Purpose of the Income StatementThe 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 MarginsTo a serious 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 (in other words, how well they are investing the money under their control). 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 StatementAs 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 or 10K, 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. Towards the end of this lesson, we will actually work through Abercrombie & 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.
This page is part of Investing Lesson 4 - How to Read an Income Statement. To go back to the beginning, see the Table of Contents.