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The Income StatementRevenue While the income statement for companies are different across industries, almost all of them begin with the company's revenues for the period. Revenue, which is sometimes called sales, represents the amount of money a company brings in from selling its product or service. Depending on a company's revenue stream, a company will record revenue in several ways. A retail company will record revenue as soon as you pay for the items and walk out of the store. An insurance company will record revenue as you pay on the policy and they receive the premiums. Be sure to check out a company's revenue recognition policy, it is found in the notes accompanying the company's financial statements. Expenses A company needs to spend money in order to make money, and these outflows from making and selling its products or providing and selling its services represent a company's expenses. Companies' expenses are usually grouped into similar categories. Cost of goods sold. Costs of sales represent all of the expenses directly incurred in creating the goods or services that a company sells. Examples include raw materials, items purchased for resale, the cost of running a factory and labor. Selling, General, and Administrative Expenses. Selling, general, and administrative expenses consists of several types of costs. Selling expenses are those expenses incurred in attempting to create sales for the company. Examples include marketing and paying sales staff. General and Administrative expenses, meanwhile, represent most overhead costs of operating a company's business. Cost related to a company's employees and finance departments and cost related to office buildings are examples of general and administrative expenses. Depreciation and Amortization. When a company purchases an asset that the company intends to use over a period of time the entire cost of that asset is not expensed immediately on the income statement. Instead the company expeses the item over a period of years. For example, the company buys a building for $1 million and the building will be useful for 10 years, the entire $1 million will not show up on the income statement. Each year for the next ten years $100,000 will show up on the income statement as depreciation expense. Amortization is similar to depreciation, but it deals with intangible assets such as brand names or copyrights. Oftentimes, depreciation and amortization is already listed in the other expense categories so you won't see them on the income statement by themselves. Other Operating Expenses. Other operating expenses represent all of the companies operating expenses not listed in the above categories. Often nonrecurring costs or accounting gains or recorded here. Pay close attention to these items. Some companies abuse these items to the point where they become annual events. Also, they frequently include items such as restructuring charges, which are cost incurred to close factories or lay off part of the workforce, for example. They may also include asset writeoffs or write downs, which often suggest that management may have paid too much for a particular asset or invested too much in an unprofitable business. Interest Income and Interest Expense. When a company incurrs debt, it is required to pay interest on thay debt. Sometimes a comapany may invest extra money and earn interest on it. On the incomes statement you may see interest income and interest expense listed seperately of lumped together as net interest expense or net interest income. Taxes. Taxes are an expense on the Income Statement. Important Income Statement Calcualtions Gross Profit. You actually won't find this amount on all income statements, but it is very easy for you to calculate yourself. Just take revenue and subtract cost of sales. Gross profit shows how much market up a company receives on the goods and services it sells. If you buy a shirt from Wal-Mart for $12, and it cost Wal-Mart $9, the gross profit margin Wal-Mart realizes is $3, or 25% of the sales price. Operating Income. Arguably the best indicator of a company's true performance, operating income is often called operating profit. It is calculated by subtracting cost of sales and all operating expenses from total revenue. Operating income measures the profit or loss the company has generated through its main operations. Operating income is also called earning before interest and taxes "EBIT" because those expenses are not considered "operating " expenses. Net Income. Net income is what's left over for a company after all expenses have been accounted for. It is sometimes refered to as the compan's bottom line. Many management and Wall Street anaylyst talk about the bottom line, but keep in mind that many types of items, such as one time gains, can distort this figure. It is generally a poor proxy for a company's cash flow. And though net income is important, it should not be thought of as the end-all, be all figure to focus on. Earnings Per Share. Earning Per Share is simply the net income divided by the number of weighted outstanding shares in a given period. Earnings per share is a useful number that should be taken into context with a company's other financial statements. Earnings per share is calculated two different ways. One is basic earnings per share and the other is diluted earnings per share. The basic calcualation takes into account the actual number of shares outstanding in a give period. The diluted earnings per share calcualation takes into account the accual number of shares outstanding plus the number of share that can be converted to outstanding shares; such as stock options and convertible bonds. Diluted earnings per share is a much better measure because the more outstanding shares, the smaller and smaller your staken gets. The Financial Reality We have laid the foundation for how to interpret the numbers on an income statement to assess a company's performance and profitability. With the ability to analyze an income statement, you should get some sense as to how profitable a company actually is, a key consideration in deciding whether or not to become an owner in that company.
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