Income Statement Formulas

Income statement formulas are calculations that you can make by using the
information from a company's income statement. As you work through ana-
lyzing a company's financial statements, income statement formulas can pro-
vide valuable insight into a company's financial performance, including rev-
enue, operating expenses, cost of debt, and profitability.

These formulas can help you be a more effective investor by allowing you to
measure a company's:
• Profitability
• Strength
• Growth
• Efficiency
• Quality

Although we delve into the formulas in more detail below, let's consider an
example in which an investor wants to measure how much profit margin a
company generated for each dollar of revenue earned from sales. We would
divide the company's revenue by profit using the net profit margin formula.

If the company had $1,000,000 in revenue and $200,000 in profit, its net profit
margin would be 20%, because ($1,000,000 revenue / $200,000 profit = .20 *
100). We multiply the resulting decimal in the formula by 100 to convert it to a
percentage. In other words, the company earned 20 cents per dollar.

Gross Profit Margin

Gross profit margin measures the efficiency of a company's manufacturing or

other production processes. It tells you how much profit is left after subtract-
ing the cost of the goods or services sold.
Research and Development to Sales
Research and development, or R&D, costs are expenses listed on an income
statement. They tell you how much the company spends per year on develop-
ing new products or services.

Operating Margin
Operating margin, also known as "operating profit margin," is a measure of
efficiency.

A company's operating profit is how much profit remains after deducting all

expenses.
The operating margin allows you to compare a company's financial activity to
that of its competitors by creating a percentage relative to revenue. It is calcu-
lated by dividing operating income by revenue.
Interest Coverage Ratio
The interest coverage ratio is important when you are dealing with banking,
insurance, real estate, or other investment companies.

This ratio compares the earnings before interest and taxes (EBIT) to interest
expense, which are listed as a separate item on the income sheet. This
shows you how much a company is relying on borrowing to fuel its growth or
to fund operations.
Net Profit Margin
Net profit margin is the ratio of net income (or after-tax profits) to revenue. It
tells you what percentage of every dollar collected actually translates into
profit for a company.
Return on Equity
Return on equity (or ROE) is one of the most important measures of profitabil-

ity that investors can use. This ratio shows how much after-tax income a com-
pany earned compared to shareholder equity.

This shows how efficiently the company has been handling its money.
Asset Turnover Ratio
The asset turnover ratio calculates the amount of revenue for every dollar of
assets owned by the company. It measures how efficient the company is at
using its assets.

What counts as a higher value is often dependent on the industry.

Return on Assets
Calculating the return on assets tells you how well a company uses its assets
to generate income. It is a measure of management and productivity.
It is generally helpful to compare this value across several time periods. Re-

turn on assets is calculated by dividing net income over a given time period
by total average assets in that same time period.
Return on assets can also be calculated by multiplying net profit margin and
asset turnover.

Balance Sheet and Income Statement Formulas

When you analyze both an income statement and a balance sheet side-by-
side, you can calculate several additional financial ratios.

Sales to Working Capital Ratio

Calculating the working capital per dollar of sales shows you how well a com-
pany uses its working capital to generate sales. This is a measure of effi-
ciency and can be used to compare competitors in the same industry.

Working capital is the amount of money a company has available for daily op-

erations. It is calculated by subtracting current liabilities from current assets,

both of which are found on the balance sheet.

The ratio is calculated by dividing total sales by working capital.

Receivables Turnover
A company's receivables turnover shows how efficiently a company collects
accounts receivable. The faster this happens, the more working capital a

company has to grow and pay investors.

Receivables turnover is calculated by dividing net credit sales in a select time

period by the average net receivables for that same time.
Inventory Turnover Ratio
Calculating a company's inventory turnover tells you how long it takes to sell
through its entire inventory. This information will give you a sense of a busi-

ness's efficiency, growth potential, and ability to generate revenue.

Inventory turnover is calculated by dividing the cost of goods sold by the aver-
age inventory for a given time period.
What Income Statement Formulas Can Tell You
Income statement formulas can tell you important information about how a
business functions, compared to competitors in its industry and to its own
past performance.

Using these formulas can help you decide whether a company is a smart in-
vestment or a risky one, as well as whether the degree of risk is worthwhile.
This can be useful information to have before making an investment or buying
stock.

These formulas can also help you evaluate the performance of a company
that you have already invested in, allowing you to decide whether to keep or
sell a stock.
Limitations of Income Statement Formulas
While each income statement formula can tell you a great deal
about a company, financial ratios are only the start. The ulti-
mate goal is to be able to calculate something known as "owner
earnings."
When you take an owner earnings approach to income statement analysis,
you need all three types of financial statements together—balance sheet, in-
come statement, and cash flow statements—as well as the ability to discount
cash flows to come up with a net present value.  
Income statement formulas are also limited in that they only look at the fi-
nances of a single company or, at best, can be used to compare multiple
companies to each other. They don't tell you anything about outside factors
that can influence your investing decisions, such as:

• International trade developments

• Changing government regulations
• Bad press, scandals, or changes in leadership
• Overall industry health