More of this Feature • Introduction • Income Statement • Revenue / sales • Cost of Goods Sold • Gross profit • Gross margin • The first three lines • Operating Expenses • R&D Expense • SG&A Expense • Goodwill Charges • Extraordinary Events • Accounting for extraordinary events • Oper. income/margin • Interest income and expense • Interest coverage ratio • Depreciation expense • Accum. Depreciation • Straight-line Method • Accelerated and Sum of the Years' Digits Method • Dbl Declining Balance • Comparing Depr. Mths • EBITDA • Income taxes • Minority Interests - cost, equity, and consolidated methods • Unreported earnings • Continuing operations • Accounting changes • Preferred dividends • Net income applicable to common shares • Net profit margin • Basic vs. Diluted EPS • Hiding share dilution • Share repurchases • Return on Equity- ROE • Asset turnover • Return on Assets- ROA • Projecting earnings • Formulas & Calculations • Putting it together • Segment 2

Related Resources • Investing Lesson 1 • Investing Lesson 2 • Investing Lesson 3 • Investing Lesson 4 - Income Statement • More Lessons

From Other Guides • Dealing with Extraordinary Events in Your Financial Ratios and Income Statement Analysis

Elsewhere on the Web • Income Statement Analysis - Financial Ratios • Income Statement Analysis - Calculations and Financial Ratios

Purpose of the Income Statement

The primary purpose of the income statement is to report a company's earnings to investors over a specific period of time.  Years ago, the income statement was referred to as the Profit and Loss (or P&L) statement, and has since evolved into the most well-known and widely used financial report on Wall Street. Many times, investors make decisions based entirely on the reported earnings from the income statement without consulting the balance sheet or cash flow statements (which, while a mistake, is a testament to how influential it is).

Using Income Statement Analysis to Calculate Expenses, Earnings, Financial Ratios and Profit Margins

To an enterprising investor, income statement analysis reveals much more than a company's earnings. It provides important insights into how effectively management is controlling expenses, the amount of interest income and expense, and the taxes paid.  Investors can use income statement analysis to calculate financial ratios that will reveal the rate of return the business is earning on the shareholders' retained earnings and assets; they can also compare a company's profits to its competitors by examining various profit margins such as the gross profit margin, operating profit margin, and net profit margin.

Beginning our Analysis of the Income Statement

As we progress through this series of investing lessons, you must remember John Burr William’s basic truth that a business is only worth the profit that it will generate for its owners from now until doomsday, discounted back to the present, adjusted for inflation. The income statement is the “report card” of those earnings, which ultimately determine the price you should be willing to pay for a business.

Sit back in your chair, take out a copy of an annual report, flip to the consolidated income statement for the most recent year, and let’s begin working through it. In the end, I think you’ll be surprised by how much you’ve learned.  In Segment 2, we will actually work through Abercrombie and Fitch and Brown Safety's income statements.  As always, there will be quiz following the lesson; you should be able to pass without missing more than two questions.

Next page > A sample income statement> Page 1, 2, 3, 4, 5, 6, 7, more >>

For more information on income statement analysis, read Benjamin Graham's Interpretation of Financial Statements.
There is also some information on financial ratios and income statement analysis in Graham's Intelligent Investor, Fourth Edition.
Lawrence Cunningham includes information on income statement analysis in How to Think Like Benjamin Graham and Invest Like Warren Buffett.