The INCOME STATEMENT: all the basics in 9 minutes: transcript

Imagine if you could quickly tell if a company was raking in massive profits or losing money handover fist. Believe it or not, but you can do just that in a few seconds by analyzing its income statement. But what is an income statement and how do you read it? In this video, I'll explain the layout of an income statement, the key terms to track, and a few tricks to analyze them quickly, all in less than 10 minutes. Hi, my name is Brian Faraldi. I'm a financial educator who's been analyzing and investing in individual businesses for more than 20 years. But the clock is ticking here, so let's get started. So, what is an income statement? It's a financial report that shows a company's revenue, expenses, and profits over a specific period of time. The primary purpose of an income statement is to show if a company is making money or losing money, and answers the question, are you profitable? And it's similar to your own personal monthly budget. The income statement tracks a few key metrics, including revenue, expenses, and various ways of measuring the company's profit. Now, to understand the income statement better, let's pretend that you own a coffee shop called Best

Coffee Company, and you just created an income statement for the year ending 2023. Here is your income statement. And notice right at the top that we have the time period of the income statement. This is a very important thing to note. And it tells us if we're looking at a quarter, a six-month period, or a year. In this case, we are measuring the company's income statement between January 1st and December 31st, 2023. Now, the top line of the income statement is a company's revenue, which is all the sales that it generated during the period. Since this is a coffee company, the formula for figuring out revenue was the price per cup of coffee sold times the number of cups of coffee that were sold. So, in this case, the price was $2 per cup times 10,000 cups sold equals $20,000 in revenue during this period. The next number on the income statement is called cost of goods sold. And these are all of the costs that go directly into making the product or delivering the service. In the case of our coffee company, this would be all of the costs related to the

coffee itself, the water, the cups, the sugar, and and any other expenses that go directly into producing the cup of coffee that's sold. Once we subtract that expense, we get a very important number called gross profit, which is the total amount of dollar profit that a company produces just from selling the product or service. Now, after that, there are lots more expenses that we continue having to subtract. One of the biggest line items on a company's income statement is the company's operating expenses, which are alo also called overhead expenses. This includes things like rent, salaries, marketing and sales expenses, administrative expenses, fixed costs, and more. Once we subtract operating expenses from gross profit, we get the company's operating income, which is the total amount of profit that the business generated during the period before subtracting other expenses and costs. Now, after we get operating income, the next line item is nonoperating income and expenses. These are various forms of income or costs

that have nothing to do with operating the business, but the company still has to pay for and take on. The most common things that you will see in this category are interest payments on the company's debt or it could be a positive number if it sold one of its assets. After adding and subtracting the company's non-operating expenses, we get pre-tax income. This is also called earnings before tax or EBT. From there, the final expense that we pay is income taxes, which includes all federal, state, and local taxes that must be paid during the period. And after subtracting income taxes from pre-tax income, we get net income, aka earnings after tax, aka profits. All those terms mean the exact same thing. Now, with a corporation, we then have to take that net income and divide it by the total number of shares that exist in that company. Doing so gives us a very important number, which is the earnings per share of the business, also called profits per share

of the business. This is how much claim on the profits each individual share of stock in that corporation has. Now, it's important to know that not all companies use these exact terms and layouts when they're making their financial statements. In fact, not all companies even call this financial statement an income statement. I've also heard this statement called the earning statement or the operating statement or the profit and loss statement or the P&L statement and more. Moreover, each of the terms that you might see on an income statement could have completely different names than the one I just showed to you. To make these terms easier to understand, I created a free ebook called Financial Statement School, which lists out the terms as well as the key synonyms of each of the three major financial statements. If you want a free copy of this ebook, just click the link that you see on the screen or the link in the video description. Now, the income statement I just showed you only had one year of data for simplicity.

However, income statements usually have multiple years of data in them. This allows readers of those income statements to see trends and tell if the company is growing or shrinking over time. Here we see 3 years worth of best coffee companies income statements. Notice that all the columns you see end in the period December 31st, 2023, 2022, and 2021. By simply looking at how the numbers change and evolve over a period of years, we can easily tell if the business is growing because the numbers are going up or if the business is dying because the numbers are going down. In this case, Best Coffee Company is clearly growing because revenue, operating income, net income are all trending in an upward direction. Now, that's what an income statement is. When it comes to analyzing an income statement quickly, there are five key numbers that I focus on. The first number that I always look at is the company's revenue. I want to see that this number is consistently growing, especially during periods of economic stress. If you find a business that's growing its revenue during a downturn, the odds are good that you found a very good business. The second number that I

pay attention to is gross profit. I think that this is one of the most important and yet underutilized numbers on the income statement. This tells us the total amount of profit that management teams have to spend in the rest of the business. And it's incredibly important that this number continuously rises after gross profit. The third number I always look at is operating income. This is the operating profit of the business itself before accounting for those other expenses that management teams may or may not have control over. If a business's operating profit is growing consistently, I view that to be a very positive sign. The fourth number that I always look at is the earnings per share. This is the profit that the company generates divided by the number of shares that are outstanding. Since the number of shares outstanding is can grow or shrink depending on the company issuing stock or buying back stock, I care more about the earnings on a per share basis than I do in absolute numbers. Speaking of shares outstanding, I always next take a look at the company's total share count.

I like to see that the share count is very stable or even better shrinking over time. If a company's share count is rapidly increasing, that tells me that the company is issuing too much stock, which could dilute me as a potential shareholder. Now that we understand the five key numbers to look at, let's take a look at the income statement of a real company to see these numbers in action. Here is 3 years worth of income statements for a American-based retailer called Dollar General. The first number that I always look at is the year-ending period. So notice in this case we are looking from the right side of the screen to the left side of the screen being the most recent and these are all annual periods for the company. This company chose to have its fiscal year end in late January or early February as opposed to the normal calendar of December. So let's take a look at the top line of Dollar General's income statements which is net sales aka revenue for the business. This number was 34 billion in 2022 and it's increased to 38 billion in 2024. So this

company is growing its revenue. The next number that I like to look at again is gross profit. In this case, gross profit grew from 10.8 billion in fiscal year 2022 to 11.7 billion in fiscal year 2024. Notice that the gross profit in 2023 is higher than it is in 2024. So, even this company was growing its revenue, its gross profit actually declined year-over-year. That's a troublesome sign. The next number that I'm going to focus in on is the company's operating profit. Notice that this number was 3.2 billion in fiscal year 2022, but this fell to 2.4 billion in fiscal year 2024. So, again, even though this company's revenue is growing, its operating profit is actually shrinking, which is a worrisome sign for investors. Next, let's take a look at the company's earnings on a per share basis. Notice once again, this company's earnings per share was $10.17 in 2022. It increased in 2023 and then

it fell pretty sharply in 2024. Again, this is during a period when revenue was increasing. So, there's something going on that investors need to investigate. The final number that I always like to look at is the weighed average shares outstanding. Notice that the diluted share count was 235 million shares outstanding in 2022. and more recently, it's 219 million shares outstanding. The share count is decreasing over time, which tells me that this company is clearly buying back its stock at a pretty rapid pace. That tells me that it's a shareholder friendly company that is actively returning capital to investors. Once you get the hang of looking for these five numbers, you can actually learn a lot about of business just by giving the income statement a quick glance. Now, like any skill, the best way to master analyzing income statements is simply to practice. But if you can train yourself to watch these five key terms when analyzing an income statement, you'll learn also how to analyze it extremely quickly. Well, I hope that you enjoyed this video. If so, give it the thumbs up and let me know in the comments what other financial statements you want me to cover. And if

you want a free copy of that accounting infographic ebook, just click the link in the video description. Brian out. [Music]