You have to know how to read an Income Statement if you want to understand Fundamental analysis.
An Income Statement follows this format:
- Revenue/Sales – The “top line” number on an Income Statement is usually the revenue/sales number that indicates the total sales of the company. This is the total cash register receipts of all of the stores if it is a retail business.
- Cost of Goods Sold – The Cost of Goods Sold is the direct costs of the product that was sold. By “direct costs” we mean the actual cost of making the product and getting it on the store shelves. If we buy shoes from China for $45 and pay a freight company an average of $2 a shoe to get them from China to our store, then our Cost of Goods Sold is $47.
- Gross Profit – The Gross Profit is how much money we make from the sale and is simply the difference between the Sales and the Costs of Goods Sold. If those shoes sold for $100 then our Gross Profit is $53.
- Selling, General, and Administrative Expenses – Often called SGA Expenses, this line includes all of the other indirect costs of doing business (except for interest charges and taxes). So this includes marketing and advertising costs, salaries, rent, electricity, accounting, legal, and all of the other costs involved in running a business
- Operating Income – The Net Income is simply Gross Profit less SGA Expenses. If the number is positive, then the company is profitable. If it is negative, then the company is losing money.
- Interest and Taxes – Usually you will see interest expense and corporate taxes as a separate line item.
- Net Income – A simple calculation of Operating Income less Interest and Taxes shows you how much, at the end of the year or quarter, a company believes they have made (assuming all of their accounting is correct)!
Just to clarify, many people use the words “revenue” and “earnings,” and “revenue” and “income” interchangeably. Yes, earnings and income are interchangeable, but revenue and income are not. When reading Income Statements, revenue is the “top line” of the Income Statements and earnings/income is the “bottom line.”