Financial Statements: The Income Statement

Before, I talked about the basic layout of the stock app in the iPhone. Keep in mind this information is for the person with little to no experience or knowledge about finances or investing. Now lets continue, the company of discussion was Apple Inc. I talked about the “open”, ” high”, “low” and volume of the stock. I also explained the market cap of a company and what the P/E ratio is as well as the dividend. If you haven’t read the article you can read it here.

Apple Stock

This was the picture in the first post that I was discussing. I’d like to resume with the picture in the middle. The picture is still selected on Apple Inc which shows the share price of the company as well as the decline of the price, indicated by the red, down $8.36 that day. But below this it shows the stock price movement with the chart. The time duration in the picture is two years but the time can be selected anywhere from one day to two years. If the phone is positioned sideways you can see the price movement of five years and ten years respectively.

The last tab on the right shows company news. This tab shows all important company information or related news by industry. It is helpful to look at the news section for any and all important events that are of may take place in the future. Important events that may be shown in this tab include new product developments for the company as well as any acquisitions the company may be involved with as well as lawsuits and other relevant information. Beyond this other helpful websites are:http://www.MarketWatch.com  and http://www.morningstar.com

Financial Statements

Businessman at work in Office

FINANCIAL STATEMENTS

The websites are good for doing further research on companies. As I said in the earlier post, stocks are  peices of a business and the best source of information on a company’s prospects are its financial statements.

What are financial statements? The financial statements are a group of documents that give the financial insight into a company. The financial statements show an in depth view of exactly what’s going on in the business. With the financial statements you can see how profitable a company is, how much the company spends on things like research and development and how much inventory the company has. Needless to say, the financial statements are by far the most important documents for an investor to review before making any decision about putting their money in a particular company’s stock.

Income StatementFinancial Statements: The Income Statement

Let’s begin with the income statement. The income statement is the snapshot of what the company has done over the past year.  The income statement entails how a business incurs its expenses and generates revenue, both from an operating and financing perspective. The above picture is an example of what the income statement will consist of. The income statement starts with the top line or revenues. The revenue is the amount of money from all sales that the company has brought in over a period of time, typically a year. However, financial statements can show the company’s progress on a quarterly basis as well.

After revenue, the expenses must be subtracted to give you gross profit or gross income. The first expenses that are deducted are part of cost of goods sold which may be abbreviated COGS. The cost of goods sold is the cost of raw materials to produce the products. After subtracting COGS including depreciation you get gross profit. After gross profit you have operating expenses or expenses incurred during ongoing business concerns.

We will start with depreciation for operating expenses. Depreciation is a lose in value of assets. It is a non-cash expense but a true economic expense. To understand what depericiation is think of a computer you bought. Technology changes every year and because so, new and better computers are introduced to the market place. Because of this you most likely won’t be able to resell you computer at the same price you bought it at. So you must lower you asking price, it is no different from a company’s perspective. When a company  acquires new computers, buildings, machinery and so forth the management must estimate its life long usefulness. We will say ten years for a building and five years for a computer. So say you purchase a computer for your business and paid $500. It’s brand new and hasn’t been used yet. Because technological advances happen rapidly you would use a lower time frame of five years. So you would spread the cost basis over five years or the asset/computer depreciates in value at a rate of $100 a year.

Other operating expenses are administrative expenses. These typically include manager salaries or payroll for employees as well as rent and utilities on office buildings, basically anything used by  employees or staff. Another key part of expenses are research and development or R&D expense. Research and development is a key part and necessity of every company. Research and development is important for technology companies to innovate and come up with better, more efficient products as well as for oil companies to do research on fracking for oil projects. R&D expenses are not necessarily a bad expense to write off as long as the company is productive and coming out with new and better products. However, if R&D expense keeps increasing without any profitable outcomes then it may be worrisome that a company is misallocating capital.

As you can see from the above example, after you subtract those expenses from gross profit you are left with operating profit. Operating profit, because it is the profit left after deducting operating expenses. The “Other Income and Expense” column shows interest income and interest expense. The interest income is typically interest earned on investments whereas the interest expense is the company’s cost of borrowing funds. After adding and subtracting the appropriate amounts from the “income and expense” column you must pay taxes to the government. The corporate tax rate varies between 15%-39% but the average tax rate is 35%. We will use 35% tax rate for this example. So after you deduct the top line expenses like COGS, selling and general administrative expenses and added and subtracted the income from investments and expense from debt financing you would take the income left, being operating income and subtract taxes. In the above example there is $3,012 left then the $1,084 in taxes that are subtracted which comes out to a 35.9% tax rate.

Conclusion

In closing, the income statement is an important tool investors can use to evaluate a company and find out how profitable a company is. The income statement allows you to see how much money a company makes as well as how the company finances its operations. The income statement further shows important expenses like R&D as well as how much the company pays in taxes. If you want to be a successful investor it is important to understand the financial statements of a company and see how a company is operating. I hope this was a helpful and insightful article, until next time.

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