Financial statements course · Lesson 2 of 10
The income statement shows how revenue becomes profit.
The income statement covers a period, usually one year or one quarter. It starts with revenue, subtracts each cost, and ends with net income.
The statement
| Line | $ millions | Share of revenue |
|---|---|---|
| Revenue | 1,000.0 | 100.0% |
| Cost of goods sold | (550.0) | 55.0% |
| Gross profit | 450.0 | 45.0% |
| Selling, general and administrative, with stock pay | (230.0) | 23.0% |
| Depreciation and amortization | (40.0) | 4.0% |
| Operating income | 180.0 | 18.0% |
| Interest expense | (12.0) | 1.2% |
| Interest income | 6.0 | 0.6% |
| Pretax income | 174.0 | 17.4% |
| Tax at 21% | (36.5) | 3.7% |
| Net income | 137.5 | 13.7% |
Read the statement from the top. Each subtotal answers one question.
- Gross profit is what is left after the direct cost of the goods. It shows the price that the company gets against the cost to make the product.
- Operating income is what is left after overhead and depreciation. It shows how well the whole business runs, before debt and tax.
- Net income is what is left for the shareholders after interest and tax.
Read the margins, not only the totals
Example Co. has a gross margin of 45.0%, an operating margin of 18.0% and a net margin of 13.7%. Revenue grew 8.0%, from $925.9 million to $1,000 million.
A total can grow while the business gets worse. Revenue can grow by 8% with a lower margin, and profit then grows more slowly. Compare each margin with the same margin a year earlier. Most 10-Ks show three years of income statements, so you can make this check.
Earnings per share
Companies report two figures for earnings per share, or EPS. Basic EPS divides net income by the average number of shares in the year. Diluted EPS adds the shares that stock units and options can create.
| EPS | Net income, $ millions | Shares, millions | EPS |
|---|---|---|---|
| Basic | 137.5 | 100.25 | $1.37 |
| Diluted | 137.5 | 101.25 | $1.36 |
Example Co. started the year with 100.5 million shares and ended with 100.0 million. The model assumes that the changes came evenly, so the average is 100.25 million. The model also assumes 1.0 million stock units that will vest.
Use diluted EPS. It shows the share of profit that each owner gets after the new shares arrive. The full rule for options, the treasury stock method, can make the added share count a little smaller.
Key points
- The income statement covers a period and ends with net income.
- Compare each margin with the year before, not only the totals.
- Use diluted EPS.
Sources
- IFRS Foundation, IAS 33 Earnings per Share, for the weighted average share count and dilution.