The corporate Income Statement is the most popular of the financial statements, as it chronicles the company’s operations over a given period of time, detailing how the company turned revenues into profits.  The most basic formula for the income statement is:

Revenues – Expenses = Net Income

Obviously, there’s more than three items listed on an income statement, but every line falls into one of the three categories as revenue, expense, or net income.  Revenues are the inflows a company receives from selling products or providing services.  Expenses represent the efforts required or expended to generate revenue, and net income is simply what remains of revenue after expenses.  Net income is the same as net profit.

Discontinued operations, extraordinary items, and accounting changes are supposed to be one-time items, which I call non-recurring items, that aren’t expected to occur on a regular basis.  Therefore, most analysts focus on income from continuing operations when determining a company’s performance, and for predicting future earnings.  For the most part, it’s reasonable to discount non-recurring items.  However, if a company has a history of non-recurring charges (what I like to call “recurring, non-recurring” items) you need to look closely at what's going on there. 

When non-recurring items appear on an income statement regularly, it’s likely a sign of trouble.  At best, it could indicate that management is engaged in too many activities unrelated to ongoing operations.  At worst, the company may be accounting for operating expenses as non-recurring charges to make continuing operations look better, which is bad, bad news.  If you suspect this is the case, run - don't walk - away from the stock.

Let's look at each of the Income Statement items in detail.

Revenues

Revenues, often called sales, are the proceeds a company gets from selling its goods or services, including discounts and returns.  Revenues are the top line item on an income statement from which everything else is subtracted. 

Cost of Goods Sold

Also known as cost of sales, the cost of goods sold is the expense a company incurs to produce a product for sale.  These costs would include raw materials, labor, overhead associated with product areas, and other costs that can be tied to the production of products for sale.  It normally excludes general and administrative expenses.

Gross Profit

Revenues minus the cost of goods sold is the gross profit, sometimes called gross income or gross margin.  This represents the profitability of the company's products, before corporate and marketing expenses are accounted for.  Gross profit represents money that a company can reinvest in the business, for such things as marketing, research and development, strategic investments, or payouts to shareholders.

Selling, General & Administrative Expenses

The selling, general and administrative expenses are costs not associated with the specific production of items for sale.  The SG&A costs include marketing expenses, corporate overhead, executive salaries, and other costs that aren't specific to a product line.  Research and development costs may also be included in SG&A.

Research and Development

Research and development expenses are used to develop new products, policies, or procedures.  If a company has a large research and development expense, it may be listed separately on the income statement. 

Depreciation and Amortization

Depreciation and Amortization is likely to be buried in with other operating expenses, but you'll always find it listed separately on a cash flow statement.  There are various methods used to calculate depreciation, but the general purpose is to expense the cost of capital purchases over their estimated useful life. 

When a company makes a capital purchase, it's generally for something that will be useful for more than one year.  Because these purchases are useful for more than a year, accounting rules don't require companies to write off the expense in only one year either.  The company estimates the useful life of the purchase, and based on approved formulas, spreads the cost to purchase over that useful life on the income statement.  This spread cost is called depreciation, and can be thought of as how much value the asset has lost over the period in question.