How to Understand Income Statements. Income Statement Explained for Beginners!

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Income statements explained!
This is an introduction to financial statements. One of the first things you see of a company's detail is the income statement. I go through how it is put together and the key numbers you should be looking for.

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1) Revenue/Sales - Revenue is the total amount of income generated by the sale of goods or services related to the company's primary operations. Revenue, also known as gross sales, is often referred to as the "top line" because it sits at the top of the income statement. Income, or net income, is a company's total earnings or profit. When investors and analysts speak of a company's income, they're actually referring to net income or the profit for the company. Revenue or net sales refer only to business-related income (the equivalent of earned income for an individual). If the company has other sources of income from investments, for example, the income is not considered revenue since it wasn't the result of the primary business. Any additional income is accounted for separately on balance sheets and financial statements.

2) Operating costs - An operating expense is an expense a business incurs through its normal business operations. Often abbreviated as OPEX, operating expenses include rent, equipment, inventory costs, marketing, payroll, insurance, step costs, and funds allocated for research and development. One of the typical responsibilities that management must contend with is determining how to reduce operating expenses without significantly affecting a firm's ability to compete with its competitors. Operating expenses are necessary and unavoidable for most businesses. Some firms successfully reduce operating expenses to gain a competitive advantage and increase earnings. However, reducing operating expenses can also compromise the integrity and quality of operations. Finding the right balance can be difficult but can yield significant rewards.

Uses of Income Statements
Though the main purpose of an income statement is to convey details of profitability and business activities of the company to the stakeholders, it also provides detailed insights into the company’s internals for comparison across different businesses and sectors. Such statements are also prepared more frequently at the department- and segment-levels to gain deeper insights by the company management for checking the progress of various operations throughout the year, though such interim reports may remain internal to the company.

Based on income statements, management can make decisions like expanding to new geographies, pushing sales, increasing production capacity, increased utilisation or outright sale of assets, or shutting down a department or product line. Competitors may also use them to gain insights about the success parameters of a company and focus areas as increasing R&D spends.

Creditors may find limited use of income statements as they are more concerned about a company’s future cash flows, instead of its past profitability. Research analysts use the income statement to compare year-on-year and quarter-on-quarter performance. One can infer whether a company's efforts in reducing the cost of sales helped it improve profits over time, or whether the management managed to keep a tab on operating expenses without compromising on profitability.

The Bottom Line
An income statement provides valuable insights into various aspects of a business. It includes a company’s operations, the efficiency of its management, the possible leaky areas that may be eroding profits, and whether the company is performing in line with industry peers.