Value Investors Tribe

Understanding business of any kind requires understanding its financials which requires understanding accounting basics. In this series of blogs focused on accounting basics, we will try to understand accounting principles required to decode financials of a business. We will cover five basic line items found in the income statement.

• Revenue: Revenue is the total amount worth of goods sold during the period for which it is reported (usually quarterly or yearly). This is sometimes also referred as total sales or gross sales and is usually first line of the income statement.
• Cost of Goods Sold: As the name suggests, it is cost of raw materials and labor used in the production of goods sold. For instance, if the company is selling shoes, cost of goods sold is the price at which the company purchased shoes or manufactured it. It is usually second line of the income statement.
• Gross Profit: Gross Profit is the amount obtained by subtracting cost of goods sold from the revenue. If the total revenue is $100 and cost of goods sold is $40, the gross profit is $60 ($100 – $40). It is also used to calculate gross profit margin which is calculated as gross profit/total revenues which in this case would be 60% ($60/$100).
• Operating Expenses: Operating expenses are business’ costs associated with running an operation. This is usually broken down into three parts which are 1) Selling, General and Administrative 2) Research and Development 3) Interest expenses. These three parts are self-explanatory (let us know if you want us to elaborate it!)
• Operating Profit: Operating profit is obtained by subtracting Operating expenses from the gross profit. For instance in the above case, assuming operating expenses of $13, the operating profit would be $47 ($60 – $13).

Action Items:

• Dig through the income statement of your favorite company and see what these line items look like.
• Dig through the income statement of the businesses we analyzed and see if you see a pattern in it!