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 in this part 2 of decoding income statement.

• Depreciation: All the machinery, buildings, vehicles and similar assets which the business owns wear out eventually. As a result the company has to spend money to replace these assets. The yearly cost associated with this wearing out it termed as Depreciation.
• Interest Expense: Most of the businesses operate with some form of debt, it can be short term (usually less than a year) as well as long term. The interest which the business has to pay out to service this debt is accounted under interest expense. For the financial businesses such as banks, this is not an expense but an income since those businesses earn by providing debt to other entities.
• Gain (or loss) on Sale of Assets: Businesses own assets such as machinery, buildings, vehicles, computer systems and other similar assets which are helpful in conducting their operations. Whenever the business sells these assets, they are recorded under this line item.
• Income Before Tax: When all the expenses are deducted from the revenue, we get income before tax. All the expenses discussed in part 1 and this part are deducted from the revenue to get to the income before tax. It is also called as pre-tax earnings.
• Income Tax: Businesses are subject to taxation on pre-tax earnings. Depending on various factors, taxes are paid and this is accounted for under the income tax line item. Subtracting income tax from income before tax provides profit after tax, also known as net earnings.

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!