Financial Modeling and Valuation: A Practical Guide to Investment Banking and Private Equity

CHAPTER 1

The Income Statement

The income statement measures a company’s profit (or loss) over a specific period of time. A business is generally required to report and record the sales it generates for tax purposes. And, of course, taxes on sales made can be reduced by the expenses incurred while generating those sales. Although there are specific rules that govern when and how those expense reductions can be utilized, there is still a general concept:

A company is taxed on profit. So:

However, income statements have grown to be quite complex. The multifaceted categories of expenses can vary from company to company. As analysts, we need to identify major categories within the income statement in order to facilitate proper analysis. For this reason, one should always categorize income statement line items into nine major categories:

1. Revenue (sales)

2. Cost of goods sold

3. Operating expenses

4. Other income

5. Depreciation and amortization

6. Interest

7. Taxes

8. Non-recurring and extraordinary items

9. Distributions

No matter how convoluted an income statement is, a good analyst would categorize each reported income statement line item into one of these nine categories. This will allow an analyst to easily understand the major categories that drive profitability in an income ...