A publicly traded company has to compulsorily publish its income statement in addition to other financial statements for a quarter or year to the public. These statements are to be filed with the government and stock exchanges as per the rules and regulations of the country.
Income statement is also known as profit and loss account. It depicts the total revenues, cost of goods sold, overheads, interest paid, taxes, other expenses and net earnings generated by the company over a specific period of time. This means, if the profit and loss account is published for a quarter, then revenue, cost of goods sold, overheads, interest paid, taxes, all other expenses and net profits as published are for the quarter.
You can also find these reports from company’s website.
One of the main purpose of publishing the income statement is to report company’s top line and bottom line to the investors and other stakeholders.
Based on this information and data, stakeholders can measure how well the company has done during the period.
Why to analyse income statement of a company
By analysing income statement of a company you can get answers to following questions to take a better investment decision;
- What is company’s gross profit margin, net profit margin and operating margin. What is the ability to generate more profits in future.
- Is the company generating enough profit to take care its interest expenses in future.
- What is the cost structure of the business.
- How effectively company is managing its expenses.
- What is company’s earning per share or EPS. You can do a trend analysis to know the growth in EPS.
- What is company’s Price to Earnings ratio (P/E). Is it high compare to industry P/E ratio. Is the stock under-priced or over-priced.
- How much dividend company has paid per share and how much has been retained.
- What is the impact of non-cash expenses on net profit and what is company’s operational cash flow.
Horizontal or trend analysis of income statement
In general, company publishes comparative income statement by showing sales, expenses, operating profit and net earnings for different periods to help readers for better understanding.
You can do a trend analysis by comparing line items of income statement for number of years to know how the company is growing its top line and bottom line over the year.
If the income statement is for a quarter, then comparison should be done with quarterly line items of the previous years. This means, if you have the income statement for the October-December quarter, then comparison for the same quarter of earlier years should be done for better understanding of company’s financial position.
While comparing net earnings and other line items of income statement, you should exclude impact of exceptional items on the net profit.
Using Vertical analysis
Vertical analysis is used by investor to measure the size of each line items in income statement as a percentage of a base figure or in comparison to revenue.
You can also analyze items of income statement as a percentage of the total turnover to understand the financial position and relationship of income and expenses.
For instance, you can show revenue from different sources as a percentage of the total revenue. In it, total revenue will be shown as 100% and break up of it in a statement to know the size of each source of revenue or sales.
Similarly, expenses can be analysed to know its size in comparison to total expenses and revenue. This type of analysis will show you how these line items are contributing to profit margins and whether profitability is increasing over time.
Vertical analysis is a excellent way to show what is happening within the financial statement of a company. It also helps to compare the financial statements of one company with another.
You can compare line items of income statement such as sales, net profit and interest with balance sheet figures to get various ratios to analyse company’s financial health.