What is it and why do I care?
The income statement tells you how much money a company has brought in (its revenues), how much it has spent (its expenses), and the difference between the two (its profit). The income statement shows a company's revenues and expenses over a specific time frame such as three months or a year. This statement contains the information you'll most often see mentioned in the press or in financial reports--figures such as total revenue, net income, or earnings per share.
The income statement answers the question, "How well is the company's business performing?" Or in simpler terms, "Is it making money?" A firm must be able to bring in more money than it spends or it won't be in business for very long. Firms with low expenses relative to revenues--and thus, high profits relative to revenues--are particularly desirable for investment because a bigger piece of each dollar the company brings in directly benefits you as a shareholder.
Revenues, Expenses, and Profit
Each of the three main elements of the income statement is described below.
Revenues. The revenue section is typically the simplest part of the income statement. Often, there is just a single number that represents all the money a company brought in during a specific time period, although big companies sometimes break down revenues in ways that provide more information (e.g., segregated by geographic location or business segment). Revenues are also commonly known as sales.
Expenses. Although there are many types of expenses, the two most common are the cost of sales and SG&A (selling, general, and administrative) expenses. Cost of sales, which is also called cost of goods sold, is the expense most directly involved in creating revenue. For example, Gap GPS may pay $10 to make a shirt, which it sells for $15. When it is sold, the cost of sales for that shirt would be $10--what it cost Gap to produce the shirt for sale. Selling, general, and administrative expenses are also commonly known as operating expenses. This category includes most other costs in running a business, including marketing, management salaries, and technology expenses.
Profits. In its simplest form, profit is equal to total revenues minus total expenses. However, there are several commonly used profit subcategories investors should be aware of. Gross profit is calculated as revenues minus cost of sales. It basically shows how much money is left over to pay for operating expenses (and hopefully provide profit to stockholders) after a sale is made. Using our example of the Gap shirt before, the gross profit from the sale of the shirt would have been $5 ($15 sales price - $10 cost of sales = $5 gross profit). Operating profit is equal to revenues minus the cost of sales and SG&A. This number represents the profit a company made from its actual operations, and excludes certain expenses and revenues that may not be related to its central operations. Net income generally represents the company's profit after all expenses, including financial expenses, have been paid. This number is often called the "bottom line" and is generally the figure people refer to when they use the word "profit" or "earnings."
The Balance Sheet >>