Along with the Balance Sheet and Cash Flow Statement, the Income Statement is one of the fundamental building blocks of financial analysis - worth familiarising yourself with it!
Now, we’re not saying you need to know all the accounting ins and outs here (boring 😴), but having a general sense of what an income statement is, and why it’s important, will take you a long way! So without further ado…
What is an income statement?
Also known as the "Profit & Loss statement (P&L)" or “statement of earnings / operations”, the income statement is just an account of how much money a company made (revenues) and how much it cost the company to make that money (costs). Oh, and the difference between revenues and costs is the company’s profit 🤯.
The income statement summarises how a company has been operating over a given time period - say over 3, 6 and/or 12 months (unlike the balance sheet, which is a view of the company at a specified date - like December 31st or June 30th for example)
The income statement is a useful way for company management to paint a picture of what’s been going on over a certain time period. Management can often make adjustments to certain items (as long as they explain their reasoning clearly) - this helps them to paint a clear picture of what they’ve been up to by taking out “one-off” or “special items”.
For example, a company might have had to pay a large fee for a legal settlement in the past year - this isn’t expected to happen every year and so it’s reasonable to remove this or split it out as a “special” or “non-recurring” item as its not related to the normal costs that the company might incur in providing its product / service.
For an unadjusted measure of the actual cash moving in and out of the company, you’d be better off looking at the cash flow statement! That doesn’t mean the income statement is useless however - financial analysts often pay the most attention to it...
Why is it important?
In the context of investing, if you want to carry out fundamental analysis in order to assess a company’s suitability for investment, many useful numbers such as revenues, costs, earnings, taxes, dividends paid and interest costs for a given period can be found in the Income Statement and used along with the company’s share price or market capitalisation to derive handy ratios (e.g. price-to-earnings, price-to-sales, dividend yield, etc.)
What does this look like in practice?
Let’s take a look at page 40 😰 of Netflix's 2018 annual earnings report. Just kidding 😉 - we’ve simplified it for you below 🙏🏼:
2018 Netflix Income Statement (in $ billions 💵💵💵)
Revenues: $15.8bn
A - Costs from operating (staying alive, growing, the usual): $14.2bn
B - Costs of paying interest on debt (they’ve borrowed their fair share!): $0.38bn
C - Tax Provision: $0.015bn 😂
Profits or Net Income (Revenues - Total Costs (A + B + C)): $1.2bn
This Net Income of $1.2bn would:
1) Be added to Shareholders’ Equity in the balance sheet (See for yourself! The "retained earnings” line on the balance sheet (page 43) grows from $1.7bn in 2017 to $2.9bn in 2018)
2) Form the basis upon which you could start tracing all the physical cash moving around the business during the same period via the Cash Flow Statement (See the top of page 42!))
Please know, the value of investments can go up as well as down and you may receive back less than your original investment, meaning, when investing your capital is at risk.
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