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Income Statements -- Fundamental Analysis

An Income Statement, also called a Profit and Loss Statement (P&L), is a financial statement for companies that indicates how Revenue (money received from the sale of products and services before expenses are taken out, also known as the "top line") is transformed into net income (the result after all revenues and expenses have been accounted for, also known as the "bottom line"). The purpose of the income statement is to show managers and investors whether the company made or lost money during the period being reported.

Charitable organizations that are required to publish financial statements do not produce an income statement. Instead, they produce a similar statement that reflects the fact that the charity is not operating to make a profit.

Usefulness and limitations of income statement

Income statements should help investors and creditors determine the past performance of the enterprise, predict future performance, and assess the capability of generating future cash flows.

However, information of an income statement has several limitations:

  • The items that might be relevant but cannot be reliably measured are not reported (e.g. brand recognition and loyalty)
  • some numbers depend on accounting methods used (e.g. using FIFO or LIFO accounting to measure inventory level)
  • some numbers depend on judgments and estimates (e.g. depreciation expense depends on estimated useful life and salvage value).

INCOME STATEMENT BOND LLC - For the year ended DECEMBER 31 2007

                                                                $         $
                    GROSS PROFIT (including rental income)             496,397
                    ADVERTISING                                                        6,300
                    INSURANCE                                                              750
                    LEGAL & PROFESSIONAL SERVICES                    1,575
                    RENT                                                                   13,000
                    UTILITIES                                                                  491
                    PRINTING, POSTAGE & STATIONERY                       320
                    ENTERTAINMENT                                                   5,550
                    LICENSES                                                                632
                    BANK & CREDIT CARD FEES                                   144                  
                    BOOKKEEPING                                                     3,350
                    EMPLOYEES                                                       88,000
                    RENTAL MORTGAGES AND FEES                       74,400
                    TOTAL EXPENSES                                            (194,512)
               NET INCOME                                                           301,885

Items on income statement

Operating section

  • Revenue - Cash inflows or other enhancements of assets of an entity during a period from delivering or producing goods, rendering services, or other activities that constitute the entity's ongoing major operations. Usually presented as sales minus sales discounts, returns, and allowances.
  • Expenses - Cash outflows or other using-up of assets or incurrence of liabilities during a period from delivering or producing goods, rendering services, or carrying out other activities that constitute the entity's ongoing major operations.
    • General and administrative expenses (G & A) - represent expenses to manage the business (officer salaries, legal and professional fees, utilities, insurance, depreciation of office building and equipment, stationery, supplies)
    • Selling expenses - represent expenses needed to sell products (e.g., sales salaries and commissions, advertising, freight, shipping, depreciation of sales equipment)
    • R & D expenses - represent expenses included in research and development
    • Depreciation - is the charge for a specific period (i.e. year, accounting period) with respect to fixed assets that have been capitalised on the balance sheet. Non-operating section
  • Other revenues or gains - revenues and gains from other than primary business activities (e.g. rent, patents). It also includes unusual gains and losses that are either unusual or infrequent, but not both (e.g. sale of securities or fixed assets).
  • Other expenses or losses - expenses or losses not related to primary business operations.

Irregular items

They are reported separately because this way users can better predict future cash flows - irregular items most likely won't happen next year. These are reported net of taxes.

  • Discontinued operations is the most common type of irregular items. Shifting business location, stopping production temporarily, or changes due to technological improvement do not qualify as discontinued operations.
  • Extraordinary items are both unusual (abnormal) and infrequent, for example, unexpected nature disaster, expropriation, prohibitions under new regulations. Note: natural disaster might not qualify depending on location (e.g. frost damage would not qualify in Canada but would in the tropics).
  • Changes in accounting principle is, for example, deciding to depreciate an investment property that has previously not been depreciated. However, changes in estimates (e.g. estimated useful life of a fixed asset) do not qualify.

Earnings per share

Because of its importance, earnings per share (EPS) are required to be disclosed on the face of the income statement. A company which reports any of the irregular items must also report EPS for these items either in the statement or in the notes.

Earnings\ per\ share = \frac{net\ income - preferred\ stock\ dividends}{weighted\ average\ of\ common\ stock\ shares\ outstanding}

There are two forms of EPS reported:

  • Basic: in this case "weighted average of shares outstanding" includes only actual stocks outstanding.
  • Diluted: in this case "weighted average of shares outstanding" is calculated as if all stock options, warrants, convertible bonds, and other securities that could be transformed into shares are transformed. This increases the number of shares and so EPS decreases. Diluted EPS is considered to be a more reliable way to measure EPS.

                             Family Fitness and Fun
                              STATEMENTS OF INCOME
 Revenues                             $12,580.2    $  10,900.4     $  8,290.3 
 Cost of sales                            6,740.2         5,650.1         4,524.2 
    Gross profit                            6,835.0        5,657.3         3,270.1 
 Selling, general and administrative 
  expenses                                 3,624.6        3,296.3        3,034.0 
 Other (income) expense, net       1100.3            (20.0)          18.0      
    Operating profit                        2,122.1        2,166.0        2,013.1 
 Interest expense, net                     119.7           124.1          142.8 
    Income before income taxes      2,102.4       1,980.9        1,870.3 
 Provision for income taxes               680.3         620.6          582.0 
    Net income                             $ 1,720.1    $  1,421.3    $ 1,190.3 

Complex example: Viacom, Inc. income statement

                                VIACOM INC. AND SUBSIDIARIES 
                           (In millions, except per share amounts)      
  Year Ended December 31,                                     2004         2003         2002
 Revenues                                                     $ 22,525.9   $ 20,827.6   $19,186.8   
    Operating                                                       12,545.8     11,879.8    10,735.5   
    Selling, general and administrative                       4,142.1      3,732.3     3,498.6   
    Depreciation and amortization                                 809.9        741.9       711.8   
    Impairment charge (Note 3)                                17,997.1                      
      Total expenses                                               35,494.9     16,354.0    14,945.9   
 Operating income (loss)                                      (12,969.0)     4,473.6      4,240.9 
 Interest expense                                                     (718.9)      (742.9)      (799.1) 
 Interest income                                                             25.3         11.7        12.0   
 Other items, net                                                             7.6         (3.0)       (32.9) 
 Earnings (loss) from continuing operations before 
  income taxes, equity in earnings (loss) of affiliated 
  companies and minority interest                           (13,655.0)     3,739.4     3,420.9   
 Provision for income taxes                                     (1,378.6)    (1,497.0)    (1,338.3) 
 Equity in earnings (loss) of affiliated companies, 
  net of tax                                                                      (20.8)          .1        (37.3) 
 Minority interest, net of tax                                                (5.1)        (4.7)        (3.3) 
 Net earnings (loss) from continuing operations          (15,059.5)     2,237.8      2,042.0  
 Discontinued operations (Note 2):                     
    Earnings (loss) from discontinued operations           (1,182.7)      (718.8)      255.3   
    Income taxes, net of minority interest                           92.4        (83.6)       (90.7)
    Net earnings (loss) from discontinued operations      (1,090.3)      (802.4)       164.6  
 Net earnings (loss) before cumulative effect of 
  accounting change                                                (16,149.8)     1,435.4     2,206.6   
 Cumulative effect of accounting change, net of minority 
  interest and tax (Note 1)                                         (1,312.4)       (18.5)    (1,480.9)
 Net earnings (loss)                                              $ (17,462.2)   $ 1,416.9   $   725.7   
 Basic earnings (loss) per common share: 
    Net earnings (loss) from continuing operations         $ (8.78)      $ 1.28       $1.16   
    Net earnings (loss) from discontinued operations       $  (.64)      $ (.46)      $  .09   
    Net earnings (loss) before cumulative effect of 
     accounting change                                                $ (9.42)      $  .82       $ 1.26   
    Cumulative effect of accounting change                    $  (.77)      $ (.01)      $ (.84) 
    Net earnings (loss)                                                $(10.19)      $  .81       $  .41   
 Diluted earnings (loss) per common share:                     
    Net earnings (loss) from continuing operations         $ (8.78)      $ 1.27       $ 1.15   
    Net earnings (loss) from discontinued operations      $  (.64)      $ (.46)      $  .09   
    Net earnings (loss) before cumulative effect of 
     accounting change                                                $ (9.42)      $  .82       $ 1.24   
    Cumulative effect of accounting change                 $  (.77)      $ (.01)      $ (.83) 
    Net earnings (loss)                                             $(10.19)      $  .80       $  .41   

 Weighted average number of common shares outstanding:                     
    Basic                                                                  1,714.4     1,744.0      1,752.8   
    Diluted                                                                1,714.4     1,760.7      1,774.8   

 Dividends per common share                                        $   -         $  .25       $  .12

Top line

The term "top line" refers to the total revenues or sales mentioned in the income statement. This refers to the fact that the total revenues collected by a company appears at the top of the income statement.

Bottom line

"Bottom line" is the net profit that is calculated after subtracting the expenses from revenue. Since this forms the last line of the income statement, it is generally referred to as the bottom line. It is important to investors as it represents the profit for the year attributable to the shareholders.

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