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Investing Basics
Explanation of the Income Statement
by InvestorGuide Staff (Write for us!)
(Click on a link within the article to get a definition of that word)
You should be careful when looking at the income statement since companies can sometimes engage in gymnastics with their accounting methods. The statements are audited by outside firms, however, so there should be footnotes or other markers whenever anything deviates from standardaccounting practices. The following list will teach you how to read an income statement and use the information from them to make some simple calculations regarding the firm's operations.
Revenues: The revenue section will tell you how much money the company took in for a specified period of time. Sometimes companies will break down revenues according to business sector or geographic region, but usually there will just be one number. Some companies, especially retailers and manufacturers, use
the term sales instead of revenues, but it's the same idea.
Expenses: The expense section will show you how the company spent its money. Companies spend their money on a lot of different activities, so this section is usually broken down into specific sub-sections. You might see expenses such as the following:
Cost of Sales: This number includes expenses directly associated with creating revenue, such as labor and materials.
Extraordinary Expenses: This figure shows any unusual or one-time charges that the firm must pay (e.g. a lawsuitsettlement).
Profit: The profit section of the income report is the part to which investors pay the most attention. It shows whether the company made money or lost money. It usually includes these specific sections:
Net Income: This is the company's bottom-line profit after all expenses and revenues have been accounted for. If this number is positive, then the company turned a profit for the period. If it's negative, then the company suffered a loss.
EarningsPer Share: This number is calculated by taking net income and dividing by the number of shares (both basic and diluted, so there are two earnings per sharefigures).
Margins: You can find out how much a company is really earning from its revenues on the income sheet by calculating its margins, which are earnings expressed as a percentage of sales. Here are a few margins that you might find useful:
Gross Margins will tell you how much a company earns taking into consideration the costs that it incurs for producing its products and/or services. In other words, gross margin is equal to gross income divided by net sales, and is expressed as a percentage. Gross margin is a good
indication of how profitable a company is at the most fundamental level. Companies with highgross margins will have a lot of money left over to spend on other business operations, such as research and development or marketing.
Net Margins are similar to gross margins, except they take into account all of the expenses associated with the business, including marketing expenses, administrative expenses, etc. (so it is equal to net income divided by net sales). Net margins provide an overall picture for the company; this is what shareholders and investors usually watch most carefully. Low (or negative) net margins might indicate that the company is struggling or is in a competitiveindustry in which it doesn't have very much power to dictate its prices.
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