You need a basic understanding of financial accounting for this class. See also revenue, costs and profit. This page also provides a real example of analyzing an income statement using Amazon.com. You can also see other guides to financial statements. Here's a more detailed guide to analyzing income statements. If you want to learn more about accounting check out this site on bookkeeping.
If your math is shaky, you may want to review how to calculate percentages.
Financial Reports - Simple Example
Your Financial Situation
Your income is $300 per week, but your cost of living (rent, food, travel, partying) is $400 a week. You have $150 in your checking account at the bank. Is that a good situation? Let's see how accountants would report on your financial situation.
Your Income Statement for the Week
| Income | $300 |
| Expenses | $400 |
| Profit (Loss) | ($100) |
Note that the income statement represents a flow of income over a period of time - in this case, one week.
The Income Statement is sometimes called the Profit and Loss Statement( "P and L") or the Statement of Operations.
Your Balance Sheet - Start of Week
| Assets | Liabilities and Owner's Equity |
| $150 | Liabilities $0 |
| Owner's Equity $150 |
The balance sheet records property and who has the property rights. It shows the property you use (assets), what you owe (liabilities) and what you own (owner's equity). The accounting equation says that assets = liability + owner's equity. For example, if you have a car for which you paid $20,000 and for which you borrowed $15,000, your assets are $20,000, your liability is $15,000 and your owner's equity is $5,000. Note that the balance sheet represents one point in time.
In this case you have no assets other than the $150 in cash in the bank. There is nothing else you can sell to raise money. If you had something else you could sell to raise money (such as a car), its value would be listed on the balance sheet. Because you have no debts that $150 in cash belongs to you. It constitutes your owner's equity - that is, your net worth.
Your Balance Sheet - End of Week
Let's assume you make up the shortfall with money from your checking account. At the end of the week your balance sheet looks like this:
| Assets | Liabilities and Owner's Equity |
| $50 | Liabilities $0 |
| Owner's Equity $50 |
Your Cash Flow Statement for the Week
| Cash Flows from Operating Activities | Notes | ||
| Cash received from wage payments | $300 | ||
| Cash paid for rent and other expenses | ($400) | ||
| Net cash flows from operating activities | ($100) | ||
| Cash flow from investing activities | $0 | Assumes you have no income from investments | |
| Cash flow from financing activities | $0 | Assumes you do not borrow money | |
| Net increase in cash and cash equivalents | ($100) | ||
| Cash at beginning of week | $150 | ||
| Cash at end of week | $50 |
Note that the cash flow statement represents a flow of cash over a period - in this case, one week.
Analyzing your Situation
In this example you are "cash flow negative" - you are paying out more cash than you are getting in. You are financing the shortfall with cash reserves, but now the cash reserves are dangerously low. They are only enough to finance another half a week! In this example you will be insolvent by the end of next week. This is not a good situation.
If this person were a business you would not want to lend it money, unless it could convince you that the cash flow situation would improve in the near future.
Real Example - Amazon.com
An income statement is like a stairway. It starts with the revenue at the top, then keeps subtracting the different costs the business incurs until it gets to the bottom line. This spreadsheet shows you how to interpret a real income statement and how to calculate operating margin, which is the key measure of profitability we use in this class.
Segment Information
Some businesses are 100% internet-related, like Google or Yahoo!. But many internet businesses are owned by larger companies. These companies' financial reports report the company's total revenues and total costs. But in this class we really want to know what the internet company's performance was. The internet company is a segment of the total company. Fortunately, many large companies also report on segment information.
Other Guides to Interpreting Financial Statements
A very basic guide.
A slightly more detailed beginner's guide from the SEC.