We kicked off this investment guide to help beginners understand the basics of company earnings reports, including key components like the income statement, balance sheet, and cash flow statement.
Today, we are zooming in on the income statement.
Think of it as the report card for how a company is doing financially.
It is often the first document that investors turn to when assessing the health of a business.
But, like an encrypted map, understanding it requires more than a cursory glance.
Here is a deeper look into the nuances of an income statement and learn how to decipher its various components.
The heart of financial performance
The income statement, also known as the profit and loss statement, paints a vivid picture of a company’s operations over a specified period.
Whether looking at it over a quarter or a year, this statement highlights the journey of each dollar earned and how it is utilised or retained in the business.
1. Revenues
Often termed as the “top line”, revenues represent the total money a company brings in from its core operations.
This does not just include sales.
It can encompass everything from service fees to interest income.
Revenues serve as the starting point, giving investors an idea of the business’s scale and market acceptance.
2. Expenses
To earn revenues, companies invariably incur costs.
These expenses range from raw materials and wages to rent and marketing costs.
Deducted from the revenues, these represent the financial sacrifices made to run the operations smoothly.
It is crucial to note that not all expenses are immediate cash outflows; some, like depreciation, are non-cash charges that account for the wear and tear of assets.
3. Net profit
When the dust settles, what’s left after deducting all expenses from revenues is the net profit.
It is the true testament of a company’s profitability and is commonly called the “bottom line”.
A positive net profit indicates that the company earned more than it spent, while a negative one spells losses.
Tips for investors
1. Yearly revenue growth
While the current revenue gives a snapshot of the company’s present stature, assessing the growth in revenues year-on-year (yoy) provides a dynamic perspective.
Steady growth can hint at a growing market, better product acceptance, or effective sales strategies.
2. Watch the expenses
A company’s revenue might skyrocket, but what if its expenses increase even faster?
It is essential to keep an eye on the rate at which expenses increase compared to revenues.
If costs are outpacing income consistently, it might signal inefficiencies or rising operational challenges.
3. Consistency in net profit
While occasional spikes in profits due to one-off events can be exciting, investors should be more interested in consistent profitability.
A steady net profit across periods indicates stable operations, sound financial management, and the company’s resilience against market volatility.
Income statement tells a company’s story
The income statement is not just a collection of numbers.
It is a narrative of a company’s operational journey over a period.
It reveals the strategies at play, the challenges faced, and the outcomes achieved.
For investors, understanding this document means gaining a clearer view of where the company stands and where it might be headed.
With the above pointers in hand, one is better equipped to navigate the intricacies of the income statement and make informed investment decisions.
Disclaimer: ProsperUs Investment Coach Billy Toh doesn’t own shares of any companies mentioned.
