Chapter 5

 

Income Statement Terminology

This is an overview of terms and numbers you might see on an income statement.

§       Net Sales – The money collected for all goods sold by the company (gross sales) minus returns and allowances.

§       Revenue – Sales

§       Cost of Goods Sold or Cost of Sales – operating expenses or the cost of producing goods, manufacturing costs, bills.

§       Non-manufacturing Costs – Selling, general and administrative expenses. These include executive compensation, sales commissions, and staff department outlays

§       Other Income – examples of other income are interest or dividends on securities owned by the business, royalties on patents, profits on foreign exchange, etc.

Analyzing the Income Statement

One of the most important things to look at in the income statement is the pre-tax profit this is arrived at by dividing profit before taxes by bet sales.

It is important that we always look at a company’s profits before taxes because taxes can have a varying effect on the bottom line since taxes vary from year to year and state to state.

Another important thing to look at is the return on book value, or return on equity. This is the amount of each stockholder earned from the company this is determined by dividing the company’s net income by value of common stock.

Another figure of interest is sales per employee you can arrive at this figure by dividing sales by the number of employees. The number of employees should be available in the annual report.

 

Evaluating Management

Important things to look at when evaluating a company’s management. Remember that the strength or effectiveness of a company’s management is one of the NAIC principle guidelines when choosing a company to invest in.

§       Age – There should be a mix of old and young. Old and you tend to have less drive, young and managers tend to be too risky.

§       Names – Be wary of same surnames this can mean that they are of the same family.

§       Executive Compensation – This figure should be inline with the company’s size.

§       Consult Employees – If possible consult an employee and see what they think of management.

§       Look at Notes – The notes section in an annual report is usually in small type but should not be overlooked.

§       Check Auditors Endorsement – is it a routine endorsement or is it qualified. This determines the amount of “Creative accounting”

§       Where to get Annual Reports – Calling the Company, S & P, Web Services.