Studying the Income Statements

What is an income statement? An income statement is one of the three major parts of a financial report. It shows how a company generates it revenues and expenses, and how these lead to the company’s net income. In effect, it measures the financial performance of the company over a period of time. So, what do you need to pay attention to when looking at an income statement? The first things you should look at are the top line (revenue) and the bottom line (profits). Look for any changes in the values of these two. Of course, change can either be growth or decline. So, what should you do for each case?

If you see a massive growth in profits, examine the other lines of the income statement to understand the cause of growth. This could either be of two things- growth in sales or cost-cutting. Now which of these two is preferable? High quality growth comes from a growth in sales, while low quality growth comes from cost-cutting. As investors, we should definitely prefer high quality growth. In most cases, though, growth is likely to be a combination of revenue growth and cost-cutting measures.

On the other hand, declines in revenues and profits are, of course, not good news. But these would normally occur in any business. The important thing is to be able to determine whether the decline is temporary or permanent. This is especially so, if one is investing in a “growth story”.

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