Finance 101: Reading an Income Statement

Factual Questions
1

I find myself confronted with a simple question – namely, is Company X making money? – and turn to Yahoo Finance to help me find out. But when I peer at the income statement, almost nothing about it makes any sense to me. You can see what I’m talking about here (the company in question is HealthSouth).

First I see a gross profit of $1.8 billion, which sounds pretty good to me. This is apparently the revenue less the cost of that revenue. So far so good. But as I travel down the page, I begin to lose my grip. First of all, I see a bunch of operating expenses, which aren’t totaled on the page, and which don’t seem to relate to anything else. Then I see Operating Income, which still looks positive at nearly $44 million.

But then down a couple of lines, I see Net Income from Continuing Ops, which is -$384,585. This figure doesn’t seem to relate in any way to the column of figures immediately above, which when totaled yields a positive number, though not one that I can find anywhere else on the sheet.

So what gives? Is this company making money from operations, or anything else? And how on earth can I tell?

2

Where is their 2006 statement?

I do not know anything about this company and haven’t done any digging. Yeah, this is probably a profitable company. However in 2005 they took large losses from non-recurring expenses and discontinued operations. These should not re-appear in the next year. Also they are paying high interest expenses on debt. Income statements do not necessarity reflect how well a company is doing because the company has huge leeway in how it reports expenses and income. Much of it is also done for tax purposes.

3

Well, this is a company that emerged from a huge accounting fraud scandal that sent a number of people to prison. They did have to pay a lot of settlement money, and did divest themselves of a number of facilities and business lines.

4

[QUOTE=Sal Ammoniac]
Well, this is a company that emerged from a huge accounting fraud scandal that sent a number of people to prison. They did have to pay a lot of settlement money, and did divest themselves of a number of facilities and business lines.
[/QUOTE]

Sounds like they overdid the leeway they have in reporting income and expenses :slight_smile:

5

Normally the net income is the total change in owner’s equity at year-end. So owner’s equity will decrease. You’d have to see a balance sheet to see what is left in there.

I don’t see where the ($384K) is coming from either.

6

Well, they have a lot of debt carrying expense, $338,000,000 of it to be exact. There’s also a regular (seemingly) $100 million charge to minority interest, which is easily explained here.

7

[QUOTE=gigi]
Normally the net income is the total change in owner’s equity at year-end. So owner’s equity will decrease. You’d have to see a balance sheet to see what is left in there.

I don’t see where the ($384K) is coming from either.
[/QUOTE]

It’s not -$384k, it’s -$384 million in Net Income from Continuing Ops.

8

That is an extremely poorly laid out statement, with a subtotal missing and several very unclear items. Plus the minority interest total seems to be screwed up.

I thought I understood it, until I tried to get from Income Before Tax to Net Income from Continuing Operations, and the numbers there don’t add up.


Gross Profit              1,777,861   
 
 Operating Expenses
 Research Development             -
 Selling Gen & Admin      1,061,584
 Non Recurring              406,881 
 Others                     265,529
                         ----------
 Total Operating Expenses 1,733,994   (Sum of Op Exp)
  
Operating Income or Loss     43,867   (GP – Op Exp)
 
 Income - Continuing Ops 
 Total Other Inc/Exp Net     17,337
                         ----------
 Earnings Bef Int & Taxes    61,204   (Op Inc – Other)
 Interest Expense           338,701
                         ----------
 Income Before Tax         (277,497)  (Earn Bef – Int Exp)
 Income Tax Expense          39,792
 Minority Interest          (96,728)
                          ---------  
 Net Inc - Continuing Ops  (384,585)  (!!!!!!!!)

 Non-recurring Events 
 Discontinued Operations    (61,409)
 Extraordinary Items              - 
 Effect Of Accounting Changes     -
 Other Items                      -
                         ----------
Net Income                 (445,994)   (Cont Ops + Discont)
                          ==========

Maybe someone else can figure out how they got the (!!!) step.

9

The bold lines are totals for what is below them.

10

Why the question?

If I knew what you were looking for, I could probably give better answers as it is what I do for a living.

11

[QUOTE=JohnT]
It’s not -$384k, it’s -$384 million in Net Income from Continuing Ops.
[/QUOTE]

Sorry, wrong letter! :smack:

Most seem to be totals of what is above them. As it should be.

12

[QUOTE=Billdo]
That is an extremely poorly laid out statement, with a subtotal missing and several very unclear items. Plus the minority interest total seems to be screwed up.
[/QUOTE]

That’s a relief. I thought it was me!

Mikemike2, I’m trying to do something really simple here: figure out if this company is making money on its operations. I don’t even know whether the income statement as given would let you figure that out.

13

To the OP: You’ve heard of the phrase “The Bottom Line”, right? As in, ‘show me the bottom line’. Well, guess where that came from.

(Of course, that doesn’t help if the company is accounting ‘creatively’… but then, in that case, none of the figures in the income statement will)
ETA: Bollocks, sorry, I thought you were asking the Q at a much more newbie level than you actually were. Your Q actually appears to be ‘why don’t the numbers add up’, in which case my A is ‘buggered if I know’, a statement intriguingly open to misinterpretation.

14

No, actually, I am asking the question at the newbie level. If the numbers don’t add up, that’s just a confounding factor. But in the example cited, I don’t really see the bottom line (“Net income applicable to common shares”) as being the bottom line, so to speak.

15

Shameless plug:

http://edgarscan.pwcglobal.com/recruit/pwc.html

(the benchmarking assistant is very cool –> all graphs can be clicked through to get to the detail…just search for the company and use the “graphs” tab.
Healthsouth 2005 10K as parsed by EdgarScan:

http://edgarscan.pwcglobal.com/servlets/RunQuery?goal=wf_html_tag&tag=net_income&accession=0001193125-06-065473&format=edgarscan

16

[QUOTE=Billdo]
That is an extremely poorly laid out statement, with a subtotal missing and several very unclear items. Plus the minority interest total seems to be screwed up.

I thought I understood it, until I tried to get from Income Before Tax to Net Income from Continuing Operations, and the numbers there don’t add up.


Gross Profit              1,777,861   
 
 Operating Expenses
 Research Development             -
 Selling Gen & Admin      1,061,584
 Non Recurring              406,881 
 Others                     265,529
                         ----------
 Total Operating Expenses 1,733,994   (Sum of Op Exp)
  
Operating Income or Loss     43,867   (GP – Op Exp)
 
 Income - Continuing Ops 
 Total Other Inc/Exp Net     17,337
                         ----------
 Earnings Bef Int & Taxes    61,204   (Op Inc – Other)
 Interest Expense           338,701
                         ----------
 Income Before Tax         (277,497)  (Earn Bef – Int Exp)
 Income Tax Expense          39,792
 Minority Interest          (96,728)
                          ---------  
 Net Inc - Continuing Ops  (384,585)  (!!!!!!!!)

 Non-recurring Events 
 Discontinued Operations    (61,409)
 Extraordinary Items              - 
 Effect Of Accounting Changes     -
 Other Items                      -
                         ----------
Net Income                 (445,994)   (Cont Ops + Discont)
                          ==========

Maybe someone else can figure out how they got the (!!!) step.
[/QUOTE]
Not me, but I do note that in 2003, Income Before Tax - Income Expense = Net Inc from Continuing Ops. However, this does not apply to 2004 or 2005.

Also, in 2004 and 2005, EBIT = Operating Income + Total Other Income/Expenses Net. But this is not the case in 2003. In 2003 the Minority Interest is somehow affecting EBIT, although the numbers do not add up - unlike in my example in the next paragraph.

I looked at several other companies’ results the mostly did add up as you would expect, but I did find that Six Flags also has funny-looking numbers. Like HLS, in 2003 Income Before Tax - Income Expense = Net Inc from Continuing Ops. This also applied in 2004, but not 2005. In 2003 and 2004 the Minority Interest is actually being subtracted from the Operating Income and Total Other Income to generate EBIT. But not in 2005, where the Minority Interest is subtracted from Income Before Tax and Income Tax Expense to give the Net Income from Continuing Ops. Where the EBIT comes from in 2005, I have no clue.

I am guessing there are changes in the way Minority Interest is handled over the years.

17

[QUOTE=Sal Ammoniac]
No, actually, I am asking the question at the newbie level. If the numbers don’t add up, that’s just a confounding factor. But in the example cited, I don’t really see the bottom line (“Net income applicable to common shares”) as being the bottom line, so to speak.
[/QUOTE]
I can give you a very basic idea, and more sophisticated accountants can correct me.

The income statement (aka the P&L or statement of profit and loss) shows the activity of a business during a given time period, with expenses and revenue netting out to a gain or loss for that period. That change becomes the overall change in owner’s equity.

The balance sheet shows a snapshot of the business’s balance as of a given date. It shows assets = liabilities plus owner’s equity (fund balance for non-profits). The net income from the income statement is reflected in the change period-over-period in the owner’s equity balance on the balance sheet.

So even if they show a loss in net income in this period, they may still have a significant balance in owner’s equity.

18

But my basic question still stands: are they making money or losing money on operations? And which line of the income statement shows that?

In other words, if the operating income is positive, and the net income from continuing ops is negative, which one should I trust?

19

Good Lord, man, don’t rely on financial data from Yahoo! Go right to the source and ask the horse. (PDF, see page F-6).

Having done so, you’ll note that the official 2005 numbers are slightly different from Yahoo’s, but close enough to see that Yahoo left out two items (interest income and equity in net income of nonconsolidated affiliates) which account for the missing link between operating income and net income from continuing operations.

[QUOTE=Sal Ammoniac]
But my basic question still stands: are they making money or losing money on operations?
[/quote]
Making money.

Operating income.

It depends. What are you trying to ascertain? If I borrow a million dollars from you at 10% interest, and use it to start a business that incurs $500,000 in revenue and $450,000 in expenses in the first year, am I making money? That is analogous to the situation at HealthSouth.

20

You also have to read the Notes that go along with the financial statements. The notes should explain year to year changes in accounting and should explain in much better detail what you’re seeing on the face of the financial statements. (Also it’s where they hide the bad stuff, i.e. stuff they HAVE to disclose but can easily hide on the income statement through the “leeway” mentioned above.)