Practice Income Statement Analysis with a Real Statement

The best way to learn how to read and analyze an income statement is to pick up a real company's annual report or Form 10-K and familiarize yourself with the financial statements contained there. Practice reading them, including the footnotes, and interpreting them. 

You can learn a great deal about the income statement by getting your hands on income statements from several different companies. This will help you see how they're similar or different. Examine some of the unique line-items you might notice on one company's income statement but that ​you don't find on those of other firms. Notice how certain businesses in different sectors or industries have completely different economic characteristics. If you can find common-size income statements for each company, which set each line item as a percent of sales, then you can also compare and contrast expenses by industry sector and other factors.

You'll find completely different profitability pictures for each company that tend to result in some sectors and industries producing much better outcomes for shareholders over the decades than others. You'll begin to "see" the business through these income statements, especially when you measure them in conjunction with other financial statements and the footnotes. You'll begin to understand the things that drive profitability and how rigid a firm's cost structure might be. 

An Example of Income Statement Analysis 

This income statement analysis lesson retains a sample income statement oldie but goodie from Microsoft, and it works because it covers all the bases and poses an understandable example. 

The income statement below is from Microsoft's 2001 Annual Report and it shows the full fiscal year income statement figures for three years: 2001, 2000, and 1999. Although the world has changed significantly since then, the big concepts and principles haven't. Seeing the timelessness of fundamental analysis can also help you realize the power of a good long-term investment. 

Sample: Microsoft Income Statement

Fiscal year 2001 2000 1999
Total Revenue $25,296,000,000 $22,956,000,000 $17,747,000,000
Less: Cost of Revenue $3,455,000,000 $3,002,000,000 $2,814,000,000
Gross Profit: $21,841,000,000 $19,954,000,000 $16,933,000,000
Operating Expenses      
Research and Development $4,379,000,000 $3,772,000,000 $2,970,000,000
Selling, General, and Administrative Expenses $5,742,000,000 $5,176,000,000 $3,953,000,000
Non Recurring N/A N/A N/A
Other Operating Expenses N/A N/A N/A
Operating Income (gross profit - op. expenses) : $11,720,000,000 $11,006,000,000 $10,010,000,000
Total Other Income and Expenses Net N/A N/A N/A
Earnings Before Interest and Taxes (EBIT): $11,525,000,000 $11,275,000,000 $11,891,000,000
Interest Expense N/A N/A N/A
Income Before Taxes $11,525,000,000 $14,275,000,000 $11,891,000,000
Income Tax Expense $3,804,000,000 $4,854,000,000 $4,106,000,000
Equity Earnings or Loss Unconsolidated Subsidiary N/A N/A N/A
Minority Interest N/A N/A N/A
Net Income from Continuing Operations: $11,720,000,000 $11,006,000,000 $10,010,000,000
Nonrecurring Events      
Discontinued Operations N/A N/A N/A
Extraordinary Items N/A N/A N/A
Effect of Accounting Changes ($375,000,000) N/A N/A
Other Items N/A N/A N/A
Net Income: $7,346,000,000 $9,421,000,000 $7,785,000,000

The Take-Away Lesson 

Truly great businesses have a certain stability in their core economic engine, and this lets them enjoy specific advantages. A firm like Microsoft, one of the best and most successful businesses of all time, is inherently less secure than a firm like Hershey.

One conclusion to draw through analysis, if you were to compare Hershey's operations with Microsoft, is that the activities that produce the numbers in Microsoft's income statement are subject to change at any given time. While people will always love chocolate, Microsoft's products are at the mercy of technological advancement and fierce competition that can attack on all fronts and from all sides. As Microsoft founder Bill Gates once said, the firm's next biggest competitor could be a kid in a garage.

The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.