what most people focus the most on when they analyze

companies, and that's the income statement.

And the income statement is one of the three financial

statements that you'll look at when you look at a company.

There's the income statement and the other two are the

balance sheet, which I have drawn a lot in a lot of the

other explanations I've done on the financial crisis and

whatever else.

And actually, in this video, we're going to see how the

income statement relates to the balance sheet.

And, of course, the last one-- well, it's not of course if

you don't know it-- is the cash flow statement.

And we'll focus on that a little bit later because

that's a little bit more nuanced relative

to the income statement.

So the income statement is literally just saying how much

a company might earn in a given period, and it's always

related to a period.

So it could be an annual income statement.

It could be for the year 2008.

It could be a quarterly income statement.

Those are usually the two types that you see, but

sometimes, there's monthly or six-month income statements.

And the general format is pretty consistent, although

there is a lot of variation depending on what a business

does, but in this video, I really just want to cover

almost a plain vanilla income statement for a company that

just sells a widget.

So the first thing when you sell a widget is you make it

and you just sell it.

You sell the widget.

You give a customer a widget, and they give you some money.

And that money that they give you-- and I'm not going to get

too technical about the accounting right now-- is

considered revenue.

It's sometimes considered sales.

And that's literally the money that they give you at a

certain period of time.

And some of you accountants out there are like, oh, well,

no, that's not just the money that they give you.

It's the money that you've earned in a certain period of

time, and that's true.

But for our sake, let's just say that when you give the

widget, you have earned the money that they give you, and

that's revenue sales.

Later on, we'll talk about different ways to account

revenue and sales.

So let's say the revenue or the sales in this case in a

given period, let's say that this is an income

statement for 2008.

So over 2008, we sold let's say $3

million worth of widgets.

So let's say it's $3 million.

And a lot of times when you look at income statements for

companies, if you go to Yahoo!

Finance, you could do this right now, instead of writing

$3 million, you'll see $3,000 there.

It's like, oh, my God!

This company, they're hardly selling anything.

But it's kind of a standard that they tend to write things

in thousands.

So 3,000 would be 3,000 thousands,

which would be 3 million.

And for really big companies, they actually sometimes write

their numbers in millions.

So if you saw 3,000 there, it would actually mean 3 billion.

But we'll actually look at real income statements in the

not-too-far-off future.

So that's how much money they give us.

But that's not how much income we made, because there was a

lot of cost that went into making that widget that we

have to account for.

It's not like when someone gives me $3 million, I can

just say, oh, I made $3 million.

Let me just put it all in the bank.

I'm done.

That was all income.

So the first thing that you tend to see on an income

statement is the cost of those actual widgets, the cost of

producing those widgets.

And I'll put all my expenses in magenta.

So it'll sometimes be written as cost of sales or cost of

goods sold.

And this is literally-- well, there's two things.

There's a variable cost which is, each widget, they might

have used some amount of metal and some amount of energy to

produce it and some amount of paint if

it's a painted widget.

And so that the cost of goods is literally how much did it

cost to buy the metal and the paint and provide the

electricity to make those $3 million worth of widgets.

That's the variable cost. And then on top of that you have

the fixed costs, or the relatively fixed costs, where

just to have the factory open, it costs a certain amount of

money every year, regardless of how many widgets you make.

And we'll go into more detail on that, But for simplicity,

let's say all those costs of making the

widgets were $1 million.

So sometimes someone might say it's a $1 million cost. When I

make models, I like to put a minus there, so that I

remember that that's a cost. Anything that detracts from

income I put as a minus.

Anything that adds is a plus, although that's not

necessarily the standard convention.

Some people say, oh, it's a positive $1 million cost,

which means you subtract.

But either way I think you get the point.

And then if you subtract your costs from your revenue, or if

you just add these two numbers, because this one is

negative, you have your gross profit.

And in this case, it would be $2 million.

And this number tells you, how much money did you make, or

how much profit did you make just from

selling these widgets?

So the more widgets you sell, in most circumstances, the

larger this number is going to be.

So this is your profit before all of the other expenses that

a company has to incur, like the taxes

and the CEO's salary.

The CEO's salary doesn't go in here, right?

Because the CEO doesn't go out there to the factory in most

cases and actually help make the widget.

So the CEO's salary or the CFO's salary or the

headquarters in a nice skyscraper, that doesn't get

factored in here.

Or the marketing expense, right?

You have to tell people, hey, we make good widgets.

So none of that is factored in here.

So that goes into the next line.

And oftentimes, you'll see it broken up, where they'll have

marketing expense.

Sometimes you have to pay salespeople, so you might have

sales expense, and then the stuff like the corporate

office and the CEO's salary, and you have to hire auditors

and accountants and all of that.

That might be included as general.

Actually, I should be doing this in magenta because it's

all expenses.

Marketing, sales, and then G&A you'll sometimes see.

Sometimes you'll see SG&A.

G&A just stands for general and administrative expenses.

If you see SG&A-- sometimes instead of that you'll see

SG&A-- that mean selling, general and

administrative expenses.

Selling is things like, it could be the commissions that

the salespeople get.

It could be just the cost of having salespeople travel

around the country and taking people out to steak dinners.

And then the general and administrative, that's just

all the stuff that the corporate office does, and all

the people who are at that level.

So if you subtract these, and I'm just making up these

numbers as I go.

Say, in marketing, the company is spending $500,000.

And I'm putting it as a minus because I like to remember

it's an expense.

Some models you'll see, they'll say

it's $500,000 expense.

Sales, let's say, this is just G&A here.

I want to make a separate line for sales.

So let's say sales, selling expenses is $200,000.

And let's say G&A, the corporate offices and all of

that, let's see that's another $300,000.

And now we're ready to figure out how much money did the

operations of this business make?

So this is operating profit.

This is really important to pay attention to, because so

many people say, oh, a company made this much.

And you'll hear these numbers, gross and operating profit and

net profit and pretax profit, and it's very hard to

understand that these are actually very, very