Income Statement: The Basics
What Can an Investor Learn from the Income Statement?
There are 3 major finical statements that every investor will need to master. The income statement shows an investor revenue vs expenses during a period. Another common name for this statement is a Profit and Loss Statement. P&L or Profit and loss isn’t GAAP’s standard name. You will always see it named the Income Statement.
A simple way to think of an income statement. It shows you how much income came in. Then it shows you how much money went out. Lastly, it shows the profit left over for shareholders. The income statement gets complex. We will explain some of the complexities to you on other pages.
The Major Sections of an Income Statement
The revenues section shows you how much income came into a business within a certain timeframe. The Revenues section shows all the income brought in within a timeframe. The income is reported when it is earned under the accrual method. This is required by GAAP accounting principles. This means that all sales within the timeframe of the income statement are on the income statement whether it is for cash or credit.
Cost of Good Sold
This was one item on the income statement that was difficult for me to understand when I was first learning to account. To put COGS into really simple terms, think of a retail store that sells one item. This store records their cost of goods sold after they sell their one inventory item.
Revenues – Cost of Goods Sold = Gross Profit
Gross Profit is the next calculation that you will see on an income statement. This is important to anyone analyzing the finical statements because this determines how profitable the business is from daily operations. This is sometimes called income from operations but is an important section of the income statement when you are doing finical ratios or comparing the income statement to previous quarters.
You might be wondering what expenses are after I talked about the COGS. The way I would define expense is that they are not part of the daily operating expenses. One example would be marketing and administrative expenses. These are important things to keep the company in business; however, they don’t add direct value to the product that is being produced. The marketers aren’t on the assembly line making the product instead they are thinking of ways to sell the product.
Net income or Net loss is the amount of income that a company made over the quarter or year depending on which finical statements you are looking at.
Advanced Income Statement Topics
This occurs when a business stops doing a normal business activity. One example would be Wall Mart when they gave up on expanding to Germany.
This is a rare income statement item. A common example would be a company that takes a loss from a natural disaster. It isn’t possible for a company to predict extraordinary items in most cases. It also isn’t something that is reoccurring.
Effects of Accounting Changes
This is a really advanced accounting subject. A company will decide that their current accounting treatment needs to change. They have to disclose this on the income statement and in the footnotes on their financial statements.
Other income isn’t directly related to company operations. This could be investment income, interest income or a gain on currency exchange. These aren’t common unless we are analyzing the accounting for a hedge fund or investment bank.