The Three Key Financial Statements: How To Read An Income Statement
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The income statement is one of the three key financial statements: the balance sheet, income statement, and cash flow statement. The income statement focuses on the company’s revenues and its expenses during a specific period of time. All of the key financial statements are used by many investors to determine if a company is financially healthy or primed to grow in the future. To better explain this topic, we will use an example of FaceBook’s (or Meta’s, I guess) most recent income statement linked here. The excel sheet is under income statement under the 3Q 2021 Section: https://investor.fb.com/financials/default.aspx
The first thing to check is what base the numbers listed are in. FaceBook list their numbers in millions USD, so although it says $29,010 it means $29.01B. The first row is revenue, which is the total amount of income made by a company, excluding expenses. For FB, that number is $29B. An example of revenue would be $60 if I sold 15 $4 glasses of lemonade. Cost of Revenue (Sometimes referred to as Cost of Goods Sold or COGS) is the costs to create the good a company is selling. FaceBook’s 5.7B would be employee salaries and other costs. For the lemonade stand it would be the price of the lemons, and sugar, and stand. The Gross Profit of a company is the revenue minus the COGS. FaceBook does not list this, but other income statements may. Research and Development (often shortened to R&D) are the costs that a company pays to innovate new products or services. For the lemonade stand this would be the prices of all the ingredients that I used while perfecting my recipe. Marketing and Sales expenses are pretty self-explanatory. General and Administrative (G&A) expenses are those that a company pays to operate without making revenue. Examples would be rent, insurance, and administrative employee salaries. Operating Income is the figure we get when we subtract all of the expenses from the revenue. FaceBook operating income (Op-Income) for Quarter 3 2021 was $10.4B on revenue of $29B. This makes their operating margin (Op-Income/Revenue) about 36%, which is considered a pretty strong operating margin.
Below the operating income, we have interest expenses. These are expenses that a company is paying back for borrowed money. If we borrowed $20 to open our lemonade stand that did $80 in operating income, we would have to subtract that $20. After subtracting the interest, we are left with pre-tax income, because companies pay taxes on their income, just like us. The taxes the company pays are listed, and once those are subtracted we are left with the net income. Net income is what we can view as the final profit of a company for a certain quarter. FaceBook’s net income for Q3 was $9.19B.
If we dive back into the lemonade stand example, we can better display each of these sections. After my day of selling lemonade, I find myself with $200, and this is our revenue. I sold 100 glasses of lemonade for $2 each, and each glass of lemonade costed me $0.25 to make. This makes our Cost of Revenue $25 (0.25 to make each cup * 100 cups). In order to perfect my lemonade recipe, I had to experiment, and I spent 2 hours tinkering (at San Francisco minimum wage) and another $25 on lemons and water. This would make our R&D expenses $57.64 (25 + 16.32 per hour * 2 hours). For sales, I sat at the lemonade stand selling lemonade for 2 hours (once again at SF minimum wage), and we did not have any marketing expenses. This makes our Marketing & Sales expenses $32.64 (16.32 per hour * 2 hours). Because this lemonade stand was such a bootstrapped operation, we did not have general or administrative expenses. This puts our operating income at $84.72 (REVENUE minus Cost of Revenue, R&D, M&S, G&A), and gives us an operating margin of 42% (Better than FaceBook!). In order to get our startup capital to buy lemons and sugar, we had to get a loan of $50 (the lemons that we used to make lemonade to sell and to create the formula). We got this loan from our loan shark of a mother charging 10% interest per day. We make the payment of $55 ($50 +10%*$50). Bringing our pre-tax income to $34.72. Corporate Income Tax is 21% in the US, so we end up paying $7.29 to the government, leaving us with our profit (net income) of $27.43, and a profit margin of 13% (unfortunately not beating FaceBook’s 31%). But, now that our company has secured a profit, we can use that $27 purely for Cost of Revenue and Sales expenses because we have already done all of our R&D. Based on this income statement, I’m thinking my lemonade stand will be IPO’ing at 60xRevenue before EOY (End of Year) 2021.
