Statement of Operations
What it is:
The statement of operations is one of the three primary financial statements used to assess a company’s performance and financial position (the two others being the balance sheet and the cash flow statement). The statement of operations summarizes a company's revenues and expenses over the entire reporting period.
The statement of operations is also known as a profit and loss (P&L) statement, statement of earnings, income statement, or statement of income.
The basic equation on which an statement of operations is based is Revenues – Expenses = Net Income.
How it works (Example):
All companies need to generate revenue to stay in business. They use revenues to pay expenses, interest payments on debt, and taxes owed to the government. After these costs of doing business are paid, the amount left over is called net income. Net income is theoretically available to shareholders, though instead of paying out dividends, the firm’s management often chooses to retain earnings for future investment in the business.
Statements of operations are all organized the same way, regardless of industry. The basic outline is shown in the following example:
Statement of Operations for Company XYZ, Inc.
for the year ended December 31, 2008
Total Revenue $100,000
Cost of Goods Sold ($ 20,000)
Gross Profit $ 80,000
Taxes ($ 10,000)
Net Income $ 30,000
Number of Shares Outstanding 30,000
Earnings Per Share (EPS) $1.00
Why it Matters:
Anyone interested in active investing, picking stocks or investigating the financial health of a company must know how to read financial statements, including the statement of operations. The importance of the information contained in the statement of operations cannot be overemphasized.
A firm’s ability or inability to generate earnings over the long term is the key driver of stock and bond prices. Operating profit (EBIT) is the source of debt repayment, and if a company can’t generate enough EBIT to pay its debt obligations, it will have to enter bankruptcy or sell itself. Net income is the source of compensation to shareholders (owners of the company), and if a company cannot generate enough profit to compensate owners for the risks they’ve taken, the value of the owners’ shares will plummet. Conversely, if a company is healthy and growing, higher stock and bond prices will reflect the increased availability of profits.
Please note that earnings/net income/profits are not the same as cash or cash flow. It is possible for a firm to be profitable on the statement of operations, but not be generating cash flow, and vice versa. To see a company’s cash flow, you will need to see its statement of cash flows.