How to Read an Income Statement

By: Mr. Moneybags

Welcome to BIG FAT MONEYBAGS! If you would like to one day afford a ping-pong table forged out of platinum, then you might want to subscribe to our RSS feed. You may also want to to follow us on Twitter for good measure as well...or else.

If you want to make a sizable fortune in the stock market, being able to read an income statement will be crucial for your wallet’s jubilation… otherwise you will be essentially gambling your money when you invest in stocks and will most likely end up having to steal peoples’ kidneys just so you can pay off the bills.

The information that you can extract from a company’s income statement is as crucial to the understanding of a company’s health as Angelina Jolie finds it necessary to adopt 47% of the children living in third world countries.

Nowhere else can you find out how much money a company is making if it is making any at all, how much money it is generating from the sales of its products, how much money selling their products is costing them or even how much the company is paying in taxes.

Think about it: would you ever consider lending somebody money who has absolutely no income and spends all her money building her collection of vacuum cleaners and hot rods? I would certainly hope not. And how would you find out what she spends her money on and where she makes it in the first place?

By reading her income statement. [Of course, only corporations have to file income statements, but there are other ways of acquiring the same information for individuals – such as via credit history or tax returns, but that’s for a completely different article.]

It’s in effect the exact same scenario (lending money to someone versus buying stock), since when you buy shares of a company you are ultimately lending the company your money in the amount of shares that you bought. That’s why you are going to want to lend money to someone you know can pay you back (preferably with interest) and buy a stock that will grow in value (and make you a profit off of your investment).

If you ever watch business news or listen to people argue about the stock market, there’s a good chance you will hear them throw words around such as revenues, net income, the “bottom line”, research and development and sometimes they will even get a little technical and use terms such as P/E ratios (Price to Earnings), Earnings Per Share (EPS) and Return on Equity (ROE).

These are all tools that investors use to measure the worth of a company and all this information can be found my manipulating the information provided in a company’s income statement with a smidge of help from the balance sheet.

Sure, all these strange words may seem complicated and overwhelming at first glance, but I assure you – learning all this is no harder than peeling an avocado in the back of a moving truck (hard for some, manageable for most).

And just because reading an income statement may sound as fun as mixing cement in your mind, it doesn’t necessarily mean it has to be so. I will do my best to make this guide as painless, entertaining and informative as humanly possible. Just keep visualizing the giant bags of money that you will be making off of the stock market if you use this information effectively and you should do fine.

Now, let’s get started!

…But first:

Instead of going over a giant list of terms and tables and using a whole concoction of made-up examples to define each term like most others do for some reason, I will just jump straight into a real-world example and will explain how to read the income statement from the top down using that one example.

As my shining example of financial literacy, I will be using the maker of the oh-so popular Blackberry smart phones known as Research in Motion (stock symbol: RIMM).

I’ve chosen this company because the number of people who don’t know what a Blackberry is in the world can be counted on your fingers; so, you people should have at least some sort of interest in this company – plus you can see what effect you buying your phone has on RIM’s financial standing.

You can find Research in Motion’s income statement in this link here (http://moneycentral.msn.com/investor/invsub/results/statemnt.aspx?Symbol=RIMM). I would highly recommend you have that page open as you read this article, otherwise you will have no idea what is going on and I would prefer to avoid bringing out peoples’ suicidal tendencies (for legal purposes).

I have chosen MoneyCentral’s website to view the company’s income statement because I find it is the most convenient to use. Many people get their information directly from the source, being annual reports (also called 10-k reports) or from other websites such as Yahoo! Finance or Reuters.

I would recommend for you to start with the MoneyCentral link above to get a feel for the company over a long-term perspective and after move on to the annual report which is significantly more detailed but only has quantitative information for the last two years. You can find the annual report here: http://moneycentral.msn.com/investor/sec/filing.asp?Symbol=US:RIMM

For the purposes of this article, I will use the information quoted on the MoneyCentral website as it is much more general and can apply to more than just a single company, otherwise you will find yourself getting lost when reading the income statement of non-cell phone making companies.

At first glance, you will most likely see a whole jumble of numbers and your first instinct will be to buy the length of rope that I sell for discount prices – but before you do that, just take a deep breath and regain your composure. We will go over every little detail together and I will explain to you the meaning and significance (or lack of) for every little word and number.

For your convenience: text under italicized headings can be easily skipped over and it probably won’t affect your multiples of moneybags very much – but I would still recommend you read it so that you understand all the little intricacies that come with rolling around in giant piles of cash.

Now, let’s get started! (For real this time)

Part One: General income statement information

Part Two: Revenue, Cost of Revenue and Gross Profit

Part Three: Operating Expenses and Operating Income

Part Four: Net Income and everything else