What is an Income Statement?
The income statement, also known as the profit and loss statement, provides insights into a company’s operational performance and profitability over a quarterly or annual period and summarizes a company’s revenue, expenses, and profits or losses.
3 Key Parts of an Income Statement
The income statement has three main parts:
- The top of an income statement shows how much money entered a business as revenue. Revenue represents the total money generated from the sale of goods or services.
- The middle of the income statement shows how money slowly left the business through expenses. Expenses are costs associated with generating revenue and are categorized into cost of goods sold (COGS), operating expenses, interest expenses, taxes, etc.
- The bottom of the income statement shows how much remained in the business as profit. Net income is what’s left in the business after all expenses have been deducted from revenue and is commonly referred to as the bottom line.
Some of the key line items on the Income Statement are highlighted in blue below:
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What the Income Statement Can Tell You About a Company
The income statement can help stock market investors gauge a company’s profitability and financial health. By analyzing trends in revenue, expenses, and profits, investors can assess whether a company is growing and becoming more profitable.
Additionally, understanding how expenses are managed relative to revenue growth can provide insights into a company’s operational efficiency.
The income statement provides several insights for long-term investors:
- Growth Trajectory: Analyzing revenue trends helps investors understand whether a company is in a growth phase, maturity phase, or decline. Investors tend to favor companies seeing consistent revenue growth because this indicates a strong demand for their products or services.
- Cost Management: By evaluating various expenses (COGS, operating expenses), investors can assess how well a company manages its costs. A company that reduces costs without sacrificing revenue growth can enhance its profitability, making it a more attractive investment.
- Profitability: The income statement reveals how efficiently a company generates profit from sales. A company with consistently increasing net income suggests that it effectively manages its business and has good growth prospects.
What the Income Statement Won’t Tell You About a Company
While the income statement is a powerful tool, it has its limitations:
- Cash Flow: The income statement does not show the actual cash flow the business generates. A company can report high profits but still face liquidity issues if its cash flow is weak. Long-term investors should examine the cash flow statement and the income statement.
- Balance Sheet Health: The income statement does not provide information about a company’s assets and liabilities. To understand a company’s financial stability, investors must review the company’s balance sheet to assess debt levels, asset management, and overall financial leverage.
- Non-Recurring Items: The income statement may include non-recurring items like asset sales or one-time expenses that can distort the company’s true operational performance. These items are often clearly reported, but investors can check a company’s footnotes on its quarterly and annual filings if an investor suspects a company’s profitability is being overstated.
How to Analyze a Stock’s Income Statement in 5 Minutes
Analyzing a stock’s income statement helps investors understand a company’s profitability, cost structure, and overall financial health. You can analyze a company’s income statement in 5 minutes by answering these 5 questions:
- Is revenue growing, and what’s driving growth?
- Are gross margins increasing?
- Are operating margins increasing?
- Are net margins increasing?
- How much is EPS growing?
These are two important terms to know before we dive in:
- YoY % Change: Year-over-year, or annual, percent change. This is important for seeing the annual trends in a company’s metrics.
- Margins = A line item’s percentage of revenue. For example, a net income margin of 20% means that net income divided by revenue is 20%. Higher profit margins are better.
1. Revenue:
Revenue, or sales, is at the very top of the Income Statement and is the total amount of money coming into the business. A consistent increase in revenue is a positive sign, indicating that the company is gaining new customers or increasing its prices while retaining customers.
From Google’s Income Statement below, you can see that revenue has grown in recent years at just under 10% annually:
The Segments tab on TIKR breaks down what’s driving Google’s revenue growth by Segment & Geography. You can see that Google Cloud is leading revenue growth, with over 25% growth in 2023 and over 35% growth in 2022:
Google’s revenue is growing, driven by its Cloud segment.
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2. Gross Margins:
Gross profit is calculated as revenue minus cost of goods sold (COGS). A business’s cost of goods sold includes expenses directly related to creating or delivering products or services.
From Google’s annual report, its cost of goods sold includes:
- Traffic Acquisition Costs
- Amounts paid to key distribution partners
- Amounts paid to Google Network partners for displaying ads on their properties
- Data center costs
- Content acquisition costs
COGS can vary based on the company’s industry because businesses can deliver vastly different products and services. For example, in a manufacturing business, COGS would include:
- Raw materials
- Direct labor
- Packaging materials
- Shipping Costs
While in a restaurant business, COGS would include:
- Ingredients
- Direct labor
- Packaging supplies
The gross profit margin, which is gross profit divided by revenue, helps investors understand how much of a premium a company can charge customers over what it directly costs to produce goods or services.
Additionally, a company with increasing gross margins generally has strong pricing power and may potentially be able to raise prices to combat cost inflation.
We like to see companies with over 50% gross margins because this indicates that customers are willing to pay a large premium to what it costs to manufacture or deliver the product or service.
A company with gross margins below 30% may suggest that the company operates in a competitive, commoditized industry with poor pricing power. It’s difficult for a company to create strong shareholder value in this kind of an environment.
Google’s gross margins have risen in the past few years to around 57%. This is a good sign:
It’s important to check that a business has at least 30% gross margins, but gross margins over 50% are better. Additionally, increasing gross margins is a good sign.
3. Operating Income:
A company’s operating profit comes after accounting for its operating expenses. These expenses are not directly tied to creating the product or delivering services but are still necessary for the business’s core operations.
Google’s two operating expenses are Selling, General & Administrative Expenses (SG&A), and Research & Development (R&D).
Google’s Sales and Marketing Expenses include everything related to selling & marketing:
- Advertising & Promotion expenses
- Sales Commissions
- Marketing Salaries
Google’s General and Administrative Expenses include all the expenses around operations that are still important but aren’t directly tied to creating revenue:
- Corporate expenses
- Legal and Professional fees
- Administrative employee’s compensation
Last, Google also spends a lot on Research and Development, which primarily includes:
- Project costs
- R&D employee compensation
The operating margin (operating income divided by revenue) indicates how well the company manages its operating expenses. A rising operating margin can signify that the business is improving operational efficiency.
Google’s operating margins have increased from the low 20s to over 30% recently, which shows that Google has increased its operational efficiency:
It’s good to see that a business’s operating margins are growing over time.
4. Net Income:
The net income is a company’s total profit after deducting all expenses.
Google’s net margins have increased from the low 20s to mid-20s over the last few years, which shows that the business is becoming more profitable:
Net margins tend to fluctuate more than operating margins. That’s mainly due to how a company pays its taxes and any one-off expenses the business may incur.
Google’s 2017 results show an 11.4% net margin, while Google’s 2021 results report a 29.5% margin. These figures noticeably deviate from the company’s typical net margins in the low 20s. However, these erratic figures are just the result of how Google paid its taxes.
Google had a $14.5 billion tax expense in 2017 when it reported net margins of 11.4% in 2017, but the following year, the company paid just around $4 billion in taxes. This significantly skewed net income, considering the operating income was only about $30 billion around this time.
For this reason, it’s often best to compare a company’s profitability with its competitors using its operating margins rather than its net margin.
The operating margin includes all the costs of running the business but excludes company-specific expenses like interest, taxes, and many one-off items. Net margins can sometimes be erratic, making this line item difficult to compare between companies.
Therefore, analyzing and comparing a company’s operating margins is often better than comparing net margins because net margins can sometimes be erratic.
5. Earnings Per Share (EPS):
Earnings per Share (EPS) is one of the most widely tracked valuation metrics because it helps investors understand a company’s profitability per share. EPS is calculated as net income divided by the total number of shares outstanding.
You can see that Google’s EPS has steadily climbed over the past few years, which is good to see:
It’s good to see companies that can consistently grow EPS.
Income Statement FAQs:
What is an income statement?
An income statement shows a company’s revenue, expenses, and profits over a specific period of time and provides insight into its financial performance and profitability.
What is on an income statement?
An income statement shows how much a company makes as revenue, how much a company spends as expenses, and how much money is left over for a company as profit. Some key line items on the income statement include revenue, cost of goods sold (COGS), gross profit, operating expenses, operating income, interest expense, taxes, and net income. These components show a company’s profitability.
What is the main thing you can learn from an income statement?
The income statement shows whether the company how profitable a company is by comparing its revenues against its expenses.
What is the difference between a balance sheet and an income statement?
A balance sheet provides a snapshot of a company’s financial position at a specific point in time, showing its assets, liabilities, and shareholders’ equity. In contrast, an income statement shows the company’s financial performance over a specific time period, detailing revenue and expenses to determine how profitable the company was.
What are some other names for the income statement?
Some other names for the income statement include the profit and loss statement, P&L, statement of earnings, and statement of operations. These terms are often used interchangeably in financial reporting.
TIKR Takeaway:
Analyzing a stock’s income statement helps investors assess a company’s financial health and profitability.
The income statement helps investors quickly gain insights into a company’s operational efficiency and growth potential by focusing on key components such as revenue, gross profit, operating income, net income, and EPS.
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Disclaimer:
Please note that the articles on TIKR are not intended to serve as investment or financial advice from TIKR or our content team, nor are they recommendations to buy or sell any stocks. We create our content based on TIKR Terminal’s investment data and analysts’ estimates. We aim to provide informative and engaging analysis to help empower individuals to make their own investment decisions. Neither TIKR nor our authors hold any positions in the stocks mentioned in this article. Thank you for reading, and happy investing!
