One of the most important financial documents a company can compile is its income statement. This report looks at a company's financial income and spending over a certain period of time, and the results can be used to produce a number of helpful ratios that help executives and shareholders both understand the financial state of the business. For publicly owned companies, the income statement helps to show shareholders important information about the equity owned and potential dividends they may have received at the end of this time period.
Calculating Net Income
According to the writers at the SEC, the income statement looks at a company's revenue over a period of time (usually a year) and breaks down the major components of both revenue and expenses for shareholders, employees and investors. There are a number of income statement items that are worth noticing. The income statement starts at the top, with the total amount of money brought in over that time period from sales of the company's products and services. This total is called gross revenue, or gross sales.
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From that bulk total, the company then steps down a variety of expenses, including discounts and returns; cost of sales or cost of goods sold; operating expenses or overhead; depreciation and amortization. This gives the company an idea of its revenue based on operations alone.
From that point, there are still expenditures to consider. The next steps subtract interest incomes and expenditures, then income tax, which leads the company to what's called net profit (or net loss). This number is used in a few key financial calculations to help determine not only whether the company made money over the time period being considered, but also how well they did when compared to their outgoing funds. Once this net income has been calculated, the company can finally look at whether the company has lost money or whether they've profited over this particular time period.
Consider also: Traditional Income Statement Vs. Contribution Income Statement
There are a number of things a company can choose to do with its net income. The company may choose to pay dividends to stockholders (encouraging reinvestment); repurchase shares (to gain back a percentage of stock); reinvest in the business as capital or add the revenue to its existing cash for upcoming investments. What a company chooses to do is the result of a number of factors individual to each situation.
A key financial measure can be found by calculating earnings per share (EPS) for that time period of performance. To do so, divide net income by the number of outstanding shares in the company; this gives you the value of a share of stock and allows a stockholder to compare this number across other metrics to determine the fate of their own share.
The net income attributable to shareholders, also called net income applicable to common shareholders, is calculated by taking the net income and subtracting a portion that belongs to what are called minority interests. These usually involve a separate class of shareholders who bought stock of a different type that comes with a fixed dividend (this is sometimes called preferred stock).
Since dividend payments on this type of stock are required, this value is subtracted from the net income as another fixed cost. The value that remains afterward is the net income attributable to shareholders. This is one of the best financial ratios for investors to understand.
Keep in mind that this is the maximum amount of money a company can choose to pay out to its shareholders. Furthermore, if the company puts all of its net income into shareholder return, it will have nothing left over to reinvest into company capital. Likewise, a company that pays no dividends at all may have difficulty with shareholders selling stock and value plunging. A company's board has to balance these two business needs against each other to determine where the money goes.