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Saturday, June 20, 2009

The Income Statement

From the Hoss's mouth
The Income Statement was formally known as the Profit and Loss Statement. Why? Because it shows all of a company's revenues and expenses for a certain period of time, and details any profit or loss.

The prudent investor will review this document in combination with the company's Balance Sheet and Cash Flow Statement when making a decision whether or not to invest in a company.

The following income statement is from Amazon and shows the years 2006, 2007 and 2008.

There are many formulas, ratios and calculations a prudent investor can apply from the information contained in a company's Income Statement. These formulas help the investor determine if a company would be a good investment.

Gross Margin, Net Profit Margin and Return on Equity are just a few. But before explaining these calculations (which The Hoss will do in a later post) one must first understand the details of the Income Statement itself.

The first line of any Income Statement shows the Total Revenue from all sales for the reporting period. (aka the Top Line).

Next we have the Cost of Revenue, which shows the total the company paid to obtain or manufacture the products it sold (aka Cost of Goods Sold or COGS).

The Gross Profit (income) follows and is calculated by subtracting the COGS from the Total Revenue. The greater the Gross Profit, the more likely a company is to have a positive bottom line. This is very clear in our Amazon example, as each year shows a significant increase in the Gross Profit and the Net Income.

Operating Expense is next and it shows...yes, you guessed it, the company's operating expenses. Investors calculate the percentage of expenses to sales to evaluate management efficiency in controlling expenses.

Now we have the Operating Income, which is a measurement of a company's earnings from its own operations. It does not include income from non-operating sources such as interest income.

Gross Profit minus Operating Expenses= Operating Income

The next line on the Income Statement is Income from Continuing Operations. This details the income (if any) that a company generates from non-operating sources such as interest from bank deposits. It is often expressed as a net (income-expenses) as is done in our Amazon example.

Now we find the line Earnings Before Income and Tax (EBIT), which simply is the total of Operating Income plus income from other sources. From this we deduct the next line entry which is Interest Expense (interest payments paid on company debt).

This gives us the next entry, which is Income Before Tax. In our Amazon Income Statement example the figure is $901,000,000. This is the profit Amazon made before paying any taxes.

Income Tax Expense is the line entry that shows the total income taxes the company paid to all government agencies. The income tax expense figure is deducted from the line income before tax to give the company's Net Income from Continuous Operations. Please Note: this is Net Income not Net Profit.

The Net Profit is the money left after any Specialty Items or Extraordinary Expenses are deducted from Net Income from Continuous Operations. What are specialty items or extraordinary expenses? They are called write offs and are supposed to be on- time occasions. Our Amazon example Income Statement provides lines for these expenses, but no actual charges were made in the three years reported.

The Net Income is (aka net profit or net earnings or bottom line) is the total funds available to preferred and/or common stock shareholders.

That pretty much sums up the information in the Income Statement.

The Hoss hopes you have found this explanation of a company's Income Statement beneficial for your investment activities.

In his next post, the Host will give a quick Income Statement summary and will provide information regarding formulas, calculations and ratios investors use for Income Statement analysis.

Stay on track,

The Hoss

Next Hoss Cents Free Financial Money Magazine Post: Gross Profit Margin
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