Change text size

• Email This Article
• Print This Article
• Digg This
• Delicious
• Subscribe

The income statement, also called the profit-and-loss statement, is a more detailed presentation of earnings, which is crucial when trying to uncover potential bargain stocks. To describe where a company’s resources are coming from and where they go over time, you need an income statement.

Where the balance sheet is really a conclusion, the income statement shows the results of operations for a period of time, known as an accounting period. If you think of the balance sheet as a photograph, then an income statement is more like a videotape: a record of company activities from the moment you switch on the video camera until the moment you shut it off again. Not surprisingly, the income statement and balance sheet are complementary.

The income statement begins with sales revenue and subtracts what it costs to make the goods sold to derive gross profit. Next, the costs of selling the goods and the company’s administrative expenses are subtracted, leaving the operating profit. Other income earned is then added to the operating profit and the total is reduced by expenses for interest and taxes, leaving net income the bottom line reached when all costs have come out of all revenues.

Typically, the income statement goes on to show you net income on a per share basis and the earnings per share, which is calculated by subtracting, preferred dividends from net income and dividing the result by the number of shares outstanding. The preferred dividends are taken out so that the earnings per share apply to common shares only. This is the critical figure for value investors because it gives a per-share indication of a company’s profits. The part of profit that isn’t paid out as dividends becomes retained earnings on the balance sheet, since it belongs to the shareholders.

Assets are used by management to produce income. Income is reduced by expenses to yield profit. And profit becomes equity because the shareholders own the assets. So the income statement tells you how efficient management is because it indicates how much profit management is generating out of existing assets. Net worth on the balance sheet is created by net income after dividends.

Companies utilize their income statement to keep track of their operations. Their many uses include determining whether a company is profitable, and if so, by how much. Knowing how profitable their operations are in turn helps companies determine their tax liability. They can also monitor the rate at which sales are increasing or decreasing, enabling management to spot difficulties with a product or its market. For example, slowing sales might mean a product is becoming obsolete or suffering from stiff competition. Likewise, the income statement can help them spot and correct weaknesses in their financial profile.

It is important to remember that revenue and expenses on the income statement can change whether cash was received or paid. If the company does not pay, for example, its phone bill as soon as it arrives, that amount is still an expense as long as its owed. This means that the company will often have to account for unrecorded items when they prepare their income statement. Accounting for such payables and receivables is essential to get an accurate reading on their financial position for a given period. Investors should certainly learn to effectively read an income statement because it will be a key component of any fundamental analysis they might do.

Jeff Neal 
Senior Writer, Options Strategist & Profit Strategies Radio Show Market Correspondent
Visit Jeff’s Forum
Listen to Jeff at www.ProfitStrategiesRadio.com

• Email This Article
• Print This Article
• Digg This
• Delicious
• Subscribe

Recent Articles by Jeff Neal, Optionetics.com

• June 12, 2009
  Interview Central: Mark Seleznov, Part III
• June 5, 2009
  Interview Central: Mark Seleznov, Part II
• May 29, 2009
  Interview Central: Mark Seleznov, Part I
• May 21, 2009
  Interview Central: Peter Reznicek, Part III
• May 15, 2009
  Interview Central: Peter Reznicek, Part II