The Income Statement

The income statement tells you whether the company is making a profit...

You might want to invest in a company for many reasons. Perhaps it's a leader in the industry. or its CEO has a great record of turning companies around. Or its products are on the cutting edge of technology. but if the company is not turning a profit (otherwise known as net income or earnings), or it doesn't show strong potential to become profitable over the medium term, you probably wouldn't want to invest in it.

The income statement tells you whether the company is making a profit--that is, whether it has positive net income. (This is why the income statement is also called a profit and loss statement.) It shows a company's profitability for a specific period of time-typically, monthly, quarterly, and annually.

How does an income statement present this profitability picture? It starts with a company's revenue: how much money has come in the door from its operations. various costs--from the costs of making and storing goods, to depreciation of plant and equipment, to interest and taxes--are then subtracted from the revenue. The bottom line--what's left over--is the net income or profit.

When looking at an income statement consider the following key terms:

• The cost of goods sold is what it cost for the materials that are being produced or sold. It included the acquisition cost for the raw materials, transportation and any direct labor costs.
• Gross profit is obtained by subtracting the cost of goods sold from the revenue--it is the profitability of the company's products or services.
• Operating expenses include administrative employee salaries, rents, sales and marketing costs, as well as other costs of business not directly attributed to manufacturing or obtaining a product.
• Depreciation is a way of estimating the "consumption" of an asset over time. A computer, for example, might have a useful life of three years. Thus, according to the matching principle, the company would not expense the full value of the computer all in the first year of its purchase, but as it is actually used over a span of three years.

By subtracting operating expanses and depreciation from gross profit you get operating income--often called earnings before interest and taxes, or EBIT.

• Interest expense refers to the interest charged on loans a company takes out.
• Income tax is levied by the government on corporate income.

ACTION POINT: Understand the items that are reported on the income statement to evaluate profitability for your operation.