In this video, we're going to try to take what we've learned about income statements and apply it to a real world set of financial statements. Our real world set of financial statements are based on a large U.S. multinational company that's in the consumer goods industry, the same one that we talked about when we talked about the balance sheet. So, if we take a look at the income statement, bottom line remember that income is about the profitability for a period of time, in particular for a year. In this case, it's the year ending June 30th. So it's again, the fiscal year is not necessarily December 31st. The income statement will tell you what period of time that we're talking about. Looking at the bottom line we see that earnings is positive, so they are making money but there hasn't been a lot of growth over this three-year period. Remember that the income statement helps explain changes in the balance sheet from the beginning to the end of the year. And that in particular is reflected in the retained earnings balance that's on the balance sheet. So, income in the most recent year was 11,312 again in millions. But if you look at the retained earnings balance, it didn't go up by that amount, and that's because some of the income was paid out as a dividend. Now, an important thing in looking at a set of income statements is year to year comparisons. So, we can see sales is going up, even though the income is not going up, it's a more up and down kind of thing. So there is something going on in between the sales line and the income line, and that's something that we would like to be able to investigate. Another important thing and trying to look at a set of income statements is to try to distinguish between recurring and non-recurring items. Income statements tell you here's what's happened, but not everything that happened this period is necessarily going to recur again next period. An important skill that analysts spend a lot of time on is to try to look at the income statement and try to sort out what do we think is going to continue to happen. Those are the important things from a valuation perspective. Valuation is a forward looking type of activity versus what happened that is less likely to recur again. If we do this, when we look at the income statement here, we see a line item that's called goodwill and intangible impairment charges. This is a lot of the variation in income over time for our firm. So what's an impairment charge? Another word for this is a write down. This is an important feature in accounting that says every year you have to take a look at your assets and decide are they really worth what you're showing them for on the books. And if they're not, you need to write them down. Writing them down means the asset moves down and owners equity moves down through the income statement. So, it's going to be a charge to income. If we've written them down the proper amount, there's no reason necessarily to expect an impairment charge to follow again the next year, at least not for that asset. So, we typically think of this impairment charges as not being recurring. Impairment charges also are not cash. We're saying we're don't expect to get as much benefit out of the asset. That's not the same as we lost cash this period. So, many people look at impairment charges and don't weigh them as much in terms of assessing the firm's performance, because they're not cash and because they tend not to be recurring. For other items, we don't have a line item title that indicates whether or not it's recurring or not. And so, here will often have to look to other sources like the footnotes to decide is it recurring or is it not. An important skill in looking at income statements is something called margin analysis or profit margin analysis. What we do is we take a look at the income statement but instead of looking at the dollars, we again scale it by something. And in particular what we do is we divide everything on the income statement by that year's sales revenue. That's then going to give us all of our costs as a percentage of revenue. This is going to help us identify our structure of costs. This is a very useful thing because it's going to tell us where did our sales dollars get eaten up. Case, sales was going up but income wasn't. Well, where did those sales dollars go. So, if we take a look at the income statement for our firm, but each year divide everything on that income statement by that year's sales, we start at 100 percent and then we see where the dollars went. So in the most recent year, 2xx3, we see that for every dollar of sales that we earned, 50.4 cents got eaten up by the cost of goods sold. That leaves 49.6 to cover all of our other costs, and contribute to profitability. Well, where did that go? Selling general administrative expenses consume 32 cents, operating profits were there for about 17 cents per dollar, interest taxes et cetera, brought it down to 13.5 cents. Note here that the percentages are pretty stable over time, and this is consistent with a mature company that's not really growing all that much. Most of the variation that we're seeing in the profitability over time, is really due to this non-recurring impairment charge that we talked about a little bit ago. And important thing to do is compare the cost structure here to the cost structure of other firms. Does the amount that we're spending on SGNA compare favorably or unfavorably to other kinds of firms et cetera. And so, we can identify strengths and weaknesses by looking at our comparative income statements through this margin analysis type of calculation.
