Tutorial: read an income statement
Read it top to bottom once, then read the gaps between the lines. The gaps are where the business lives.
Understand what a company sold, what it cost, and what was left.
How read an income statement works, in one picture
The same argument as the text, as a chain. Each step is what makes the next one possible.
How the three statements lock together
Profit flows from the income statement into the balance sheet as retained earnings, and the cash flow statement reconciles what was earned with what actually arrived.
- 1
Revenue: what was sold
The top line. It is the least manipulable number on the statement and the least interesting, because revenue without profit is just expensive activity. Check whether it is growing, and whether that growth is slowing.
- 2
Gross profit: what it cost to make
Revenue minus the direct cost of the goods. What is left, as a percentage, is the purest measure of pricing power in the accounts. Software runs at 80%, groceries at 25%, so only ever compare it against the same industry.
- 3
Operating profit: what it cost to run
Now take off salaries, marketing, research and rent. This is the profit from actually being this business, before the accidents of how it is financed and where it pays tax. It is the fairest line for comparing two rivals.
- 4
Net income: what was left
After interest, tax, and anything management decided to call exceptional. Every judgement call in the accounts eventually lands here, which is why it is the most quoted number and the most vulnerable one.
Then divide by the share count to get EPS, and use the diluted figure. Basic EPS flatters any company that pays its staff in stock, which is most of technology.
If a company reports 'adjusted' profit every single year, the adjustments are not exceptional. They are the business.
Ordinary. The market expects steady, unremarkable growth.
You can point at the line where a company stops looking good, if it does.
Read next
Read it top to bottom once, then read the gaps between the lines. The gaps are where the business lives.
We screen for yield AND the balance sheet behind it, because the biggest yields belong to the companies least able to pay them.