Five Tips for Analyzing Income Statements
			by Chris Mallon
	In today's article, we’ll be looking at the income statement, which is the most deceptively simple of the major financial statements.  I say simple because it’s just a list of all the revenue, minus all the expenses, to calculate what’s left over in profit.  Deceptive because it doesn't tell you the whole story without a little encouragement. These tips will help you to encourage the Income Statement to tell the whole story.  Put them to use with every company you plan to evaluate, and you'll find yourself making better investment decisions.    1.        Create a Common Size Statement A common size statement is the income statement, only with each line item represented as a percentage of sales.  Net Sales is always 100% at the top, and each of the expenses is divided by total sales to arrive at a percentage.  For example, if a company has $100 in sales and $50 in cost of goods sold, the common size statement will look like this: Sales                            100% Cost of Goods Sold      50% Gross Profit                  50% 2.        Create a Year-to-Year Comparison Statement The next step is to make a year-to-year comparison statement.  You can’t evaluate financial statements for just a single year; they have to be compared to previous years.  The only formula you need to know for these calculations is: (current year / previous year) – 1 = % change I like to have five years of data, which yields four years of comparison data.  This way you aren’t just looking at an exceptionally good or bad year for the analysis.   3.        Read the Management Discussion and Analysis If you take the time to read the MD&A, you’ll have an advantage on most investors.  A majority of individual investors simply skip this part, and go right to calculating ratios or looking at the EPS.  Seasoned investors know that the MD&A provides the backup data for the income statement line items, and they will take time to read it.   If you can’t make sense of the MD&A, that should set off alarm bells in your head.  If you don’t find the information you need in the MD&A, you should… 4.        Look at the Notes to Consolidated Financial Statements (Footnotes) The footnotes tend to be more difficult to understand than the MD&A, but you get really detailed information here.  The footnotes are where management hides the dirty laundry.  And when you’ve got guys making today’s corporate salaries, that laundry pile can get pretty big.  Here’s where you’ll likely find what you couldn’t in the MD&A, it’s just that in the notes you may have to do some putting of two and two together.   5.        Look at segmented data I always like to look at segmented sales and profit figures to determine which product lines, or operating businesses, are growing sales faster than the others.  This information is usually in the MD&A.  If you can, try to find the operating profit for each business segment as well.  Then look at the profit margins for each segment of the business.   You may be surprised at the different profitability levels of each business segment.  Compare the segment with the fastest growing sales versus the segment with the highest operating profit.  If these are the same segment, that’s good news.  If they aren’t, that’s okay too.   About the Author: Chris Mallon is the founder of www.dynamicinvestors.net, and a member of the Dynamic Investors partnership.   He is a regular contributor to The Motley Fool, the #1 financial website on the net.