Financial StatementsFinancial Statements

The Income Statement

Crow River Investment Club

www.bivio.com/crowriver

Introduction to this SeriesIntroduction to this Series

This is first of 4 short overviews

• 3 Main Financial Statements:– Income Statement – Balance Sheet– Cash Flow Statement

• Finally, Annual Report Worksheets– By Bob Adams– By Paul Schneider

Income Statement: The BasicsIncome Statement: The Basics

1. Financial analysis is about Comparison. That’s why these statements all come with more than one year of data.

2. The Income Statement (or Profit & Loss Statement) reports the income, expenses and profits for a specific period of time.

Income Statement: The BasicsIncome Statement: The Basics

3. Product Companies report “Net Sales”

4. Service Companies report “Net Revenues.”

5. Net Sales & Revenues are the same thing.

6. “Net” means after the return of defective products.

Income Statement: The BasicsIncome Statement: The Basics

7. Everything on the Income Statement can be expressed as a percentage and compared to competitive companies.

8. Everything on the Income Statement can be compared as a percentage to Net Sales or Revenues.

Income Statement: The BasicsIncome Statement: The Basics

9. Companies are valued based on the cash produced from “core” operations (or Operating Income).

10.Focus your attention on the “core” business. What business is the company in? How much money did that business generate or cost?

Income Statement: The BasicsIncome Statement: The Basics

11.Finally, be aware of income and expenses that are “not” generated from the “core” business.

12.If a company restructures, or takes one-time gains and losses annually, they are no longer “one time”, are they??

The Anatomy of an The Anatomy of an Income StatementIncome Statement

Net Sales or Revenues- Cost of Goods Sold= Gross Profit

Gross Profit divided by Sales =Gross Margin, the percentage of every

dollar it costs to produce sales.

Comparing Business ModelsComparing Business Models

Let’s compare Mentor (MNTR) with Factset (FDS) 2002 annual figures:

MNTR FDSNet Sales $321,062 $205,853Cost of Sales $130,455 $ 67,947Gross Profit $190,607 $137,906

Gross Margin 59% 67%

Which one has a more profitable business model?

What’s Next?What’s Next?

Other Operating Expenses, such as:• Utilities• Labor Costs• Advertising

Then, Other Income & Expenses, such as:• Short-term Investments• Royalties on Patents• Payment on a Lawsuit• Foreign Exchange Rate deficit• Interest Income & Expenses

The Anatomy of an The Anatomy of an Income StatementIncome Statement

SO…

Gross Profit- SG&A Expenses+ Other Income- Other Expenses= Income Before Income Taxes

This is an important SSG figure!

Taxes?Taxes?

Why do we look at pre-tax income? • Companies have no control over taxes• Taxes vary from state to state• Taxes don’t show the true picture• Various industries are taxed differently• Tax credits skew year-to-year earnings

Taxes have their own line on the Income Statement.

The Anatomy of an The Anatomy of an Income StatementIncome Statement

So…

Income Before Taxes- Provision for Income Taxes= Net Income

The Anatomy of an The Anatomy of an Income StatementIncome Statement

And…

• Net Income divided by Shares Outstanding = Earnings Per Share or EPS

• Diluted Earnings Per Share:

The value of each share “after” the effects of stock options and convertible shares and bonds have been taken into consideration.

Income Statement RatiosIncome Statement Ratios

Which Ratios are Important?

Gross Margin:

Sales – Cost of Sales div. by Sales • How profitable is this business model?• Is it more profitable than its peers?• Is it getting more profitable from year-to-year?

Income Statement RatiosIncome Statement Ratios

Which Ratios are Important?

Net Margin:

Net Income divided by Net Sales

• Is there any money left over for the shareholders after all expenses and taxes are paid?

• Is Net Margin growing from year-to-year?• How does it compare to its competitors?

Income Statement & the SSGIncome Statement & the SSG

Sales- Cost of Goods Sold- SG&A Expense+Other Income- Other Expenses= Income Before Taxes- Income Taxes= Net Income (div. by Shares Outstanding)= Earnings Per Share (EPS)

These are the items required on the Quarterly

Data Update Screen & PERT Report

A Quick Look at FactSetA Quick Look at FactSet

2002 2001 Change

Commissions $ 62,196 $ 56,462 + 10%Cash Fees $143,657 $120,226 + 19%Total Revenue $205,853 $176,688 +16.5%

Cost of Services $ 67,947 $ 61,576 + 10%SG&A Expenses $ 75,084 $ 64,209 + 17%Total Op. Expenses $143,935 $125,785 + 14%

Net Income $40,848 $ 33,401 + 22%Diluted EPS $ 1.17 $ .96 + 22%Shares Outstanding 34,862 34762 0%

A Quick Look at FactSetA Quick Look at FactSet

2002 2001

Total Revenue $205,853 $176,688- Cost of Services $ 67,947 $ 61,576

$137,906 $115,112Div. By Revenues = Gross Margin 67% 65%

Net Income $ 40,848 $ 33,401Div. By Revenue = $205,853 $176,688

Net Margin 19.8% 18.9%

Are they getting better!!?

Next Month: The Balance SheetNext Month: The Balance Sheet

The End