Net income or earnings is the bottom line figure that attracts the most attention. Usually, however, it is reported in a different format, as earnings per share. The earnings per share figure (basic earnings per share) is simply the net income of the firm, less any preferred dividend payments, divided by the average number of common shares outstanding during the period. If a company had convertible bonds or stocks, stock options, and warrants, it must also calculate diluted earnings per share, which measures the impact on earnings per share created by the conversion and exercising of all of these securities into common stock. Both the basic and fully diluted earnings per share must be reported in the income statement. The same line item may be labeled basic and diluted if the company has no convertible securities. The notes to financial statements should include a table describing the calculation of basic and diluted earnings per share.
The statement of retained earnings section details how the retained earnings figure on the balance sheet is affected by the current period earnings and dividend decisions. The retained earnings are not necessarily available cash, but instead may be invested in other current and long-term assets of the firm.
Conclusion
The income statement provides insights on how well management can translate sales revenues into earnings. There are many management judgments, estimates, and choice of accounting methods that affect the bottom line, so it is important to be aware and alert to these issues when judging the quality of the firm's earnings.
No single year will capture the dynamics of the firm. A careful comparison of changes and an identification of trends can aid in judging the attractiveness of the stock. The income statement provides valuable guidance on the sales and earnings trend of a firm, but it does not identify whether the company is producing cash flow.
