Investors tend to know the basics about earnings when they pick potential stocks. They understand earnings-per-share and year-over-year growth and how to compare a company's figures to Wall Street's estimates. But many investors don't understand much more than that, like what calculations go on to determine a company's bottom line.
That's where a profit and loss statement comes in. It's the behind-the-scenes of the final earnings number that gets released each quarter (alongside the company's balance sheet and cash flow) and repeated across financial news outlets.
A profit and loss statement (or income statement) breaks out revenue, often by segment, and then costs, and subtracts the two to get profit, which we all know is the same thing as earnings. But let's go a bit further. Here is how to read deeper into a profit and loss statement. We'll use Apple's (NASDAQ: AAPL ) profit and loss statement as an example.
How to Dive Deep Into a Profit and Loss Statement
In the 2017 annual statement, Apple reported revenue of $229 billion and that revenue cost $141 billion, leaving the company a gross profit of $88 billion. But if you scroll down a bit, you'll notice other figures. For example, the company posted operating income of $61 billion and net income of $48 billion.
So what's the difference?
Operating income represents the company's profit, minus the day-to-day costs of running its business, which are known as operating expenses. In 2017, Apple spent $11.6 billion on research and development, plus $15.3 billion on selling, general and administrative expenses - the two most common buckets of operating expenses. This figure is also sometimes referred to as "earnings before interest and taxes" - or EBIT.
Another subset of operating expenses, though its not always broken out on websites that summarize the financials of publicly traded companies, is direct costs or cost of goods sold (COGS). Operating expenses like rent or utilities don't count here, but everything you spend directly on making a product or delivering a service does count.
Net income, on the other hand, means more figures are subtracted from the bottom line, including - you guessed it! - interest and taxes. In 2017, Apple's income tax expenses totaled $15.7 billion. But it also made $2.7 billion in additional income. So that income gets added to the operating income, then the $15.7 billion gets subtracted to get the company's net income of $48.4 billion.
Now, technically, that's the company's net income from continuing operations. The final net income figure would also factor in non-recurring events - discontinued operations or extraordinary items. But because Apple, according to its statement, didn't have any of those, the figure is also it's final net income figure.
Understanding the calculations that go into a company's quarterly and/or annual earnings figure is important to understanding its business model and what affects fluctuations each quarter/year. As such, the profit and loss statement is one important component of a fundamental analysis that every investor should master.
As of this writing, Robert Martin was long AAPL.
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