Income statement – A keystone in the stock analysis (Fundamentals)

The income statement is one of the Reports Troika that indicates the financial status of a company and is a key document in the process of Fundamental Analysis. The other two being the Balance Sheet and the Cash flow statement.

Today our discussion revolves around the Income statement, synonymous with the Profit & Loss (P&L) statement.

What is an Income Statement?

The P&L statement is usually published quarterly & annually to show if the organization has made profit or loss during the period. Further,

It is crucial to publish, as it promotes transparency, builds confidence among the stakeholders like business owners, organizational management, shareholders as well as consumers.

To put it simply when the income exceeds expenses we call the difference profit and when the expenses exceed income we call it a loss.

Below is a generic statement for Indian Railways for the duration 2016-20.

But what are the different factors that come under income and expenses need to be examined in order to understand the P&L statement holistically. The above-shown statement does not delve much into the breakup of income or expenses.

Analysis of an Income Statement

It is important to analyze the Income Statement in detail when one is reading the document, as it has the details of,

what went within the organization during the specified period when it comes to sales/services?

whether revenues have increased or decreased?

whether any corrections or adjustments needed with respect to the dynamic macroeconomic scenario?

The typical expenses that organizations incur are Salaries Benefits and wages, Administrative costs, advertising & promotion, Selling Expenses, Office supplies, Rent, Travel & Utilities, Interest on borrowings, and any other miscellaneous expenditure.

And the typical income would be from the sale of products and services. Usually, a component of other income is included that covers income from the sale of any depreciated or unused assets, etc.

So, in another perspective, what comes into the pocket of an organization that is termed as revenues and what goes out can be termed as expenses. Now let us examine a bit detailed quarterly statement of Microsoft company.

Shown in the report above, are some of the important parameters, and let us try to understand each component by correlating what we have discussed so far.

Components of an Income Statement

Total Revenue: It is the total amount received for that particular year by the company. Usually from the sale of products/services.

Cost of Revenue:  It is the total costs that the company incurred in the process of manufacturing and delivering a product or service to the customers.

Gross Profit is calculated as the total revenue less the cost of revenue.

Expenses

Operating Expenses: It indicates the amount that was spent to run the processes while manufacturing and delivering product/services. Typically it includes R&D, Administrative expenses, Salaries, Rent, Utilities, etc

Other important factors that fall under expenses are,

Amortization & Depreciation: Amortization is an accounting technique that periodically lowers the value of an intangible asset over that asset’s useful life. Depreciation is similar to Amortization but the difference is that it is used for tangible assets. These parameters come under expenses to the organization.

Interest Expenses: It is the cost incurred by the organization for borrowed funds. It falls under the Expenses category of the Income statement.

Operating Income: It is calculated as the Gross profit less Operating expenses. It can be treated as Income before tax.

Interest Income: It is the income earned by the organization such as a savings account or certificate of deposit.

Net Income: It is the final income after taxation by the government.

There could be a large number of activities that can be added income or expenses that can be made by an organization in the process of making business. But the above mentioned are some of the commonly encountered ones.

Conclusion

The motive here is to understand the basic fundamentals behind the Income statement on how initial capital is invested to make the sale of services and products that in turn results in income with some depreciation of few assets, consumes some capital as expenses, and finally generates a taxable income.

At the end of the day, it is important for any business to generate higher Net income by efficiently utilizing available resources in turn generating profits for all the stakeholders.

Keep Learning…Happy Investing…!!!