Financial Statements – Terms and Explanations


Definitions on Income Statements

Here is a brief synopsis of key financial terms for introductory finance majors and business folks regarding income statements and balance sheets. Firstly, defining some terms:

Income Statement : A statement measuring a firm’s financial performance over a period of time. Generally, it records revenues and expenses to derive income over a specified period

Balance Sheet : This analysis sheet provides a “snapshot” at a point of time of the firm’s health in terms of total assets (what do they own), total liabilities (what do they owe), and equity (how much of the firm’s assets are financed by the owners).

The basic idea for financial statements is to make decisions and provide information on the firm. At the most essential element you seek: Revenue – Expenses = Income

The time period can vary, perhaps monthly, quarterly, or annually.

Financial Statement Formulas:

Sales (Revenue) – Cost of Goods Sold (COGS) – operating costs and depreciation = Earnings Before Interest and Tax (EBIT)

– interest paid = Earnings Before Tax (EBT) or taxable income – Taxes = NET INCOME (NI)

Highlights: The initial thing reported on an income statement is revenue & expenses from the firm’s principal operations. Revenue – operating expenses = EBITI

Subsequent parts include the financial expenses (interest paid), Taxable income (EBT), Taxes paid. Combine them all and you are left with the last item: Net income.

About Revenue: Also called sales or net sales, revenue is what a business earns for the sale of its products and/or services. Therefore in a basic formula:

Net Sales = Gross sales – Returned products – Discounts taken for prompt payments of invoices – Allowances made for damaged products

About the Expenses: Let’s talk briefly about expenses including the Cost of Goods Sold (COGS). COGS is the cost incurred in making or producing the goods that were sold (also called Cost of Sales). The value captures manufacturing expenses for the products sold. So that would mean: raw material + labor + factory overhead (which includes utility, property taxes, insurance, etc.)

Also included in expenses is operating costs, also called G&A (General & Administrative) expenses. Selling expenses, marketing expenses and Administration which includes: Selling: salespeople’s salaries, bonuses, office expenses, etc; Marketing: promotions, advertising, marketing research, salaries, etc.; Administrative: corporate & divisional staff, executive compensation, R&D, etc.

Don’t forget depreciation is not treated the same. Equipment and building and land = NO depreciation, (and when you depreciate never goes to zero; depreciation also becomes part of cash flow.)

Switching gears let’s talk more specifically about Net Income (NI), in this case on a per-share basis. The formula would be: Earnings per share (EPS) = NI / # of common shares. This changes when you consider distribution of Net Income, then the formula is: Net Income = Dividend paid to shareholders + Addition to Retained Earnings. When you consider the stock market: market price / earnings per share = P/E ratio.

This discussion continues with a discussion on earnings per share and dilution.

One response to “Financial Statements – Terms and Explanations”

  1. What you wrote regarding depreciation makes absolutely no sense. I think you need to check on your facts.

    Maybe you meant depreciation is a non-cash expense? Equipment, buildings and land don’t depreciate? I believe land is the only one in your list that doesn’t depreciate. Equipment and buildings, most certainly, are subject to depreciation. Also, what doesn’t go to zero when you depreciate? How could you continuously depreciate an asset and not have its value approach zero, unless the depreciation is based on some type of crazed formula, which would be illegal? Listen, if you just look at the MACRS depreciation table, it could be easily understood. For the 3 yrs MACR, the first year you depreciate 33.33%, yr 2 44.45%, yr 3 14.81%, yr 4 7.41%. Now add that up. Given that when using MACRS you ignore residual value, if all 4 figures do not sum up to 100%, then you’re absolutely right, the value of the asset will not be zero after it’s fully depreciated. Of course, it does sum up to 100%!!

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