Financial statements for online casinos (with examples), part 2

Like any other business, online casinos and sportsbooks need to track their performance. Which financial statements do they need, and what do those statements contain? Keep reading for a full introduction to how you can analyze your betting or gaming business’s financial statements. 

In this article, we’ll look at how you can analyze financial statements for your online casino or sportsbook business. 

This is part 2 — in part 1, we covered the different kinds of financial statements your business needs to track its operations. If you haven't already, go back and read part 1 before continuing this article — you’ll need to be familiar with them before moving into how to analyze them. 

There are three main methods of analyzing financial statements — vertical, horizontal, and ratio analysis.

Vertical analysis

Vertical analysis entails working your way down either a balance sheet or an income statement and calculating each item as a percentage of its category. 

In the vertical analysis of a balance sheet, each item is shown as a percentage of overall assets. This shows you, for example, what share of your total assets is accounted for by goodwill (essentially, a company’s reputation) and what percentage is cash. The same goes for the liabilities and equity section. 

To calculate the percentages for a balance sheet, divide each line item by its category’s total. In the example below, the $167,000 of “Goodwill and other intangible assets” was divided by the $538,000 sum total of assets, showing that intangible assets accounted for 31% of the company’s holdings. 

 For an income statement, each item is divided by total sales (or revenue) and multiplied by 100. 

You can also use vertical analysis across several sequential years to see trends over time. 

Example 1: Vertical Analysis 

 

Horizontal analysis

While vertical analysis primarily looks at a single point in time, horizontal analysis compares the company’s performance over two successive periods of time, going line by line through the statement.

Horizontal analysis can cover any period of time, but most commonly it’s used YoY (Year over Year) or QoQ (quarter over quarter).

To conduct a horizontal analysis, calculate the difference between your base and comparison year (in the example below, 2020 and 2021, respectively) and divide the result by the base year, then multiply the result by 100 to get a percentage. Once you have your percentages, you can start asking questions. If revenues are up but profits aren’t, what costs have increased, why, and what can be done? 

For example, below, the difference between the two years’ revenues is $130 million. Dividing 130 million by 850 million and multiplying the resulting fraction shows growth of 15.3%.

Example 2: Horizontal analysis

 

As we go down the income statement, you can see which line items have grown and which have shrunk (negative numbers are indicated by parentheses). You can see that while revenues increased, so have costs of sales, marketing expenses, and other expenses.

You can use horizontal analysis to see if, for example, costs are growing at a disproportionate rate compared to revenues; if so, the casino must either increase sales through use of bonuses or other promotions or find ways to cut costs. However, the innate complication is that increased marketing efforts will come with increased marketing costs, so careful planning is necessary to make sure your strategy isn’t counterproductive. 

One noticeable contribution to the 153% growth in operating profit is the steep dropoff in the exceptional items, which saw a 69% decrease. Exceptional items are one-off events that materially affect a company’s profit margins. One example in the iGaming world would be the acquisition of new licenses; licensing comes with a substantial up-front fee, followed by yearly contributions. If the company expanded into several new markets the first year, but paid only the annual fee the next year, there would be a comparative decline in exceptional items.

Ratio analysis

Mainly used by investors, ratio analysis is another way of evaluating a company’s financial health. 

Ratio analysis can be used to evaluate trends, or to look at the same aspect of your own company’s finances over successive years, or to compare your company against your competitors. 

There are several different categories of ratio analysis. We’ll look at liquidity, solvency (or leverage), and profitability ratios. 

Liquidity ratios

Liquidity ratios are used to analyze a company’s ability to cover its short-term liabilities without having to borrow money. They draw information from a company’s balance sheet, and concern themselves with liquid assets — cash or those that can be easily converted into cash. 

The cash ratio compares cash to current liabilities. 

Here’s the formula: 

Cash ratio = cash / current liabilities

If the ratio is greater than 1, the company can pay off all of its current liabilities using the cash it has at hand, without having to liquidate any other assets. Online casinos, in particular, should have a high cash ratio, as they’re often required by their licensing authority to keep significant amounts of cash on hand to pay out winnings. 

The current ratio measures a company’s ability to cover its current liabilities with its current assets. It differs from the cash ratio in that it includes all liquid assets (such as securities, bonds, accounts receivable), not just cash.

Here’s the formula:

Current ratio = current assets / current liabilities

A current ratio of less than 1 indicates that a company doesn’t have enough cash and other liquid assets to cover its short-term debts. However, a current ratio that’s too high, such as 3 or 4, could indicate that the company isn’t properly managing its working capital, letting huge pools of cash lay stagnant instead of putting them to work through investment or expansion. 

The quick ratio measures a company’s ability to immediately pay down short-term liabilities with nothing but its most liquid assets — cash and cash equivalents (assets which can be converted into cash in a short period of time, like securities and accounts receivable).

Here’s the formula: 

Quick ratio = (current assets - inventory) / current liabilities

The higher this number is, the better — 3 or 4 is good, indicating that the company is more than capable of meeting its current liabilities. However, a quick ratio of less than 1 indicates that your company will struggle to pay its short-term debts. 

Solvency ratios

While liquidity ratios evaluate a company’s ability to pay its short-term liabilities, solvency (or leverage) ratios look at how easily a company can manage its non-current liabilities. 

The equity ratio measures how much leverage, or debt, a company has by comparing its equity and assets.

Here’s the formula: 

Equity ratio = total equity / total assets

Companies with an equity ratio of 0.5 or less are called leveraged, relying on debt for funding; those with an equity ratio of 0.5 and above are more conservative, as they rely on equity for funding instead of debt.

The debt-to-equity ratio shows how much a company is financing its operations with debt as opposed to its own assets by calculating how much debt it has for each dollar of equity. All the information is available on the balance sheet. 

Here’s the formula: 

Debt to equity = total liabilities / total shareholders’ equity.

If the total shareholders’ equity isn’t clearly itemized in your balance sheet, subtract total liabilities from total assets.

Companies incur debt when they borrow in order to expand, so debt isn’t necessarily a bad thing; however, interest paid on loans can accumulate over time. 

A number higher than 2 is regarded as risky, with the risk increasing as the number rises. However, gambling is a risky enterprise to begin with, and if you sit down to work out the numbers, you’ll find that a number of industry juggernauts like 888 have debt-to-equity ratios over 2.

The debt-to-assets ratio shows how much of a business’s assets have been financed using debt. 

Here’s the formula: 

Debt-to-assets ratio = total liabilities / total assets

A ratio over 1 shows that a company is funding a significant amount of its assets with debt, and is technically insolvent. A ratio lower than 0.5 means that the company is largely funded by its own equity, a far more secure position.

The debt-to-capital ratio assesses your company’s risk of defaulting on its debts. 

Total capital is the sum of all interest-bearing debt and all shareholders’ equity. 

Here’s the formula: 

Total debt / (total debt + total shareholder’s equity)

The higher the ratio is, the greater the risk for your company, as this indicates that too much of your funding is coming from debt instead of your own equity. 

Profitability ratios

Profitability ratios, as the name implies, measure that most-important-of-all thing: your business’s ability to earn money. 

The gross profit margin measures how much profit the business can generate from each dollar (or other unit of currency) of revenue earned.

Here’s the formula: 

Gross profit margin = (Gross profit / revenue) * 100

Gross profit is calculated by subtracting the cost of goods sold from revenues. Divide this by revenue and then multiply the result by 100 to get a percentage — that’s your gross profit margin.

The operating profit margin measures how profitable a company was before accounting for taxes and interest.

Here’s the formula: 

Operating profit margin = operating profit / total revenue * 100

Operating profit is calculated by subtracting costs of goods sold, operating expenses, and depreciation and amortization from revenues. Operating profit margin is indicative of how well-managed a company is, as it directly compares how much money is earned with how much was spent to earn it.

The net profit margin, which measures how much of every dollar of revenue makes its way to becoming net profit,is slightly more complicated to calculate. We arrive at net profit, lower down the income statement, by subtracting operating expenses, other expenses, interest, and taxes from gross profit. 

Here’s the formula:

Net profit margin = (R - COGS - OE - O - I - T) / R * 100

Where:

R = Revenue

COGS = Cost of goods sold

OE = Operating expenses 

O = Other expenses

I = Interest

T = Taxes

At first, it might seem that these are highly repetitive; how many times do you need to calculate profit, and what’s the point of calculating anything but the final number? But if you’re unsure of where the profits are leaking out, going step by step like this through your income statement will help point out which holes you can plug. 

For example, if the biggest hit to your final profit margin comes along when calculating net profit margin, it could be that you’re simply paying too much in taxes and need to relocate to a more tax-friendly jurisdiction. 

To learn more about your options for opening and running an online casino or sportsbook, get in touch for a free consultation.