Income over the resources that earned it

◈ 5 cards

Why profitability cannot be judged from the income statement alone; how to average balance-sheet accounts for every return and turnover ratio; the course’s conventions, stated once.

Is 480 good?

Tamarack Outfitters Inc., the public outdoor-equipment retailer whose statements Module 8 analysed, earned net income of $480 thousand in 2025, up from $330 thousand. Is that good? The honest answer is it depends on what it took to earn it. A corner store that earns 480 on 800 of assets is remarkable; a chain that earns 480 on 40,000 of assets is in trouble. Net income is a flow for the year; the resources that produced it are stocks on the balance sheet. A return puts the flow over the stock — which is why every ratio in this module needs both statements.

Why average?

The income statement covers the whole of 2025. The balance sheet is a snapshot at 31 December 2025 — after the year’s profits, the new borrowing and the capital spending have all landed. Dividing a year’s income by the year-end balance compares a twelve-month flow with the resources that existed only on the last day. The convention this course uses for every return and turnover ratio is the average of the opening and closing balances:

$Average balance = \frac{opening + closing}{2}$

For Tamarack’s total assets, the opening balance is 31 December 2024 and the closing balance 31 December 2025:

$Average total assets = \frac{3 , 400 + 4 , 000}{2} = 3, 700$

So the resources that earned the 480 were, on average through the year, 3,700 — and a return of about 13 % is the first sensible thing anyone can say about the 480. Lesson 9.2 does that properly.

The averages the rest of the module uses

From the pack (CAD thousands):

                          31 Dec 2025   31 Dec 2024   Average
Total assets                   4,000         3,400     3,700
Shareholders’ equity           2,200         1,800     2,000
Accounts receivable              600           480       540
Inventory                        720           560       640
Accounts payable                 480           400       440
Current liabilities              700           600       650

Equity is common shares plus retained earnings: 900 + 1,300 = 2,200 at the end of 2025 and 900 + 900 = 1,800 a year earlier. Tamarack has no preferred shares, so all of its equity is common equity (lesson 9.2 adds a preferred variant).

What the averaging does and does not fix

Averaging two year-ends assumes the balance moved evenly through the year. If Tamarack bought a $1 million warehouse on 28 December, the average still overstates the assets that actually earned the year’s income; a quarterly average would be better, and an analyst with monthly data would use it. The exam gives you two balance sheets, so the exam’s average is the two-point one — and the answer key is built on it.

The convention also has a knock-on: every days ratio in lesson 9.5 uses a 365-day year, credit sales for receivables, and cost of goods sold for inventory and payables. Some finance texts use 360 days and a closing balance; when a ratio from another source does not match yours, the first thing to check is which convention each of you used.