Understanding Financial Statements: Income Statement

income statement
Publicly traded companies are required by law to produce financial statements. Financial statements are used by shareholders, potential shareholders, creditors, suppliers, etc. to evaluate the financial condition of the organization. The problem with the financials is that most people do not understand what they are looking for on these documents. There are four basic financial statements:

  • Income Statement
  • Balance Sheet
  • Statement of Cash Flows
  • Statement of Shareholder’s Equity

Over the next few days I’ll discuss each of these statements. First, let’s take a look at the Income Statement. The purpose of the Income Statement is to review the financial performance of the organization within a period of time usually quarterly or annually. It is worth noting that quarterly (interim) financial statements are not as detailed as annual reports and are not required to be audited so the information contained is wholly produced by the organization in question. To better understand the income statement let’s view Barnes and Noble’s income statement for last year.

Income Statement

  • Total Revenue – simply, total sales; if this were a business which performs services revenue would translate to fees.
  • Cost of Revenue – (also referred to as Cost of Goods Sold) this is the amount associated with the inventory which was sold during the period, basically how much we paid for the books we sold
  • Gross Profit (Loss) – refers to the amount of revenue in excess of the cost of goods sold. Basically if Barnes and Noble bought $100,000 in inventory (books) and sold them for $130,000, gross profit is $30,000
  • Operating Expenses – cost of doing business (salaries, utilities, rent, etc.) You’ll notice Barnes and Noble has this broken out into continued operations and non-recurring events. This is to allow the user to make an educated projection as to future income by separating items that are isolated to the current period. Example, if the company had a major fire in one of their facilities the cost of rebuilding would be included as an expense but by showing that item separately the end user understands that in a normal operating period the company would not incur that cost.
  • Net Income (Loss) – Gross Profit less operating expenses; using our earlier example if Barnes and Noble had $16,000 in operating expenses net profit would be $14,000 (gross profit of $30,000-$16,000 of operating expenses)
  • Earnings (loss)per share – income per outstanding share of stock: if Barnes and Noble had 1,000,000 shares of stock in our continuing example, earnings per share would be $0.01 per share ($14,000/1,000,000).

Note, financial statements are presented with the prior two years information in order for the user to notate growth or any other trends which may be present. Additionally, I added earnings per share because it is common to most income statements although it did not appear on the example provided. This is a very basic example which outlines the general methodology of understanding an income statement. To fully understand the origins of the data presented within an income statement one must look in depth at accrual accounting which is too broad a topic for this forum. The income statement is really not complicated in its broadest sense; it is basically sales or fees minus expenses. Pretty simple right? Translated to personal finance its income minus bills equals disposable income.

Please send any questions or comments to Jeremy R Woods.

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