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Master the Art of Income Statement Analysis with These 8 Tips

Income statement analysis

An income statement reports how much a company earned and how much it spent over a particular period of time s well as the net income or loss during that period. All of the revenues of a company and the expenses that were incurred to achieve those revenues are detailed on the income statement in order to come up with a final net income or net loss.

An income statement analysis can reveal a great deal of useful information about a company including:

  • Rate of return on shareholders assets and retained earnings
  • Interest income and expense of the company
  • The amount of taxes paid by a company
  • Gross profit margins, operating profit margins and net profit margins of the company over a specific period of time

This information can be used to determine the effectiveness of management in controlling expenses and the compare the performance of the company against its competitors and also used by specialists in auditing assignment help. Many investors base their decision as to whether or not to put money into a company strictly on information that they obtain from the income statement.

Tips to remember when doing an income statement analysis

The following eight tips and suggestions should be kept in mind when you are performing an income statement analysis:

  1. Breaking revenue down into clearly defined and separate categories makes analyzing an income statement easier and growth can be predicted more accurately
  2. Create a common size statement that represents each line item as a percentage of sales/revenue. This is the income statement with everything restated as a percentage. Net Sales will always be 100% at the top, and divide each of the expenses by total sales to get a percentage for that particular expense. The common size statement gives you the calculation of all profit margins, from gross to net, and shows how much each cost item takes away from profits.
  3. Remember that the income statement measures profit and not cash flow. Showing a profit doesn’t necessarily mean there is money that can be spent
  4. Use trend analysis to help predict how a company will perform in the future. Trend analysis is a type of income statement analysis that compares the income statements from two or more years to look at different trends in expenses, income and profitability over time.
  5. Perform a percentage change income statement analysis to obtain growth rates for all income statement items and relative to a specific year that will be used as a base. Using this form of income statement analysis lets you see how different income statement items grew or declined relative to growth or declines in sales.
  6. Gross profit margins are a ratio that investors are very interested in. Gross profit margin is calculated by dividing gross profit by the total revenue. The higher the percentage, in most cases the more favorable it is.
  7. The same income statement can reflect a different outlook depending on whether cash-basis accounting or accrual accounting methods were used.
  8. Bench marking is using the ratios from an income statement to compare with others in the industry to analyze the performance of one company against another.

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