What Is an Income Statement?
An income statement is one of the three important financial statements used for reporting a company’sfinancial performanceover a specific accounting period. The other two key statements are the balance sheetand the cash flow statement.
The income statement focuses on the revenue,expenses, gains, and losses of a company during a particular period. Also known as the or the statement of revenue and expense, an income statement provides valuable insights into a company’s operations, the efficiency of its management, underperforming sectors, and its performance relative to industry peers.
- An income statement is one of the three major financial statements, along with the balance sheet and the cash flow statement, that report a company’s financial performance over a specific accounting period.
- The income statement focuses on the revenue,expenses, gains, and losses of a company during a particular period.
- An income statement provides valuable insights into a company’s operations, the efficiency of its management, underperforming sectors, and its performance relative to industry peers.
An Introduction To The Income Statement
Understanding the Income Statement
The income statement is an integral part of the company performance reports that must be submitted to the U.S. Securities and Exchange Commission (SEC). While a balance sheet provides the snapshot of a company’s financials as of a particular date, the income statement reports income through a specific period, usually a quarter or a year, and its headingindicates the duration, which may read as “For the (fiscal) year/quarter ended June 30, 2021.”
The income statement focuses on four key items: revenue,expenses, gains, and losses. It does not differentiate between cash and non-cashreceipts(sales in cash vs. sales on credit) or cash vs. non-cash payments/disbursements (purchases in cash vs. purchases on credit). It starts with the details of sales and then works down to computenet incomeand eventually earnings per share (EPS). Essentially, it gives an account of how the net revenuerealized by the company gets transformed into net earnings (profit or loss).
Revenue and Gains
The following are covered in the income statement, though its format may vary, depending upon the local regulatory requirements, the diversified scope of the business, and the associated operating activities:
Revenue realized through primary activities is often referred to as operating revenue. For a company manufacturing a product, or for a wholesaler, distributor, or retailer involved in the business of selling that product, the revenue from primary activities refers to revenue achieved from the sale of the product. Similarly, for a company (or its franchisees) in the business of offering services, revenue from primary activities refers to the revenue or fees earned in exchange for offering those services.
Revenue realized through secondary, noncore businessactivities is often referred to as nonoperating, recurring revenue. This revenue is sourced from the earnings that are outside the purchase and sale of goods and services and may include income from interest earned on business capital parked in the bank, rental income from business property, income from strategic partnerships like royalty payment receipts, or income from an advertisement display placed on business property.
Also called other income, gains indicate the net money made from other activities, like the sale of long-term assets. These include the net income realized from one-time nonbusiness activities, such as a company selling its old transportation van, unused land,or a subsidiary company.
Revenue should not be confused with receipts. Payment is usually accounted for in the period when sales are made or services are delivered. Receipts are the cash received and are accounted for when the money is received.
A customer may take goods/services from a company on Sept. 28, which will lead to the revenue accounted for in September. The customer may be given a 30-day payment window due to his excellent credit and reputation, allowing until Oct. 28 to make the payment, which is when the receipts are accounted for.
Expenses and Losses
A business's cost to continue operating and turning a profit is known as an expense. Some of these expenses may be written off on a tax return if they meet Internal Revenue Service (IRS) guidelines.
These are all expenses incurred for earning the average operating revenue linked to the primary activity of the business. They include the cost of goods sold (COGS); selling, general, and administrative (SG&A) expenses; depreciation or amortization; and research and development (R&D) expenses. Typical items that make up the list are employee wages, sales commissions, and expenses for utilities such as electricity and transportation.
These are all expenses linked to noncore business activities, like interest paid on loan money.
Losses as Expenses
These are all expenses that go toward a loss-making sale of long-term assets, one-time or any other unusual costs, or expenses toward lawsuits.
While primary revenue and expenses offer insights into how well the company’s core business is performing, the secondary revenue and fees account for the company’s involvement and expertise in managing ad hoc, non-core activities. Compared with the income from the sale of manufactured goods, asubstantially high-interest income from money lying in the bank indicates that the business may not be using the available cash to its full potential by expanding the production capacity, or that it is facing challenges in increasing its market share amid competition.
Recurring rental income gained by hosting billboards at the company factory along a highway indicates that management is capitalizing upon the available resources and assets for additional profitability.
Income Statement Structure
Mathematically, net income is calculated based on the following:
Net Income = (Revenue + Gains) - (Expenses + Losses)
To understand the above formula with some real numbers, let’s assume that a fictitious sports merchandise business, which additionally provides training, is reporting its income statement for a recent hypothetical quarter.
It received $25,800 from the sale of sports goods and $5,000 from training services. It spent various amounts listed for the given activities that total of $10,650. It realized net gains of $2,000 from the sale of an old van, and it incurred losses worth $800 for settling a dispute raised by a consumer. The net income comes to $21,350 for the given quarter. The above example is the simplest form of income statement that any standard business can generate. It is called the single-step income statement as it is based on a simple calculation that sums up revenue and gains and subtracts expenses and losses.
However, real-world companies often operate on a global scale, have diversified business segments offering a mix of products and services, and frequently get involved in mergers, acquisitions, and strategic partnerships. Such a wide array of operations, diversified set of expenses, various business activities, and the need for reporting in a standard format per regulatory compliance leads to multiple and complex accounting entries in the income statement.
Listed companies follow the multiple-step income statement, which segregates the operating revenue,operating expenses, and gains from the nonoperating revenue, nonoperating expenses, and losses, and offers many more details through the income statement produced this way.
Essentially, the differentmeasures of profitability in a multiple-step income statement are reported at four different levels in a business's operations: gross, operating, pretax, and after-tax. As we’ll see shortly in the following example, this segregation helps in identifying how the income and profitability are moving/changing from one level to the other. For instance, high gross profit but lower operating income indicates higher expenses, while higher pretax profit and lower post-tax profit indicate loss of earnings to taxes and other one-time, unusual expenses.
Let’s look at an example based on the 2021 annual income statements of two large, publicly listed, multinational companies from different sectors: technology (Microsoft) and retail (Walmart).
Reading Income Statements
The focus in this standard format is to calculate the profit/income at each subhead of revenue and operating expenses and then account for mandatory taxes, interest, and other nonrecurring, one-time events to arrive at the net income that applies to common stock. Though calculations involve simple additions and subtractions, the order in which the various entries appear in the statement and their relationships often get repetitive and complicated. Let’s take a deep dive into these numbers for a better understanding.
The first section, titled Revenue, indicates that Microsoft’s gross (annual) profit, or gross margin, for the fiscal year ending June 30, 2021, was $115.86 billion. It was arrived at by deducting the cost of revenue ($52.23 billion) from the total revenue ($168.09 billion) realized by the technology giant during this fiscal year. Just over 30% of Microsoft’s total sales went toward costs for revenue generation, while a similar figure for Walmart in its fiscal year 2021 was about 75% ($429 billion/$572.75 billion). It indicates that Walmart incurred much higher cost than Microsoft to generate equivalent sales.
The next section, called Operating Expenses, again takes into account Microsoft’s cost of revenue ($52.23 billion) and total revenue ($168.09 billion) for the fiscal year to arrive at the reported figures. As Microsoft spent $20.72 billion on R&D and $25.23 billion on SG&A expenses, total operating expensesare computed by summing all these figures ($52.23 billion + $20.72 billion + $25.23 billion = $98.18 billion).
Reducing total operating expenses from total revenue leads to operating income (or loss)of $69.92 billion ($168.09 billion - $98.18 billion). This figure represents the earnings before interest and taxes (EBIT) for its core business activities and is again used later to derive the net income.
A comparison of the line items indicates that Walmart did not spend anything on R&D and had higher SG&A and total operating expenses than Microsoft.
Income From Continuing Operations
The next section, titled Income from Continuing Operations, adds net other income or expenses (like one-time earnings), interest-linked expenses, and applicable taxes to arrive at the net income from continuing operations($61.27 billion) for Microsoft, which is nearly 60% higher than that of Walmart ($13.67 billion).
After discounting for any nonrecurring events, it’s possible to arrive at the value of net income applicable to common shares. Microsoft had a much higher net income of $61.27 billion compared with Walmart’s $13.67 billion.
Earnings per share are computed by dividingthe net income figure by the number of weighted average shares outstanding. With 7.55 billion outstanding shares for Microsoft, its 2021 EPS came to $8.12 per share ($61.27 billion ÷ 7.55 billion). With Walmart having 2.79 billion outstanding shares that fiscal year, its EPS came to $4.90 per share ($13.67 billion ÷ 2.79 billion).
Microsoft had a lower cost for generating equivalent revenue, higher net income from continuing operations, and higher net income applicable to common shares compared with Walmart.
Uses of Income Statements
Though the primary purpose of an income statement is to convey details of profitability and business activities of the company to the stakeholders, it also provides detailed insights into the company’s internal activities for comparison across different businesses and sectors. By understanding the income and expense components of the statement, an investor can appreciate what makes a company profitable.
Based on income statements, management can make decisions like expanding to new geographies, pushing sales, expanding production capacity, increasing the use of or the outright sale of assets, or shutting down a department or product line. Competitors also may use them to gain insights about thesuccess parameters of a company and focus areas such as lifting R&D spending.
Creditors may find income statementsof limited use, as they are more concerned about a company’s future cash flows than its past profitability.Research analysts use the income statement to compare year-on-yearand quarter-on-quarterperformance. One can infer, for example, whether a company’s efforts at reducing the cost of sales helped it improve profits over time, or whether management kept tabs on operating expenses without compromising on profitability.
What Are the Four Key Elements of an Income Statement?
(1) Revenue,(2) expenses, (3) gains, and (4) losses. An income statement is not a balance sheet or a cash flow statement.
What Is the Difference Between Operating Revenue and Non-Operating Revenue?
Operating revenue is realized through a business' primary activity, such as selling its products. Non-operating revenue comes from ancillary sources such as interest income from capital held in a bank or income from rental of business property.
What Insights Should You Look for in an Income Statement?
The income and expense components can help an investor learn what makes a company profitable (or not). Competitors can use them to measure how their company compares on various measures. Research analysts use them to compare performance year-on-year and quarter-on-quarter.
The Bottom Line
An income statement provides valuable insights into various aspects of a business. It includes readings on a company’s operations, the efficiency of its management, the possible leaky areas that may be erodingprofits, and whether the company is performing in line with industry peers.
How do you read an income statement? ›
Your income statement follows a linear path, from top line to bottom line. Think of the top line as a “rough draft” of the money you've made—your total revenue, before taking into account any expenses—and your bottom line as a “final draft”—the profit you earned after taking account of all expenses.What is an income statement and how is it used? ›
An income statement is a key financial document for your business. It shows what your company earns, what it spends and if it's making a profit over a specific period of time. It is also an important tool for managing your business and planning your strategy.What are the 3 most important things on an income statement? ›
Earnings before taxes: This refers to your income before you pay any taxes on it. Gross profit: Calculated by subtracting the cost of goods sold from revenue, gross profit is the profit the company makes. Net income: Net income is the income left over after you subtract all of your expenses from your gross profits.What do the 3 columns in an income statement mean? ›
The income statement shows us three columns, the far-right column being the full year audited results, and the other two columns being six months for the period ended for the current year and the previous year in order to compare.What are income statements for dummies? ›
The income statement summarizes your company's financial transactions for a particular time period, such as a month, quarter, or year. It starts with your revenues and then subtracts the costs of goods sold and any expenses incurred in operating the business.How do you remember what goes on the income statement? ›
Revenue (Income) Statement
Also called the profit and loss statement, revenue, or income, and expenses are all you need to remember about this financial statement. Company income minus its expenses is the simple calculation that displays the profit or loss for operations during the time period covered by the statement.
- Revenue/Sales. Sales Revenue is the company's revenue from sales or services, displayed at the very top of the statement. ...
- Gross Profit. ...
- General and Administrative (G&A) Expenses. ...
- Depreciation & Amortization Expense. ...
- Interest. ...
- Income Taxes.
- Single-Step Income Statement.
- Multi-Step Income Statement.
- Generate Your Income Statement Using Deskera Books.
The income statement focuses on four key items: sales revenues, expenses, gains and losses. It does not concern itself with cash or non-cash sales, or anything regarding cash flow. Revenue: This includes money generated from normal business operations.Is income statement the same as profit and loss? ›
A business profit and loss statement shows you how much money your business earned and lost within a period of time. There is no difference between income statement and profit and loss. An income statement is often referred to as a P&L.
What are the 3 parts of an income statement? ›
What Are the Four Key Elements of an Income Statement? (1) Revenue, (2) expenses, (3) gains, and (4) losses. An income statement is not a balance sheet or a cash flow statement.