The income statement gives us a picture of one of the most important figures for a company, earnings per share. Earnings potential is one of the most important aspects of a stock's value as the investment community monitors earnings statement announcements with close scrutiny.(Barton & Simko 2002) Stock price fluctuations are highly sensitive to earnings announcements. Its important to be able to understand key parts of an income statement.
The main goal of the income statement sheet is to be able assess revenue in a coverage period and then tie expenses to that revenue. This statement gives a window into how profitable a company is over a time period covered. By contrast, a balance sheet gives a picture of a company's financial condition at a specific point in time rather than over the course of an entire time period. The income statement shows revenues, expenses and is organized in a format which is intended to be read starting at the top and moving downwards. Like the balance sheet, the income statement is a direct reflection of the choices of accounting and management at a firm. (Bujikowsi 1999) Careful analysis of the income statement is useful to understanding how a business operates from an investor's point of view. A typical income statement will have at least 5 steps involved, including 1. gross income, 2. operating income , 3. income before taxes, 4. income after taxes and 5. net income. Firms have discretion in the particular format they use for the document, however the 5 steps outlined above provide the basic of the logic involved.
Understanding the reporting method of transactions is important for understanding how income is reported on the statement The majority of US companies use an accrual method of accounting, which means transactions are posted as they accrue, whether or not cash or revenue has been paid (Bujikowski 1999).. Sales of goods are recorded only when the exchange has been completed. Expenses are recorded when goods and services that are the basis for the expenses are actually used. Credit sales are recorded as accounts receivables on the asset side of the accounting equation. Net sales revenue is thus the total of sales for the period. Gross income is the result, then, of subtracting COGS from net sales revenue. Subtracting the cost of goods sold from the net sales revenue produces gross income or gross profit. Taking operating expenses from gross income gives us operating income, also called earnings before interest and taxes (EBIT) which is all income during the period after which all costs have been taken away except for interest, non operating costs, and other charges. Taking non-operating expense from operating income leaves income or earnings before taxes (EBT). EBT is then adjusted for taxes and the result is after tax income, which is equivalent to net income. Net income is an important figure in investment reports, as earnings per share (often written as “EPS”) is the net income (minus dividend payments) divided by the mean average of outstanding common shares during the time period. (Bujuikowski 1999)
Understanding these ideas, we can now turn our discussion to consider Ford Motor Company's Income Statement for FY 2012 (Ford 2012). Ford's revenue in 2012 was $134, 252.00, while its cost of revenue was $115, 693.00. Gross profit was was $18, 559.00. In 2012, $12, 268.00 was the figure for Total Operating Expenses in 2012 (Ford 2012) Thus, from Gross Profit we have subtracted Total Operating Expenses, we now arrive at our figure for Operating Income, which is $6, 291.00. After taxes and other deductions, the figure we arrive at is net income, which totaled $5, 225 million in FY 2012. (Ford 2012)
Bajikowski, J.(1999) Fundamentals: a look at the income statement. AAII Journal, 67(3) 22-26
Barton, J., & Simko, P. J. (2002). The balance sheet as an earnings management constraint. The accounting review, 77(s-1), 1-27.
Ford Motor Company (2012). Form 10-K 2012. Retrieved from Gale Business Insights database.