An income statement reveals a company’s revenues and expenses over a given period. Sometimes it’s also called an earnings statement or a profit-and-loss (P&L) statement. It shows the revenue generated from selling products and services. It shows how much you spend to generate revenue.
While the primary purpose of an income statement is to communicate details about profitability and business activities to stakeholders, it also provides detailed insights into the company’s internals which can use for comparison across sectors and businesses. These statements may be prepared at the division- and segment levels. It allows them to monitor the progress of different operations throughout the year. Can still be provided Interim reports to the company.
Management can use income statements to help them make decisions about expanding their reach into new regions, increasing sales, increasing production, decreasing costs, or closing down an area or product line. You may also find information from competitors about your success and areas to focus on, such as R&D expenditures.
Because creditors are more concerned about the future cash flows of a company than past profitability, they may limit their use of income statements. For comparison purposes, research analysts use the income statements to assess year-over-year and quarter-over-quarter performance. One can determine whether a company’s attempts to lower the cost of sales resulted in higher profits over time. Or whether the management was capable of keeping a close eye on operating costs without compromising on profitability.
3 Main components of income statement Revenues, expenses, and profit
Net Income = (Revenue + Gains) – (Expenses + Losses)
The income statement consists of three main components. Each one is explained below.
Revenues. It is often the most basic section of the income statements. It is common to have a single number that indicates all the Money a company earned over a certain period. However, large companies might break down revenue to give more information (e.g., segregated by geographical location or business segment).
Operating revenue refers to revenue earned through primary activities. In a company that manufactures a product or is a wholesaler or distributor of that product, revenue from primary activity refers to the revenue earned from the sale of that product. In the same way, revenue from the primary activities refers only to revenue or fees earned for offering services.
Nonoperating, recurring revenues are revenue that is generated through secondary activities. These are earnings that are not related or tied to the purchase and sale of goods and services.
Expenses. Though there are many types, the two most popular are the cost for sales and SG&A (selling general and administrative) expenses. Cost of sales (also known as cost for goods sold) is the most direct expense to create revenue. Gap GPS, for example, may charge $10 to make a shirt that sells at $15. If the shirt is sold, its cost would be $10 – the price Gap paid to produce it. Operating expenses can also be referred to as general, administrative, and selling expenses. This category also includes most other costs involved in running a company, including marketing, management salaries, technology expenses, and administration.
Primary Activity Charges
All expenses are required to generate normal operating revenue. They include the cost of goods sold (COGS), general and administrative expenses, SG&A, depreciation/ amortization, research and development expenses (R & R&D), and all other expenses incurred to earn average operating revenue. This list typically includes employee wages, sales commissions, and costs for utilities such as electricity, transportation, and other items.
Secondary Activity Fees
All expenses connected to noncore activities, such as interest paid for loan Money.
Losses as Expenses
All expenses related to a loss-making transaction of a long-term asset, including one-time or other unusual costs or expenses for lawsuits.
While primary revenue, expenses, and other information can give insight into how well the company’s core business is doing, secondary revenue, expenses, and expertise account for the company’s involvement and expertise in managing noncore, ad-hoc operations. In contrast to the income earned from the sale and purchase of manufactured products, a substantial amount of interest income from Money held in the bank is indicative that the business may not be using its available cash effectively. It could also indicate that it faces challenges in expanding its market share or overcoming competition. If the management uses the existing resources and assets to generate additional profits, it will likely earn recurring rental income by having billboards placed at the factory.
Profits. The simplest definition of profit is the sum of total revenues and total expenses. There are a few profit subcategories investors should be familiar with. Gross profit can be defined as the difference in revenues and sales. It simply shows how much Money remains after a sale has been made to pay for operating expenses (and possibly profit to stockholders). If we take the Gap shirt as an example, the gross profit after the shirt sale would be $5 ($15 sales price x $10 cost of selling = $5 gross profits). Operating profit equals revenues minus costs of sales and SG&A. This figure represents the profit that a company made in its actual operations. It excludes certain expenses, revenues, and other costs that may not be directly related to its core operations. Net income usually refers to the company’s profit after all expenses have been paid, including financial expenses. This number is sometimes called the “bottom line” or the “bottom line,” and it is what people refer to when using the words “profit” and “earnings.”
However, real-world firms often operate globally, have multiple business segments that offer a range of products and services, and are involved in mergers, purchases, and strategic alliances. The many operations and diversified expenses can cause the complexity of accounting entries for the income statement.
The Multiple Step Income Statement is the standard for listed companies. This segregates operating revenues, operating expenditures, and gains from nonoperating revenues, nonoperating expenses, or losses. Additionally, the income statement provides many details. The four levels of profitability reported in a multiple-step income statement are: gross, operating (pretax), pretax and post-tax. This separation allows you to see how income and profitability move/change from one level or another. For example, a high gross profit with a lower operating income means higher expenses. A higher pretax profit and lower after-tax profit indicate a loss of earnings to taxes or other unusual expenses.
An Income Statement can give valuable insight into many aspects of a business. It includes the company’s operations, the efficiency of its management, potential leaky areas which could be eroding profits, and whether the company performs in line with peers in the sector.