ALEXANDRIA, VA (Mar. 30, 1998) -- Before we go on with the various financial statements, we'll lay out a glossary that will be kept in the DRIP port archives. This way, you can familiarize yourself with some of these terms and refer back to the glossary when you need to.
Income Statement Terms
Interest Income This is the first component of a bank's or financial services company's revenues. It is comprised of interest, dividends, and fees received on earning assets such as loans, bonds, preferred stock, and other interest-bearing assets. Depending on the company, interest income will be broken down by business line (such as lending, trading, and securities).
Interest expense The cost of funds the company borrows on a short- and long-term basis, buys in the money markets, or takes in from depositors.
Net interest income This is interest income minus interest expense. Net interest margin, which is the net yield on earning assets, is calculated as interest income minus interest expense divided by average earning assets:
Interest income minus interest expense ------------------------------------------ Average earning assets
Mathematically, it can also be calculated by:
Interest income Interest expense ------------------- minus ------------------- Avg. Earning Assets Avg. Earning Assets
The three components can tell you a lot about what sort of business the company is in, even if you have no idea what type of bank you are looking at. This takes some experience, but the general rule of thumb in lending and in the securities markets is the higher the rate of interest (reward), the higher the amount of risk.
By breaking down a company's interest income and interest expense as a percentage of average earning assets, you can see the difference between the yield of earning assets and the cost of earning assets. The combination of the two is the net yield on earning assets. Unlike the income statement of a manufacturing or service company, what can be seen as an explicit expense is shown on the revenues line. The income statement of a bank is somewhat more integrated than other income statements, as a major cost of revenues -- interest expense -- is right next to interest income (a major part of revenues) on the income statement.
Tomorrow, loan loss provisions, charge-offs, and noninterest income.