In the last post on the beginners investing guide, I took a look at the importance of evaluating a company’s balance sheet. I listed all of the reasons as to why the balance sheet is an important place to start. Today, we want to take a look at the second most important financial statement that investors should look at known as the income statement.

What is an income statement?

Income Statement Definition

The income statement is also known as the P&L statement. This stands for profit and loss. The income statement is broken down into revenue and expenses. The amount left over is either reported as net income or a net loss. If revenue exceeds expenses then a company has a profit or net income. If expenses are greater than the revenue generated then a company has a net loss.

The income statement looks at the revenue of a company minus all of the expenses. Here is the equation.

Revenue – Expenses = Net Income (Loss)

The income statement is important because it allows you to track a company’s revenue growth on a year to year basis and see just how much a company is paying for its revenue. Cost of revenue on the balance sheet is known as the Cost of Goods Sold. This involves manufacturing, operating, distribution, and sales costs. This bears watching because it can help you assess how efficiently management is managing costs.

For example, let’s say a company had revenues of $5 billion dollars in 2009 and $6 billion dollars in 2010. This looks good at the surface because it shows 20% revenue growth. However, if the company’s cost of revenue increased from $3.2 billion in 2009 to $4.5 billion dollars in 2010, then the company’s profit margin would be lower. This could be a sign that growth may be slowing as the company is having to pay out larger sums of cash to increase sales.

Sample Income Statement

Income Statement Sections

The revenue section of the income statement contains information about operating and non-operating revenue. Operating revenue are the sales that are a direct result of the company’s operations. Non-operating revenue can come in many forms such as one time asset sales.

The expense section of the income statement contains operating expenses and non-recurring expenses. I pay more attention to operating expenses since those are recurring expenses that the company will have to deal with quarter after quarter. Non-recurring expenses are less important because these are one time charges that often have only a temporary effect on earnings.

The final portion is the net income available to shareholders. This is the amount of cash that is available to you and me. Companies can distribute this capital back to shareholders in the form of dividends or stock buybacks. They can also use the earnings for expansion or add the cash to their balance sheet.