The Finance Professor: How to Read an Income Statement

Operating Costs and Expenses

The next section of the income statement deals with a majority of the costs and expenses associated with the operation of a company's business. The description of such expenses will vary from company to company, but we can divide them into several general categories:

• Cost of Sales: This line item represents the expenses incurred by the company to produce and deliver the product or service to the customer. For McDonald's, this would include, but is not limited to, the cost of its hamburgers, French fries, beverages, labor, utilities, occupancy (rent and depreciation) and paper goods. A retailer such as CVS Caremark (CVS Quote) describes these costs as "costs of goods sold, buying and warehousing costs."
• Selling, General and Administrative Expenses (SG&A): These are expenditures related to the management of the overall company, which cannot be directly linked to product sales or the delivery of services. This will include items such as corporate overhead, legal, accounting, Sarbanes-Oxley compliance, management, stock based compensation, advertising, marketing, travel, entertainment and licensing expenses.
• Depreciation: This represents the expensing of asset costs over a prolonged period of time. For example, McDonald's might build or buy a structure to house a company-owned restaurant. That cost is first capitalized and then expensed in piecemeal fashion over a period of time. Some companies, such as McDonald's, might actually consider this a cost of sales. Other companies might break this out separately as another line item under operating expenses.
• Amortization: This cost is similar to depreciation except that it relates to the expensing of intangible items over a period of time. Intangible items include goodwill and intellectual properties, such as trademarks or licenses. Goodwill represents the excess of the purchase price over the book value of a company when one company acquires the other.