Every business and enterprise owner uses the income statement. It is considered as one of the essential financial statements. Apart from the income statement, the other significant financial statements include cash flow statement, balance sheet, comprehensive income statement, statement of stockholder’s equity. Sometimes income statement is also referred to as profit and loss statement, statement of operations, or statement of income.
The profitability of the company is determined by the income statement; that is why it has gained a lot of importance. The explanation usually shows the profitability for a while, which could be a financial year or a particular period as requested by the company.
Income statement must be submitted to the securities and exchange commission or the fiscal commission of that country. The balance sheet provides only a snapshot of the financials of the company from a particular date to a specific date. On the other hand, the income statements reports the entire income for a particular period, including the duration and the sources of income.
The major components of the income statement are revenue, expenses, losses, and gains. It is not concerned with the money received in the business or the cash payments which are given by the business.
Components of an income statement
The income statement has minor differences throughout the companies. The reason being expenses and incomes will be dependent on different types of operations or the way that business is conducted. However, several other components are generic to all the income statements and are found in every industry.
Following are few of the standard components of an Income Statement:
Sales are the only mode of earning money for the company. This is the reason why it is displayed at the very top of the statement. That is, the value of the sales will be gross of all the costs that are associated with manufacturing the goods or services.
Some companies have multiple revenue generation methods. All of them are added to the total revenue line. The calculation is done for the specific period for which the statement as requested.
2. Cost of goods sold
It is also abbreviated as COGS. It is the item which aggregates all the indirect and direct costs which are associated with selling the produce. This is sometimes referred to as the cost of sales because it is the cost that is required for selling the product in the market.
The components that are included in the price of goods sold include salaries of the employees, labor charges, materials, parts, and other expenses such as depreciation. Transportation and warehousing are also included in COGS because it is an additional cost to the company. Packaging charges, if any, promotional charges for promoting the product in the market can also be included in this head.
3. Gross Profit
The gross profit is the final profit after subtracting the expenses. In the case of the income statement, the gross profit is calculated by subtracting the total sum of costs of goods sold from the total sales revenue.
4. Marketing and promotional expenses
As mentioned above, sometimes marketing and promotional expenses may be included as the cost of goods sold or in some companies, they may be kept separate.
This head includes marketing expenses, advertising expenditure, and other promotional expenses that are required to promote the product or service. Costs which have event expenses, trade fair, or promotional event expenses are all grouped under this category.
5. General Admin expenses
This category includes all the settings, general and administrative department, which contains all the other indirect costs which may be associated with the business.
Salaries and wages of employees, rent of the office, or other expenses related to the office space, travel expenses, insurance of the employees, and the office and sometimes depreciation is also included in general and administrative costs.
It is the abbreviation of earnings before Interest, Tax, Depreciation, and Amortization. It is not present in every income statement, but most of the income statements do include it.
7. Depreciation and amortization expenses
These expenses are classified as non-cash expenses and are created by accountants to spread out the initial cost of assets. These costs include the value of assets, such as equipment, property, and land.
8. Operating Income
Operating income is also known as earnings before interest and tax. It is also abbreviated as EBIT. Operating expenses are the ones that are earned in the company by regular business operations. It can also be termed as profit before non-operating income, interests, non-operating fees, or taxes and is usually subtracted from the revenue.
It is a common term which is used in finance, and it is one of the essential ratios looked by investors and shareholders.
The interest expenses are common to spell it out the interest expense on interest income. They are represented as a separate line income statement. This is usually done to eliminate and reconcile the differences between EBT and EBIT. The debt schedule is generally determined by interest expense.
10. Other expense
There are usually other expenses associated with business and their industry. There are many examples of additional costs that are specific to specific industries like fulfillment, research and development, betterment charges, technology, stock-based compensation, and much more.
Apart from this, there are many losses which may have been because the product may get expired, there could be transportation associated damage of product or any such other expense.
11. EBT (Pre-Tax Income)
Earnings before tax are also known as the income before tax. It can be calculated by subtracting interest from the operating profit. This is the final total which should arrive before arriving at the net income.
12. Income tax
Income tax is the tax that is levied by the government on the income, which is before the tax. That is, the taxes are levied on gross income.
13. Net income
The net income is the one that is calculated by reducing taxes from the gross income. This is the amount that goes back into the earnings on the balance sheet post-reduction of any dividends.
Income Statement Structure
Let us have a look at the following The income statement of Wayne Enterprises Inc.
Sales – $70,000
Other revenues – $20,000
Total revenue – $90,000
Procurement – $5,500
Wages – $1,500
Rent – $750
Interest paid – $250
Utilities – $200
Total expenses – $8,400
Income from the sale of old equipment – $5,000
Consumer lawsuit – $10,000
(Revenue + Gains) – (Expenses + Losses)
(90,000 + 5,000) – (8,400 + 10,000)
95,000 – 18,400
Therefore, the net income of Wayne Enterprises Inc is $76,600
Formats of Income Statement
There are two popular types of forms for Income statement:
1. Single Step Income Statement
One of the popular methods of formats representing profit and loss. It uses only one step of subtraction to arrive at the net income. In the example above, we have used the single-step income statement.
Net income = ( Revenues + Gains ) – (Expenses + Losses)
In a single-step income statement, the name of the company appears at the top, followed by the term income statement. The next line Reveals various sources of income; then, expenses are presented that are supported by Gains and losses.
The final step shows the formula for arriving at Net Income.
2. Multiple Step Income Statement
There is an alternative method to arrive at the final income, which is called a multiple-step income statement. It uses various steps of subtraction to arrive at the net income, which is shown at the bottom line.
The multiple-step separates the operating revenues and operating expenses in the statement from the non-operating expenses like gains and losses and non-operating taxes. The gross profit is also shown in the multiple-step income statement, which is calculated by reducing the cost of goods sold minus the net sales.
Unlike Single-step income statement, In case of multiple steps income statement, the calculation is done after every segment of entries are calculated.
Gross profit is calculated immediately after Sales by reducing the Cost of Goods sold.
Total operating expenses are calculated after reducing all the selling expenses, administrative expenses, etc.
There are primarily three advantages of using a multiple-step income statement, which is as follows:
- The gross profit amount is clearly stated in the multiple-step income statement, unlike the single-step income statement. Many financial statement reader companies look after the gross margin, which is the gross profit as a percentage of net sales. These business leaders often compare the gross margin of a company to its past gross margins and also to the industrial standards of gross margin.
- The subtotal of operating income is presented by the multiplicity of an income statement, which is an indication of the total profit earned from the primary activities of the company like buying and selling the merchandise.
- The final bottom line of the multiple-step income statement shows the net amount for all individual items on the income statement. If the net amount is definite, then it is referred to as net income. And if the net amount is negative, then it is called as a net loss.
Reading standard income statements
The standard format of the income statement focuses on the calculation of profit or income at each subhead of revenue. It also calculates the operating expenses and then reduces the taxes.
All the calculations are simple addition and subtractions; it is essential to have a proper order of entries because reducing a wrong entry from the wrong head can result in a significant error on the statement.
The gross profit for the given period is indicated in the revenue section of the company. It is arrived after reducing the cost of revenue from the total revenue.
operating expenses are the ones that take into consideration the cost of revenue and also the total revenue so that they can arrive at the reported figures. Once the total operating expenses are reduced from the total revenue, it yields the operating income for the organization for a given period. It is often represented as EBIT.
Income from other operations
Income from other expenses adds to the net income like one-time earnings. Apart from these one-time earnings, it can have an interest, which is linked to costs, and other applicable taxes which are used to calculate the net income from other operations.
The earnings per share are calculated by dividing the total income figure with the number of weighted average shares outstanding.
Uses of Income Statement
- One of the primary purposes of the income statement is to depict the profitability and business activities of the company to its stakeholders.
- The income statement also provides a detailed insight into the internals of the company for the sake of comparison. This is useful specifically in businesses which are multiple sectors and different companies.
- Income statements are also prepared more frequently to gain a more in-depth insight by not only shareholders but also the management of the company. They can keep checking for progress throughout various departments for any given period.
- It is based on the income statement that the management decides to expand its operations to increase sales or increase production capacity. Many such primary decisions are taken entirely based on the income statement. Decisions of shutting down the department or ending a business line because of this profitability are also dependent on the income statement. Decisions of shutting non-profitable divisions are also taken based on the Income statement.
- It is useful for gaining insights into the competition and its activities. Many of the strategic decisions are to be declared an income statement that can be monitored by all the companies. This is why the income statement is also useful in gaining insight into competitor activities.
- Another advantage of having an income statement is that the creditors may find it helpful, albeit for some limited activities. Creditors have often preferred the cash flow statement of the company, but they may find a small use for the income statement also.
Research analysts often use an income statement to compare quarter on quarter or year on year performance. Predictions such as, ‘Has the cost of sales helped the company to improve its profits?’ can be made depending on the income statement.