What is the Income Statement?

It Shows the Bottom Line Which Investors Value Highly

The income statement similar to the balance sheet statement helps investors with analyzing the operating strength of a company which helps to further solidify the financial health of a company. 

While the balance sheet dives into the assets, shareholder’s equity, and liabilities on a company’s book, the income statement highlights the performance of a company for a particular period as it captures the revenue and expenses leading down to the bottom line (net income). 

This is why the income statement can also be referred to as the profit and loss statement (P&L). 

Much like the balance sheet statement, the income statement has a few financial ratios that investors will pay attention to but these are entirely subject to change as the company moves forward.

Margins Vary Depending on the Industry but Show Operating Efficiency

Gross Profit Margin

The gross profit margin shows the profit from the revenue (sales) in relation to the cost of goods sold (COGS). It is the leftover money from the sale of products and services after being subtracted from the cost of providing the goods or services. The gross profit ratio can give valuable insight for investors who want to see how efficiently a company has operated during a specific time period.

Fluctuations in gross profit margins can be normal since companies are constantly upgrading their technology to decrease operating costs or at times can hold pricing power with superior products and services in comparison to their competitors. 

Similar to how investors and analysts use relative valuation to compare companies in the same industry on a price to earnings ratio (PE), investors will also compare gross profit margins amongst companies of the same industry to see which companies are continuously improving the efficiency of their business model. 

The standard percentage for a gross profit ratio varies depending on how capital intensive a particular industry is so investors will look to compare on an apples to apples basis.

Gross Profit Margin= (Revenue-COGS)/ Revenue  

Net Profit Margin

Also known as net income, the net profit margin is similar to the gross profit margin in that it continues to capture the earnings a company generates but in a slightly different manner. 

Investors see this ratio as the bottom line since it is placed at the bottom of the income statement to capture all associated costs and expenses with the revenue generated. 

Think of it as the money officially leftover for the company to utilize at the end of a specific period leading into their cash flow statement. Net income goes beyond the Cost of Goods Sold (COGS) and will include other expenses such as tax, depreciation and interest on debt. 

At the end of the day, the net profit margin sees how much of each dollar earned remains as profit for the company. It will usually be expressed as a percentage.

Net Profit Margin= (Net Income/ Revenue) x 100  

Margins are Insightful but Top Line Revenue and Outlook move the Equity Needle

Investors certainly place focus on profit margins whether it be gross or net and it is important to see a company increasing their margins over time but they are subject to fluctuations as business models go through changes. 

Reported earnings can certainly move the direction of common stock, but it is usually Business Outlook and whether or not a company will continue to grow top line revenue in relation to their Total Addressable Market (TAM) that moves the stock price. 

An investment thesis involves multiple components inclusive of taking a look at the income statement.