Overview
The income statement summarizes
an answer to the question “how is the business performing?” It is called different names ranging from “Consolidated
Statement of Income” to “Consolidated Statement of Operations.” Irrespective of the terminology it always
starts with the top line “Revenue” and works down to the bottom line “Net
Income.” A detailed tour of the income
statement is in Chapter 2 of the online text.
The most important
information in the income statement relate to the revenues recognized under US
GAAP and the costs associated with obtaining those revenues. It also consists of gains and losses arising
from other parts of the business that support but need not be essential to the
primary operations of the business. Net
Income is then calculated as revenues and gains less expenses and losses.
The sub-components can
vary from statement to statement but they usually contain Revenues less Cost of
Revenues which is referred to as Gross Margin, less other costs associated with
operations which is referred to as “Income from Operations” (or equivalent
terminology). Then US GAAP distinguishes
between “Continuing Operations” and “Discontinued Operations” and so reports
gains and losses from the latter.
Finally taxes are accounted for to get to Net Income or the bottom
line.
You may ask what
happened to expenses associated with financing?
These are often included
in operations and so a good analyst usually recasts an income statement to
separately highlight non US GAAP numbers such as “EBIT” or Earnings Before
Interest and Taxes, and then step down to “EBT” or Earnings Before Taxes before
getting to the bottom line. Sometimes
they further add back non-cash expenses such as Depreciation and Amortizations
to arrive at “EBITDA” or Earnings Before Interest, Taxes, Depreciation and
Amortizations.
Evaluating the strength
of a company with income statement information
You can see how strong a
company is performing from the income statement in two ways: by looking at
changes in the income statement over time, and by comparing the company to
others (e.g. to its competitors). Let’s look at an actual company, 1 800
FLOWERS.COM:
The above has plotted some key fields down to Operating Income. The company has reported data for two sets of
time period: (3-Months End current
quarter versus immediate prior quarter, and 6-months ending current quarter
versus the corresponding 6-months for 1-year ago). This immediately provides an analyst with a
rich source of information about current performance because sending flowers
has a strong seasonality component attached to it.
The immediate and one year apart comparisons provide insights into
how the business is performing controlling for seasonality effects. Two positives are that Net Revenue and
Operating Income are increasing from previous quarter and from current 6-months
compared to the same period one year ago.
However, operating income has benefited significantly from one
number that has been added to both sets of figures in the current quarter. This is “Gain on Sale of Stores” equal to
$3.8 million which if adjusted out of operations because it is not a
re-occurring source of revenue, flattens significantly both sets of Operating
Income comparisons. This causes a
careful analyst to look closer at the cost side of the Income Statement as
depicted above and below:
The pie chart (enlarged on a computer screen) makes it easy to spot
the change in the composition. Three
broad types of costs are worth looking at.
Those that are related to accrual accounting and depend upon management
assumptions such as Depreciation and Amortization, those that relate to the
sales cycle such as cost of sales and similar expenses and those that are at
management’s discretion such as sales and marketing and research and
development. The pie charts and bar
charts let you check at a glance these sub categories. So for example, depreciation and amortization
have declined, which in turn boost net income; Marketing and Sales have
increased which suggests there is increased managerial emphasis upon boosting sales
revenue and cost of revenues have been creeping up which serve to reduce
operating income.
Relative changes such as this let you evaluate the strength of the
company’s performance plus provide immediate insights into current management
actions. This company has sold off some
stores that generated realized gains, plus they have increased their marketing
efforts in an attempt to boost sales.
Sales revenue has increased but in addition costs have increased at the
operations level such that if the store gains are adjusted out of operating
income business performance has been flat.
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