rises while BFR/revenue explodes hides a profitability financed on credit. Choose your two or three priority ratios according to your activity, track them every month, and you will speak the same language as your CFO.
- ROCE = operating result (EBIT) / capital employed. Measures what each euro invested in the activity returns. To be compared to the cost of capital: a ROCE of 12% for a cost of 8% creates value.
- EBITDA margin = EBITDA / revenue. Indicates operating profitability before depreciation and financing. Track its trend more than its absolute level: a margin that erodes quarter after quarter is a signal.
- DSO (client payment period) = trade receivables / revenue × 365. Number of days to get paid. A DSO of 75 days when your terms are at 30 betrays a faulty collection and blocked cash.
- DPO (supplier payment period) = trade payables / purchases × 365. Number of days before paying your suppliers. A DPO higher than the DSO relieves the cash; the reverse drains it.
- Gearing = net financial debt / equity. Measures the leverage effect. Beyond 1, the debt dominates the equity and reduces your room for manoeuvre in case of a downturn.
- Current ratio = current assets / short-term debt. Ability to honour the near-term deadlines. Below 1, the company does not cover its short debts with its short assets: liquidity tension.
- BFR / revenue = working capital requirement / revenue. Indicates how many days of revenue are tied up in the cycle. A ratio that climbs with growth signals that each additional sale consumes cash.