An income statement tends to come in handy for a company’s management in more ways than one. To begin with, it helps business owners to estimate the profitability of their current business ventures. Furthermore, it proves useful in running business operations smoothly.
What is an Income Statement?
Typically, it is one of the three major financial statements besides the cash flow statement and the balance sheet. All publicly owned companies must prepare and publish this particular financial statement as a part of their firm’s annual reports.
An income statement of a company is also known as the statement of revenue and expense or the profit and loss statement. The said statement mainly focuses on the total revenue and expenses of a firm during an accounting period. Consequently, it helps to report a firm’s overall financial performance within a given accounting period.
Notably, revenue is given by the summation of the income generated from a firm’s operating and non-operating activities. Nonetheless, revenues are not receivables and are earned and reported on a firm’s income statement. On the other hand, total expenses make up the cost incurred in due course of said firm’s primary and secondary activities.
To further understand the income statement meaning, it is crucial to learn about its different components.
Components of Income Statement
Depending on the type of business and nature of operations, the components of an income statement may vary.
Nonetheless, the most common elements of the income statement include –
- Revenue or sales
Essentially, it is the revenue earned by a firm through sales or services. It is usually recorded at the top of the statement and serves as the gross expense involved in the manufacture of the goods sold or while providing services. It must be noted that some firms tend to have multiple revenue streams, which directly adds to the total revenue.
- Cost of goods sold
It can be defined as the direct costs involved with the sale of products to generate earnings or revenue. Cost of goods sold is known as the cost of sales if the firm is service-oriented. Typically, direct costs include – labour, raw materials, expense allocation, etc.
- Gross profit
A firm’s gross profit is computed by subtracting the cost of goods sold from sales revenue.
- Marketing, advertising and promotion expenses
Cost of marketing, advertising and promotion are related to selling and are reported on the income statement together. It is because expenses of selling goods which are similar are often grouped together.
- General and administrative expenses or SG&A expenses
These expenses include all indirect costs involved with running a business like – wages, salaries, office expenses, rent, insurance, depreciation and amortisation, etc. Some firm owners may decide to treat depreciation and amortisation separately under a different section.
- Depreciation and amortisation expense
Both depreciation and amortisation can be categorised as non-cash expenses. Typically, they are created by accountants to help distribute the cost of capital assets like Property, Plant and Equipment.
- EBIT or operating income
Earnings before interest and taxes or EBIT signifies the income earned through a regular business venture.
Earnings before Interest, Tax, Depreciation, and Amortisation or EBITDA may not be recorded in all income statements. Usually, the EBITDA of a firm is computed by subtracting the selling, general and administrative expenses exclusive of amortisation and depreciation from its gross profit.
- Interest Expense
Generally, companies tend to split-interest income and interest expense and record the same in the income statement separately. It is mostly done to account for the difference between earnings before tax and EBIT. Interest expense of a firm is ascertained by the debt schedule and is reported in the income statement accordingly.
- Pre-tax income
Pre-tax income or earnings before tax are ascertained by simply subtracting interest expense from a firm’s operating income. Notably, it is the final total before achieving the net income of the company.
- Income taxes
It makes up the relevant taxes charged on the pre-income. The total tax expenses often comprise both the current as well as the future tax liabilities.
- Net income
In simple words, a firm’s net income is computed by subtracting income taxes from its pre-tax earnings. It makes up the retained earnings reported on a firm’s balance sheet once deductions for dividends are made. Net earnings income statement formula is expressed as –
Net income = (Total Revenue + Gains) – (Total Expenses + Losses)
- Other expenses
This component often includes expenses which are unique to specific industries or ventures. Some of the most common ones include – technology, fulfilment, stock-based compensation, research and development, foreign exchange impacts, proceeds from the sale of investments, etc.
A quick look at a company’s income statement comes in handy for those who intend to avail a more precise understanding of the financial statement’s structure in general.
Income Statement Structure
This excerpt below is taken from the financial statement of Hindustan Unilever Limited as on 30th March 2019. It will not only serve as a suitable income statement example but will also provide us with a fair idea about the ideal structure.
|Cost of revenue||18,47,40,000|
|Selling, general and administrative expenses||6,20,60,000|
|Total operating expenses||12,19,20,000|
|Operating income or loss||8,31,50,000|
|Income before tax||8,60,40,000|
|Income tax expenses||2,54,40,000|
|Income from operations||6,06,00,000|
Significance of Income Statement
A company’s income statement is used extensively in corporate finance, financial modelling and accounting. It provides a coherent report of all revenue earned and expenses incurred by a company within a specific period.
These pointers below highlight the significance of income statement accounts.
- It serves as a predecessor to both cash flow and balance sheet.
- It helps shareholders gain a useful idea about a firm’s operational efficiency and management.
- The statement further comes in handy for financial analysts and investors and helps them identify under-performing sectors and poor performing companies in a given industry.
- An income statement offers a detailed account of how a firm’s net revenue is accrued and in turn, gets converted into net earnings.
- Helps to classify revenue and expense better and allows firm owners to review their financial standing and business operations at regular intervals.
Nonetheless, the income statement also has its share of limitations. For instance, the net income computed with the help of this financial report is not always accurate. It is mostly because several accounting treatments are based on mere assumptions and estimates. Consequently, business owners, financial analysts and investors must factor in the pros and cons of an income statement to ascertain accurate financial reports.