Module 5 · Financial Statements · Lesson 3

How to Read an Income Statement

An income statement shows revenue and expenses over a stated period, ending with profit or loss. Follow the subtotals in order and read the notes before deciding what a change means.

Where do you find the income statement?

In a U.S. public company’s Form 10-K or 10-Q, open the financial statements section and look for a title such as “Consolidated Statements of Operations” or “Statements of Income.” Different companies may use different labels and line items. The annual 10-K contains audited statements; the quarterly 10-Q usually contains unaudited interim statements. Read the accompanying notes, which are part of the financial statements.

How do revenue, gross profit, and operating income connect?

Revenue is the amount recognized from goods or services under accounting rules. Subtract the company’s reported cost of goods sold or cost of revenue to get gross profit, where that subtotal is presented. Subtract operating costs such as research, sales, and administration to arrive at operating income or loss. Line labels and whether a gross-profit subtotal is shown vary by business. Read the notes rather than assuming two companies classify every cost alike.

How do you get from operating income to net income?

Items outside operations, such as interest and other gains or losses, affect income before tax. Income tax expense or benefit then contributes to net income or loss. Some statements separately show earnings attributable to different owners. Earnings per share divides earnings available to common shareholders by an appropriate weighted-average share count; diluted earnings per share considers potentially dilutive shares under accounting rules. A higher earnings-per-share figure can reflect changing share count as well as changing profit.

What do margins show, and what can they hide?

A margin divides a relevant profit measure by revenue for the same period: gross margin uses gross profit, operating margin uses operating income, and net margin uses net income. In the illustrative example above, those margins are 40%, 15%, and 10%. Compare each margin with the company’s own prior periods and a suitable peer only after checking accounting policies and business mix. A margin alone does not show cash generation, debt, or whether an unusual item will recur.

How do you compare income statements over time?

Write down each fiscal period, currency, and unit. Compare full year with full year, or quarter with a comparable quarter, and check whether there was a restatement or a change in accounting presentation. Look at both the amount and the percentage change in revenue, major expense categories, and earnings. Read management’s discussion and the notes for stated reasons. Treat a company explanation as a disclosure to examine, not a guarantee that a trend will continue.

Why can profit differ from cash flow?

Revenue and expenses can be recognized before or after the related cash changes hands, and some expenses such as depreciation do not use cash in the reporting period. Compare net income with net cash from operating activities in the cash flow statement, then read the reconciliation and relevant notes. Neither a positive profit nor a positive operating cash flow settles the full picture by itself.

Where can you check the accounting and filing basics?

• SEC: Beginners’ Guide to Financial Statements
• SEC Investor.gov: How to Read a 10-K
• SEC Investor.gov: How to Read a 10-K or 10-Q
• SEC Investor.gov: Using EDGAR to Research Investments

End of Lesson · Continue to the Balance Sheet