What is Income Statement Analysis?
The analysis of the income statement involves comparing the different line items within a statement, as well as following trend lines of individual line items over multiple periods. This analysis is used to understand the cost structure of a business and its ability to earn a profit. A proper analysis of the income statement includes the activities noted below.
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The Interpretation of Financial Statements
Ratio Analysis
Several ratios can be extracted from an income statement, each of which reveals different types of information about a business. They are as follows:
Gross margin. This is revenues minus the cost of goods sold, divided by revenues. It indicates the amount of money earned from the sale of goods and services, before selling and administrative charges are considered. In essence, it reveals the ability of an organization to earn a reasonable return on its offerings.
Contribution margin. This is revenues minus all variable expenses, divided by revenues. This margin is used to construct a break even analysis, which reveals the revenue level at which a business earns a profit of zero. The break even calculation is all fixed costs divided by the contribution margin.
Operating margin. This is the profit earned after all operating expenses have been subtracted from the gross margin, divided by revenues. It reveals the amount that a business has earned before financing and other costs are considered.
Net profit margin. This is the profit earned after all operating and non-operating costs have been subtracted from the gross margin, divided by revenues. This is the ultimate analysis item - can a business earn a profit when all deductions are considered?
