Understanding and Analyzing an Income Statement

The income statement is one of the most important financial statements used in making business decisions. The income statement is an analytical tool that can be used in business and personal finance that summarizes business and personal transactions for a time period. Students must learn the components of an income statement and the ratios used to analyze a company's operations for a fiscal time period. This lesson will provide the tools for construction of an income statement for a service business and a merchandising business. In addition, students will be able to calculate the component percentage that each revenue, expense, and net profit. One of the main goals of this rigorous examination of the income statement is to prepare students for an accounting or personal finance class.

Introduction

Imagine that you are interested in buying a business.  What information would you want to see? The income statement summarizes much of the information that you would want to know before you would buy a business such as revenues, expenses, and net income.

In this lesson, students will learn how income statements are constructed for both service and merchandising businesses and how to calculate component percentages.  This personal finance lesson will help student prepare to make sound investment decisions in both their personal and financial lives.  

The income statement is the backbone of fundamental analysis for investors and the cornerstone for sound management decisions.  This lesson is rigorous in content to support students as future investors and decision makers.

Learning Objectives

  • Learn relevant vocabulary.
  • Use an Excel template to complete an income statement and compute component percentages for a service business.
  • Use an Excel template to complete an income statement and compute component percentages for a merchandising business.
  • Complete a worksheet that reinforces and assesses the student's comprehension of an income statement.
  • Analyze an income statement from HNI Incorporated by answering questions about net sales, net income, and the rate of taxation.

Resource List

Process

1.  Introduce students to an income statement by showing an income statement and explaining its construction.  Explain how to calculate component percentages.  Use Income Statement 1, Income Statement 2, and Income Statement 3.

2.  Have students download Service Business Income Statement and complete the calculations on an Excel spreadsheet.  Make sure that students write calculations using the spreadsheet software to make the calculations.  Have students print and submit.

3.   Have students download Merchandising Business Income Statement and complete the calculations on an Excel spreadsheet for the component percentages.  Make sure that students write calculations using the spreadsheet software to make the calculations.  Have students print and submit.

4.  Assign students the Assessment Activity.

5.  Assign the Extension Activity.

Conclusion

In this lesson, students learned to identify the fundamental components of an income statement including component percentages, and how to analyze an income statement.  From this lesson students will take away common-sense business applications from what they have learned. Consequently, students will be able to strategically look at their own personal finances, consider business opportunities, and analyze the positions of corporations.

Extension Activity

The concepts developed in this lesson can be used to analyze almost any business.  Download the HNI Annual Report for 2010 and find the Income Statement listed Financial Highlights section.  You will find the summarized Income Statement on the second page.  Students will be asked to answer the following questions:

1.  How much were sales in 2010? [$1,686,728,000]

2. Did sales increase from 2009? [Yes. Sales increased by $63,401,000]

3.  Gross Profit increased from $562,801,000 to $585,616,000 from 2009 to 2010.  By what percentage did HNI increase Gross Profit?  [4%]

4. HNI restructured their plant and equipment in 2009 at a cost of $40,443,000.  Restructuring charges in 2010 were only, $9,449,000.  How does seeing this restructuring cost on the Income Statement help interpret the $26,941,000 net income from operations? [Without the income statement an investor, who did not do due diligence would have thought all of the sales were from the businesses' operations and not a reduction in one-time only restructuring costs.]

5.  Use BIG CHARTS to find the historical stock price for HNI Industries, ticker symbol, HNI.  Did the share price of HNI increase during 2010 on news of positive earnings? [Use Yahoo Finance .   At the time this lesson was written, HNI paid $.23 dividend per share.  A student will find that the share price rose.]

Assessment

1.  Assign the Income Statement Exercises.