Mapping Earnings: Finding the Bottom Line in Profits

Step 1: What Can I Determine About a Company From the Income Sheet?

Mapping Earnings: Finding The Bottom Line In Profits Splash image

The income statement reports on one of the most critical company figures—its earnings per share. Over the long run, a stock's value is dependent upon its earnings potential. Investors closely monitor earnings announcements. Stock price can nose dive when earnings expectations are missed by even a few pennies. Therefore, it is important to be able to read and understand an income statement and identify trends of key items that impact earnings.

The goal of the income statement is to determine revenue for the period that it covers and then match the corresponding expenses to the revenue. The income statement, sometimes referred to as the statement of earnings or statement of operations, presents a picture of a company's profitability over the entire period of time covered. This is in contrast to the balance sheet, which presents a snapshot of a company's financial condition at a specific point in time.

Classroom Steps

The income statement cumulates revenues and expenses and presents the results in a statement that is designed to be read from top to bottom. Like the balance sheet, the income statement reflects management's decisions, estimates, and accounting choices. Just looking at the bottom-line profits may mislead investors. A careful, step-by-step review of the income statement is useful in order to judge the quality and content of the bottom-line earnings figure.

The income statement outline presented in Table 1 has five income steps: (1) gross income, (2) operating income, (3) income before taxes, (4) income after taxes and (5) net income. There is wide latitude for the format of the income statement used by firms, but the five-step format is useful in explaining the information provided by the statement.
