The income statement is one of the most important documents at an
investors disposal. This sheet displays the revenues and expenses of a
company for a specific period of time. Investors can find a wealth of
valuable information on the income statement including the companys
sales, profitability, retained earnings, gross profit, and operating
income.
From these numbers, investors can calculate and
discern vital information about the company. Usually income statements
provide information for more than one period, for example two
consecutive years. It is easy to compare the results from one period to
the next and determine trends in sales and income growth.
Here are a few items on the income statement that are important, yet often overlooked:
COST OF GOODS SOLD (COGS):
This is the amount of money
it costs the firm to produce the goods or services sold. It includes
the cost of raw materials, manufacturing and labor (but not wages).
GROSS PROFIT:
COGS is subtracted from sales in
order to arrive at the gross profit. Strong management teams will work
to keep the COGS low, without compromising the quality of goods and
services sold. Fatter gross margins equal fatter profits.
Gross
profit is vital to a companys business because it can be used for so
many purposes. Increased research and development spending and higher
dividends are just two examples. Both of these areas will have direct
effects on the companys stock price going forward.
OPERATING INCOME:
This is derived by subtracting
general operating costs (rent, salaries, R&D) and depreciation from
gross profit. Operating income is income from core operations minus
day-to-day activities and expenses. If these core profits are dropping
or disappointing, the stock cant be far behind.
OTHER INCOME:
This is income that comes from outside
the realm of core operations. Capital gains income and rental property
income are common items in this category. Companies sometimes try and
fool investors by considering a large gain on a sale of stock as
regular income. It is still considered income, but obviously investors
want to see the bulk of earnings coming from core operations.
RETAINED EARNINGS:
These are earnings that are left
after dividends are paid out. Retained earnings are plowed back into
the expansion of the business for growth companies.
Its time to take a look at a sample income statement from our favorite company: Vandelay Industries.
| (dollar figures are in thousands) |
2006 |
2005 |
| |
|
|
| Sales Revenue |
| |
| Latex Sales |
$ 12,347 |
$ 9,746 |
| Services |
6,912 |
5,688 |
| Total Sales Revenue |
19,259 |
15,434 |
| |
|
|
| Sales Costs |
|
|
| Widget Sales |
5,649 |
4,688 |
| Services |
3,166 |
2,712 |
| Total Sales Costs |
8,815 |
7,400 |
| |
|
|
| Gross Profit |
10,444 |
8,034 |
| Gross Margin |
54 % |
52 % |
| |
|
|
| Operating Expenses |
|
|
| Sales & Marketing |
4,078 |
3,132 |
| General & Administrative |
916 |
705 |
| Research & Development |
2,364 |
1,831 |
| Total Operating Expenses |
7,358 |
5,668 |
| |
|
|
| Operating Income |
3,086 |
2,366 |
| Operating Margin |
16 % |
15 % |
| |
|
|
| Interest Payments to Bondholders |
147 |
253 |
| Earnings Before Taxes |
2,939 |
2,113 |
| Provision for Taxes |
1,028 |
739 |
| Earnings ("net income") |
1,911 |
1,374 |
| |
|
|
| Profit Margin |
10 % |
9 % |
| Dividends paid to Shareholders |
10 |
- |
| Earnings available to Shareholders |
1,901 |
1,374 |
