The majority of people want to be investors. However, most investors have no idea how to read an income statement. Here’s how it’s done:
An income statement’s purpose is to show how a company performs over time based on its revenue and expenses. The profit and loss statement is another name for it. Companies publish their income statements in their 10-Q (Quarterly Report) and 10-K (Annual Report) (Annual Report). Every company in the stock market’s primary goal is to maximize shareholder value by making as much profit as possible. As a result, the income statement is critical to read and analyze in order to understand a company’s profits.
In its most basic form, the income statement formula is as follows:
Gross profit = revenue minus cost of goods sold (COGS).
Operating income is calculated as the sum of gross profit and operating expenses.
Revenue minus total expenses equals net income (including COGS)
Let us dissect each;
Revenue
The top-line figure that shows a company’s income from any products or services sold. This revenue is net, which means it includes any returns or discounts that may occur.
Cost of Goods Sold (COGS)
Direct costs associated with the manufacture of goods sold by a company. If you sell phones, these are the costs of: chips, labor, technology, and so on.
Gross Profit
This is your “Net Income.” Revenue minus Cost of Goods Sold You sold $10 worth of phones and spent $5 to make them, so your gross profit is $5.
Operating Expense (OPEX)
The costs associated with a company’s normal day-to-day operations. Rent, utilities, salary, marketing, research and development, and so on. Some businesses will group this together, but I prefer specifics.
Operating Income
Operating expenses minus gross profit After deducting COGS and operating expenses, a stock’s operating income is what it profits. It is useful to investors because it does not take into account taxes, interest, or any other one-time items that may skew net income.
Income Before Taxes
Non-operating expenses minus operating income This is a company’s profit after all deductions other than taxes have been made from revenues. Non-operating expenses include interest expense, asset losses, and intangible asset write-offs.
Income Tax Expense
Simply put, the federal, state, and local governments’ taxes.
Net income
This is the financial statement’s bottom line. A positive net income indicates that a company is profitable, whereas a negative number indicates that the company is not profitable. Net income will also be reported on the balance sheet and cash flow statement.
Earnings Per Share
EPS is a measure of profitability that shows how much a company earns for each share of its stock. A higher EPS indicates that a company’s profits are higher relative to its share price, implying greater value. Earnings per share (EPS) equals net income divided by the number of outstanding shares. If a company earns $10 million and has 1 million outstanding shares, each share is worth $10.
When comparing similar time periods, income statements should be used. This will allow an investor to determine whether the company is expanding or contracting. Examine Apple’s annual earnings over the last five years, for example.
