Income Statement
An income statement (sometimes referred to as a profit and loss statement (P&L), statement of operations, or statement of financial performance) is a financial document that summarizes the revenue, expenses, and the resulting net income or loss of a company over a specific period of time. It is history of how a business has done financially in a given accounting period and provides general financial performance insight into a company’s operation.
Purpose
The main purpose of the income statement is to inform stakeholders of a business’s financial performance, its profitability, and net income. The statement can be used to measure and compare the financial performance of a business in relation to prior years, across multiple locations, and to industry benchmarks. Additionally, the statement can be used to analyze business performance, identify trends and calculate key profitability metrics such as gross margin, operating profit margin, and net profit margin.
Components
An income statement consists of three major components:
Revenue: Revenue is the money a company generates by selling goods or services. It also includes non-operating income, such as interest earned or a gain on the sale of an asset.
Expenses: Expense includes the cost of goods sold, operating expenses, such as salaries, overhead, marketing, and research and development, and non-operating expenses, such as interest payments on debt.
Net Income (Loss): The difference between a company’s total revenue and total expenses, also referred to as operating profit, is known as net income (or loss).
Other Items
Income statements sometimes include additional items such as extraordinary items, discontinued operations, and non-recurring items. Extraordinary items are very large and unusual transactions, such as natural disasters, legal judgments, or the sale of a subsidiary. Discontinued operations refer to the segment of a business that has been shut down or sold and no longer exists. Non-recurring items are events that are outside of the normal course of a company’s operations and are not expected to happen again, such as a restructuring event.
Real-World Example
A real-world example of an income statement would be a publicly traded company that files its statement of financial performance with the Securities and Exchange Commission (SEC). The statement will include the company’s revenues, expenses, and net income (or loss) for the given period of time. This particular type of income statement is highly scrutinized by the public and must adhere to generally accepted accounting principles (GAAP).
Analyzing Income Statements
Income statements are typically used for comparative analysis, which requires the use of ratios to measure and compare financial performance over time. A few important ratios to look for include gross margin, operating profit margin, and net profit margin.
Gross margin is calculated by dividing gross profit by total revenue. Gross profit is the revenue earned minus the cost of goods sold. This ratio measures the profitability of a company’s products.
Operating profit margin is calculated by dividing operating profit by total revenue. Operating profit is the gross profit minus operating expenses. This ratio measures how efficient a company is at controlling its operating expenses.
Net profit margin is calculated by dividing net income by total revenue. This ratio measures a company’s ability to turn revenue into profit after all expenses have been accounted for. It reflects the company’s overall profitability.
Conclusion
The main purpose of an income statement is to provide financial performance insight into a company. It provides stakeholders with the information necessary to analyze a company’s financial performance, compare it to prior years or industry benchmarks, and calculate key profitability metrics, such as gross margin, operating profit margin, and net profit margin. When using an income statement for comparative analysis, companies and financial managers should pay attention to the additional items that may or may not be included.