The Comprehensive Guide on How to Read a Financial Report: Wringing Vital Signs Out of the Numbers, + Website

CHAPTER 4

UNDERSTANDING PROFIT

Why Discuss Profits Last?

If you hadn’t noticed, we’ve intentionally taken you down a different road than most reference material when it comes to understanding the big three financial statements. That is, the income statement or profit and loss statement is usually the place most start when evaluating a business’s financial results. Or to be blunt and cut to the chase, most simply want to know how much sales revenue a business generated and what was its profit.

No doubt very good questions to ask but in reality, the usefulness of the income statement is directly dependent on the trust worthiness of the balance sheet and the reliability of the statement of cash flows, covered in Chapters 3 and 2, respectively. The point we’re trying to emphasize with the layout or order of the book’s chapters is not to de-emphasize the importance of the income statement but rather to highlight the critical importance of both the balance sheet and statement of cash flows, and unfortunately how these two financial statements are often ignored and overlooked when evaluating an entity’s complete financial performance and condition.

The balance of this chapter is now directed toward understanding the logic and structure of the income statement and how profits and losses are calculated and dependent on properly recording sales revenue and expenses to measure net profits or losses. But remember that with one simple misstep, estimate or calculation error, and/or intentional ...