What is income? | The Motley Fool

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Revenue is the total gross amount of money generated from the operations of a business during a financial period. Revenue is the first amount shown on a company’s income statement; all expenses are deducted from this to calculate the company’s net income.

Non-operating amounts – interest income from litigation or gains on the sale of equipment or other assets – are generally not included in income.

Determining which sales should be transaction-based should be straightforward. For example, McDonald’s (NYSE:MCD) the income would include all the money he gets from selling hamburgers, but none of the money he gets from the bank as interest on a savings account.

Turnover is often referred to as sales – or “turnover”. Identifying a stock’s earnings and earnings growth is an important part of stock analysis. Let’s review the differences between income and some other common measures of income and some examples of income.

Turnover vs net profit

Where revenue is the top line of the income statement, net income is the bottom line. After all expenses are deducted from income, net income is what remains. Let’s take a look at a typical income statement.

Income

$1,000,000

Cost of Goods Sold

$500,000

Gross revenue

$500,000

Operating Expenses

$250,000

Operating result

$250,000

Other income/expenses

$50,000

Net revenue

$200,000

Table by author.

The first deduction from revenue is the cost of goods sold to calculate gross margin. The cost of goods sold is the direct/variable cost of sales to the business. For a retail business, it is the cost of inventory sold by the business. For a construction company, this is the cost of materials and labor on site. A company’s gross income or gross margin indicates how much it is able to mark up its revenue.

Next, we deduct operating expenses, commonly referred to as overhead. Operating expenses are generally indirect (ie not directly related to the sale of goods or services) and fixed. These are expenses such as rent, utilities, administrative salaries and other maintenance items. Operating income tells you how much the business earned from its core business minus all of its direct and overhead costs.

Finally, we subtract other income and expenses to find the net income. Other income and expenses include legal settlements, interest income, and gains or losses from the sale of assets that represent money coming in or going out of the business but are not considered current or not not result from the main activities of the company.

Revenue vs Cash Flow

One of the first things you need to know about financial statements is accrual accounting. Public companies in the United States are required by generally accepted accounting principles (GAAP) to use accrual accounting.

It’s a simple concept: instead of recognizing income and expenses when money changes hands, they are recognized when earned or incurred.

For example, if a construction company buys 17 doors on credit from its door supplier, it will recognize the expenses for the doors at that time, and the door supplier will recognize the revenue from the sale. The construction company then has an account payable (AP) for the door supplier, and the supplier has an account receivable (AR) from the construction company. The money may not change hands for months, depending on the terms of the sale, but each company reports the transaction on its respective income statement when the doors are delivered to the site.

Accrual accounting makes intuitive sense. You want expenses and income to match the financial period when they actually occur. Suppliers may offer generous terms that allow businesses to wait months to pay, but the economic reality of the business is that it has incurred an expense.

That said, it’s also useful (and, according to some investors, imperative) to assess a company’s true cash flow. If a company is offering its customers crazy AR terms to speed up sales, you want to know if it has the cash to fulfill the orders.

There are ways to manipulate revenue and net profit while adhering to GAAP rules, but true cash flow cannot be manipulated outside of fraudulent activity.

An example of income

Let’s finish with an example of revenue from McDonald’s recent financial statements. You can find the company’s annual revenue in its SEC 10-K form and its quarterly figures in its 10-Q form. Let’s start with the 10-Q for the period ending September 30, 2021.

Revenue is reported in the income statement, which is referred to as the condensed consolidated income statement in this report. For 2021, McDonald’s had total revenue of $6.2 billion, and $2.6 billion came from sales at company-owned restaurants. Another $3.5 billion came from non-company restaurant franchise fees, and about $100 million came from various other sources.

We can compare this to the other numbers we discussed. The cost of goods sold (the cost of the burgers and the direct costs of running the franchise) brings revenue down to a gross profit of $3.5 billion. After that, operating expenses were about $500 million, bringing operating profit to just under $3 billion (most of McDonald’s expenses are direct revenue expenses) .

Finally, other expenses, including tax and interest expense, drove net income to $2.1 billion. Cash flow was $2.6 billion due to the addition of nearly $500 million in depreciation.

Revenue is the key to stock analysis

The type of long-term investing we do at The Motley Fool begins with proper fundamental analysis of a company’s financial statements and growth prospects. The first step in this analysis is to understand revenue and its relationship to bottom line and cash flow. Once you have this level of understanding, you can move on to a more exciting part of fundamental analysis: stock valuation.

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