Important Income Statement Calculations

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Important Income Statement Calculations

Once you know some of the major line items found on the income statement, you can discuss some of the important figures that are already calculated for us on it.

Gross profit

You actually won’t find this amount on all income statements, but it is very easy for you to calculate yourself. Just take revenue and subtract cost of sales. Gross profit shows how much of a markup a company receives on the goods and services it sells. If you paid $12 for an item at Best Buy, and Best Buy’s acquisition cost was $9, the gross profit Best Buy realizes is $3, or 25% of the sales price.

Operating income

Arguably the best indicator of a company’s true performance, operating income is often called operating profit. It is calculated by subtracting cost of sales and all operating expenses (SG&A, depreciation, amortization, restructuring, and other operating expenses) from total revenue. Operating income measures the profit (or, in the case of poorly performing companies, the loss) that a company is able to generate through its main operations. Operating income is also sometimes called "earnings before interest and taxes" (EBIT) because those expenses are not considered "operating" expenses.

Net income

Net income is what’s left over for a company after all expenses have been accounted for. It is sometimes referred to as a company’s "bottom line." Many management teams and Wall Street analysts talk quite a bit about net income, but keep in mind that many types of items, such as one-time gains, can distort this figure. It is generally a poor proxy for a company’s cash flow. And though net income is important, it should not be thought of as the end-all, be-all figure to focus on.

Earnings per share

Earnings per share, or "EPS," is simply net income divided by the weighted average number of shares outstanding during the relevant period. (This number of shares is also listed on the income statement.) EPS is what management and Wall Street analysts seem to focus on most, since it is the profit left over for stockholders. While EPS can be a useful number, be sure to consider it in context with the company’s other financial information.

You’ll notice that two EPS calculations are performed on the income statement: one for basic EPS and the other for diluted EPS. The difference is in the way the number of shares outstanding is used. The basic EPS calculation uses basic shares, which are the actual shares of a company’s stock outstanding, as its denominator.

Conversely, the diluted EPS calculation uses diluted shares outstanding, which takes into account securities that could be converted into common stock at some future point. Such securities include stock options issued to employees and convertible bonds. Using diluted shares is much more informative than using basic shares, because if and when these securities are converted into shares of common stock, your stake in the company, or your piece of the total pie, gets smaller and smaller.