What is Income Statement?
The income statement is one of the financial reports of the company providing a summary of all the revenues and the expenses over the time period in order to ascertain the profit or loss of the company and measuring its business activity over the time period depending upon requirements of users .
We note that Box, Inc has been making losses for the past three years. What does this tell us about the company, it’s business model, its revenue generation capacity, its control on costs?
The basic purpose of looking at the income statement of the company is to ensure that you get the whole picture of a company’s income and expenses during the year.
Here is a snapshot of what an income statement format is all about –
- First, an income statement is a statement that shows you how much revenue a company has earned over the years. Revenue means the total sales over the period (Total Sales = Units * Price per Unit). Colgate’s Revenue in 2015 was $16,034 million
- An income statement format also shows you the “costs and expenses” incurred during the year. These costs can directly or indirectly affect the revenue of the company. Colgate’s Cost of Sales was $6,635 million in 2015.
- That means, comparing the revenue and costs, an income statement provides you a comparative analysis of what mattered for a company during the year. How much profit (net profit) they have earned (if any) or how much loss (net loss) they have incurred. Net Income of Colgate in 2015 was $1,384 million.
- An income statement structure also portrays the EPS of a company during the same period. The calculation is based on an assumption that if the net earnings are all distributed among shareholders, how much each share would get priced! Usually, the firm never distributes all its earnings. Major portions are reinvested into the company which is called “plowing back of profits). Colgate’s Basic Earnings Per Share is $1.53 per share.
- According to the Securities and Exchange Commission, “think of …. (income statements) as a set of stairs.” The idea is to look at the revenue and cost one by one. First, we will look at the revenue, then the cost which is, directly and indirectly, affecting the sales (cost of sales). And then we will take the stairs and take interest and taxes into account which will ultimately provide us with the net profits or net loss
- Finally, remember that the ultimate “net profit” or “net loss” is called “the bottom line”. It is how much a company earned and lost during the accounting period. And as an investor, you should also start from the top (revenue) and come toward the bottom (the net profit or net loss).
Structure of Income Statement
As a financial analyst, we should look at the Income Statement structure very carefully. The primary objective of analyzing the Income Statement is to understand how the business is generating recurring revenues in contrast to its expense and whether the business is profitable or not.
Below is the Income Statement structure. We study each line item one by one.
Sales / Revenues
At the top of the income statement structure, an accountant has to write the “total money brought into” the company by sales. It includes the total sales revenue. The total sales can be generated via the selling of products or services. It is called “gross revenue”. “Gross” means “not refined”. In this case, “gross” means expenses are yet to get deducted from “revenue”.
The next line would be “the unexpected item” which the company never expected while making the sales. It can be “sales return” or any “sales discount”.
In the next line, “sales returns” or “sales discount” would be deducted which will provide us with “net revenue”. That means this is the actual revenue the company has earned after taking “sales return” or “sales discount” into account.
Please note the following
- Follows the revenue recognition principle: Revenue is recognized even though cash may not be collected until the following accounting period.
- Net sales = gross sales – sales returns and allowances – discounts.
- The number of sales and trends in net sales over time is used to analyze a company’s progress.
Let’s take an Income Statement example of Alphabet (Google) to see how revenue is recognized. Google has primarily three sources of revenues
- Google Properties – Google properties revenues consist primarily of advertising revenue that is generated on Google search properties. This includes revenue from traffic generated by search distribution partners who use Google.com as their default search in browsers, toolbars, Gmail, Maps, and Google Play, YouTube, etc
- Google Network Members’ properties – Google Network Members’ properties revenues consist primarily of advertising revenues generated from ads placed on Google Network Member properties through AdSense, AdMob, and DoubleClick AdExchange
- Google Other Revenues – Google’s other revenues consist primarily of revenues and sales from Apps, in-app purchases, and digital content in the Google Play Store, Hardware, Licensing-related revenue; and Service fees received for our Google Cloud offerings.
Also, note that the United States contributes the most to the revenues.
source: Alphabet (Google) SEC Filings
Cost of Goods Sold
The cost of goods sold is the amount paid for merchandise sold, or the cost to manufacture products that were sold, during the accounting period.
In the case Income Statement example of Google, the Cost of revenues consists of traffic acquisition costs (TAC) which are paid to Google Network Members primarily for ads displayed on their properties and amounts paid to our distribution partners who make available search access points and services.
source: Alphabet (Google) SEC Filings
Gross Profit
Gross Profit is the difference between revenue and the cost of making a product or providing a service, before deducting overhead, payroll, taxation, and interest payments.
Gross profit = Net sales – Cost of goods sold.
Management is interested in both the:
- The amount of gross margin; and
- The percentage of gross margin (gross margin/net sales).
Both are useful in planning business operations.
Gross Profit figure is not provided by Google. However, it is very easy to find.
Gross Profit = Revenues – Cost of Revenues
source: Alphabet (Google) SEC Filings
- Gross Proift (2016) = 90,272 – 35,138 = 55,134 million
- Gross Profit (2015) = 74,989 – 28,164 = 46,825 million
Selling General and Admin Expenses
SG&A are the expenses other than cost of goods sold that are incurred in running a business.
- These expenses are grouped into categories: Selling expenses, General and administrative expenses, Other revenues and expenses.
- Careful planning and control of operating expenses can improve a company’s profitability.
In Income Statement example of Google, SG&A expenses are divided into two parts a) Sales and Marketing b) General and Administrative
source: Alphabet (Google) SEC Filings
- SG&A Expense (2016) = 10485 + 6985 = 17,470 million
- SG&A Expense (2015) = 9047 + 6136 = 15,183 million
Operating Income or EBIT
Operating Income or “earnings before interest and tax” (EBIT) is the difference between gross margin and operating expenses. It represents the income from a company’s normal, or main, business. It is used to compare the profitability of companies or divisions within a company.
- EBIT is important for the analyst as this is considered to be one of the indicators of future earnings
- An analyst should remove nonrecurring items to normalize the EBIT
Cleaning of the Numbers – Removing non-recurring numbers
Please note that this Income Statement example of Google includes Research and development cost as an Operating Expense.
source: Alphabet (Google) SEC Filings
- EBIT or Earnings Before Interest and Taxes of Google was $23,716 million in 2016 and $19,360 million in 2015.
EBITDA or Earnings Before Interest Taxes Depreciation and Amortization
- EBITDA (Earnings before interest, taxes, depreciation, and amortization) is Independent of depreciation policy.
- EBITDA Formula = EBIT + Depreciation & Amortization
- EBITDA is an analyst specific measure and many companies do not provide this measure. EBITDA is especially useful to measure for comparing capital intensive companies.
Google’s Income Statement structure does not provide Depreciation and Amortization as a separate line item. In order to find EBITDA, we need to find Depreciation & Amortization figures.
Cash Flows provide us with this details as seen below.
source: Alphabet (Google) SEC Filings
- EBITDA (2016) = EBIT (2016) + Depreciation (2016) + Amortization (2016)
- EBITDA (2016) = $23,716 + 5,267 = 28,983 million
- EBITDA (2015) = EBIT (2015) + Depreciation (2015) + Amortization (2015)
- EBITDA (2015) = $19,360 + 877 = 20,237 million
Also, see the difference between EBIT vs EBITDA
Interest Income & Interest Expense
- Most companies keep their excess cash in short-term bank deposits, money market funds or savings account. These interest income for the company.
- Interest expense, on the other hand, is the interest paid on money borrowed from banks/bondholders or private Capex or fund day to day operations.
Below is the snapshot of the Income Statement example – Googles Interest Income and Interest Expense.
source: Alphabet (Google) SEC Filings
- Google Interest Income was 1,220 million in 2016, whereas its Interest Expense was 124 million.
Income Before Tax
- Income before income taxes is the amount a company has earned from all activities – operating and non-operating – before taking into account the amount of income taxes the company incurred. This is used to compare the profitability of two or more companies or divisions within a company. Comparisons are made before income taxes are deducted because companies may be subject to different income tax rates.
- Income before income taxes is defined as the money retained by the firm before deducting the money to be paid for taxes. EBT includes the money paid for interest.
Thus, it can be calculated by subtracting the interest from EBIT.
EBT = EBIT – Interest
Please see the below calculation from Google’s Income Statement example
source: Alphabet (Google) SEC Filings
- We note that Google’s Income Before Tax was 24,150 million in 2016 and $19,651 million in 2015.
Net Income
Net income (PAT) is what remains of the gross margin after operating expenses are deducted, other revenues and expenses are added or deducted, and income taxes are deducted. It is the final figure, or “bottom line,” of the income statement.
Net income is an important performance measure:
- Represents the number of business earnings that accrue to stockholders.
- Is the amount transferred to retained earnings from all income-generating activities during the year
- Often used to determine whether a business has been operating successfully.
Please see the below Net Income calculation from Google’s Income Statement example
source: Alphabet (Google) SEC Filings
- Google’s Net Income was 19,478 million in 2016 and 15,826 million in 2015.
Earnings Per Share
EPS can be calculated by dividing the “net profit” or “net income” with “outstanding shares”. For example, if we need to calculate the EPS of Company ABC and we know that the “net profit” is $100,000 and the number of “outstanding shares” is 10,000; the EPS would be = ($100,000/10,000) = $10 per share.
Please see the EPS Calculation from Google’s Income Statement example
source: Alphabet (Google) SEC Filings
- We note that Google increased its Earnings Per share from $23.11 per share in 2015 to $28.32 per share in 2016.
Nestle Example
Let’s have a look at Income Statement example of Nestle’s where along with normal income statement structure, we will take “income from associates & joint ventures” etc. into account.
Consolidated income statement of Nestle for the year ended 31st December 2014 & 2015
source: Nestle.com
Few things in Nestle’s income statement structure that are different than the example we did before –
- Gross profit is not dealt with separately.
- Second, there are two types of operating expenses and income. First, trading operating expenses and incomes are taken into account and then, general operating expenses and incomes have been considered.
- Instead of labeling “interests income” and “interest expenses”, “financial incomes” and “financial expenses” have been mentioned which are similar.
- After deducting the taxes, “income from associates & joint ventures” has also been considered.
In the final analysis
The income statement is one of the most important financial statements investors should look at before they ever make a decision to invest in a company. If you want to invest in a company, you can use vertical and horizontal analysis of the income statement to make an informed decision.
