As mentioned in our last blog, Company Financials is one of the key influencers determining a stock’s value. It includes a bunch of reports such as income statements, balance sheets, and cash flow statements. An investor should know the basics of these statements and what they signify to understand the company’s position when it releases these reports.
Let’s start with the income statement. An Income Statement is one of the most important statements that reveals a company’s income and expenditure and shows how profitable it has been over a specific period. Because of this reason, it is also known as the Profit and Loss (P&L) Statement.
While Income Statement covers a lot of information and contains several sections and subsections, the three main headings to keep in mind are Revenues, Expenses, and Net Income.
Revenue refers to the total income a company generates. Because it appears at the top of an income statement, it is also referred to as ‘top line.’ Another word synonymously used with revenue is ‘sales.’ While it can be true for certain income statements, it is inaccurate because a company’s revenue might differ from its sales. A core difference between ‘revenue’ and ‘sales’ is that the former is the entire income a company makes, and the latter is the income it generates solely from selling goods and/or services to its customers. You might wonder how a company produces extra income without selling its goods and services. While ‘sales’ is part of the ‘revenues,’ it might not be the ‘only’ part. There are non-operating revenues that a company may make from occasional events. These can be the sale of assets, investment windfalls, the money awarded through litigation, and many more.
Within sales, we have other categories, but the two most important are Gross sales and Net sales. The sales that we just talked about are Gross Sales, i.e., the total sale transactions within a specific period for a company. On the other hand, Net Sales takes sales allowances, sales discounts, and sales returns into account and deducts them from Gross Sales. It gives a much clearer picture of the Company’s sales performance and the revenue generated from it.
Next comes Expenses. Expenses are mentioned in an income statement to calculate the sustaining and operating costs of the company. There are two main terms to remember within the ‘Expenses’: Cost of Sales and Operating Expenses. Cost of Sales, also called Cost of Goods Sold (COGS), is the direct cost associated with producing goods and services sold by a company. The amount includes the cost of raw material and direct labor. For example, for a French Fries stall, COGS would be the cost of potatoes, oil, salt, spices, and any direct labor associated with the production of French fries.
Gross Profit= Revenues – COGS
Gross Margin = (Revenues – COGS)/Revenues