How can you analyze income statements for strategic decision making?

1 Understand the format

An income statement typically has four main sections: revenue, cost of goods sold (COGS), operating expenses, and net income. Revenue is the amount of money that a company earns from selling its products or services. COGS is the cost of producing or acquiring those products or services. Operating expenses are the other costs that a company incurs to run its business, such as salaries, rent, utilities, marketing, and depreciation. Net income is the result of subtracting COGS and operating expenses from revenue. It shows how much profit or loss a company made in the period.

4 Adjust for non-recurring items

Sometimes, an income statement may include items that are not part of the normal operations of a company, such as gains or losses from the sale of assets, restructuring charges, legal settlements, or impairment charges. These items are called non-recurring or extraordinary items, and they can distort the true picture of a company's performance and profitability. To analyze income statements more accurately, you should adjust for these items and calculate the adjusted net income and adjusted net margin. These are the net income and net margin that exclude the impact of non-recurring items. They can give you a better sense of how sustainable and consistent your business results are.

5 Use benchmarks and ratios

Finally, to analyze income statements more effectively, you should use benchmarks and ratios to compare your results with your competitors, industry standards, or historical averages. Benchmarks and ratios can help you assess your relative strengths and weaknesses, identify gaps and opportunities, and set realistic and achievable goals. For example, you can use the return on assets (ROA) ratio, which is the ratio of net income to total assets, to measure how efficiently you are using your assets to generate income. You can compare your ROA with your competitors' ROA or the industry average ROA to see how you rank among your peers. You can also use the earnings per share (EPS) ratio, which is the ratio of net income to the number of shares outstanding, to measure how much income you are generating for each share of your stock. You can compare your EPS with your previous EPS or the market expectations to see how you are meeting or exceeding the expectations of your shareholders.