RSS feedThe second of the three sheets that we’ll look at is the Income Statement. The income statement is the financial statement used by companies to report their earnings, or income, hence the name. For reference, please click here (link will open in a new window) to see an example of an annual income statement available at Yahoo!Finance. As with all the financial statements available on Yahoo!Finance, you have the option of getting the income statement in quarterly or annual form. These financial statements are made available through EDGAROnline and are also available for free from all publicly listed companies if you inquire about an annual report.
The Income Statement is simple enough. Basically, it shows revenues, expenses, and a calculation of income (or loss). It’s simple enough. The revenue minus the expenses should give us our income (also known as profit or earnings). As with all things accounting and financial, these basic categories are broken down into all sorts of subcategories in hopes of either confusing the reader as much as possible or allowing more transparency into the company’s financial workings depending on how savvy the reader is and how devious the company’s accountants are. So, let’s break down the income statement. I hope you have the above link to an income statement open. We’ll be starting from the top and working our way down.
Total Revenues (also known as Total Sales) - always the first line on an income statement. This shows how much money the business brought in over the given time period. Sometimes revenues will be further broken up into specific categories to help show where revenues are coming from. For someone truly interested in learning about an investment like a value investor or someone hoping to acquire the company in full, it is important to keep in mind where a business’s revenues come from and which avenues are driving growth.
Cost of Revenues (also known as cost of sales or cost of goods sold) - This is the amount of money the business spend on the goods it sold to bring in revenues.
Gross Revenue - The amount of money the company made assuming it had no expenses outside of making a product and selling it.
Operating Expenses - The section of the income statement which reports the expenses that arise from running the business. The two biggies tend to be Research and Development and Selling, General and Administrative expenses. These two are the biggies to keep an eye on. R&D expenses tend to range depending on industry and market leadership. For example, tech companies will likely spend more on R&D expenses than trucking companies. A market leader will tend to have more to gain from high R&D expenses as opposed to a smaller competitor - Intel tends to spend a disproportionately large amount of its earnings on R&D as compared to its competitor AMD which tends to follow Intel’s innovations and then attempt to compete on a cost basis. Selling, General and Administrative expenses also tend to be a percentage of earnings. Obviously, you want to spend as little on these expenses to gain as much as possible in sales. Non-recurring Expenses are one time expenses and all other expenses not covered in these categories are reported as Other.
Operating Income or Loss - This is simply Gross Profit minus the Operating Expense. This gives you how much money the company gets simply by operating its core business.
Total Other Income/Expense Net - This is money that the company gets from things separate to it its operations. This could include interest income which is money the business generates from cash on hand or income from other kinds of investments.
Earnings Before Interest and Taxes - The sum of operating income and total other income. This is how much the company earns before it has to pay interest on its debt and pay taxes.
Interest Expense - The money the company must pay on its debt obligations.
Income Tax Expense - One of the only sure things in life.
Sometimes you will also see Depreciation and Amortization, this is where EBITDA comes from (Earnings before Interest, Taxes, Depreciation and Amortization). We have here shown the interest and taxes that come off of the EBIT. Depreciation and Amortization are ways a company can account for the wear and tear on purchased goods or to smooth out the consumption of goods. The first case is simply a write down for the depreciation in value of fixed assets or accumulated depreciation. The second case is known as depreciation expense which is a way of reporting expenses for a good purchased today but with a projected life span of 5 years. Simply put, you would just report 1/5 of the expense each year for those five years to get a more accurate picture of the purchase’s effect on earnings.
Minority Interest - Any time a company owns less than 50% of another company or subsidiary, it may just report its share of the earnings here. On the balance sheet, it would report its minority investment in a company or subsidiary. If the company owned more than 50% of another company, it would include all revenues, expenses, etc. from that company and use Minority Interest to deduct the amount of earnings that it does not receive as a result of other minority interest.
Discontinued Operations - Describes earnings generated from parts of the operation that will not be part of the company for much longer. For example, if a company wants to spin off a division, it might begin reporting this division’s earnings as a discontinued operation in order to warn investors that they should not continue to count on these earnings from the company.
Net Income from Continuing Operations - Earnings or losses the company generated from business it plans to continue to operate.
Extraordinary Items - Capital value of some sort of happening which caused a material change in the company’s earnings and is explained in greater detail in the annual report.
Net Income - Adding and subtracting in the appropriate sections as one goes down the income statement results in the total amount of money the business made or lost from all of its operations (continuing and non-recurring) over that time period.
Preferred Stock and Other Adjustments - Money that must be paid from net income to preferred stock holders. Preferred stock is a kind of stock which is sort of between a bond and a common stock. The preferred stock holders get first dibs at the company’s assets should there be a liquidation and also get a predetermined, usually rather high, dividend. Preferred stock holders, though, typically do not have voting rights and lose out on some of the capital appreciation properties of common stock.
Net Income Applicable to Common Shares - After the Preferred Shareholders take their chunk of net income, the rest is for the common shareholders. This is so-called bottom line and represents the money the company (and in turn its owners) made after taking in revenue and paying out all the expenses and obligations it had over a time period. This divided by total shares outstanding will give Earnings Per Share which is what we all so eagerly await each quarter.
As you can tell, the income statement is a pretty important financial statement. This post is meant as a primer for how to read the income statement. After we introduce all three sheets, we’ll go more in depth into the kinds of analysis you can do with the three sheets and one thing you will notice is that, more often than not, the income statement will be the sheet used to judge both the management efficiency and the financial health of a company. It does not, however, mean that you can ignore the two other sheets.
