What is an income statement?

An income statement summarizes a company’s revenue, costs and expenses over a specified period, typically by fiscal quarter or by year. The income statement shows how a business’s revenue is turned into net income by subtracting all expenses from income. 

The income statement provides stakeholders, investors, and decision-makers information about a company’s ability to generate profit by increasing revenue or reducing costs. It can contain information related to sales revenue, cost of goods sold (COGS), selling, general and administrative (SG&A) expenses, interest, taxes, and net income.

The income statement goes by many names. You’ll hear it referred to as a profit and loss statement, P&L, statement of operations, statement of financial results, statement of income, or earnings statement.

Why is an income statement prepared and why is it important?

The income statement is important because it clearly states whether a company is making a profit or showing a loss over a reporting period. This information is useful for investors who are using profitability as a gauge or indicators of decline when making investment decisions. Management looks to the income statement to assess performance and identify areas that need improvement. Both investors and management turn to the income statement for a lens on consistent profitability, improved margins and higher EPS (earnings per share). The income statement also becomes useful when consecutive income statements are grouped and reviewed over time. An example of this would be comparing quarterly P&L from year-to-year. Emerging patterns of revenue and expenses reveal themselves over the long term. 

What are the main components of an income statement?

Here is an example of the sections of a typical multi-step income statement. Note that the income statement can vary based on the industry in which a company operates.

Section One: Gross Revenue/Net Revenue
This section represents your gross revenue or net revenue. This figure represents your total sales for the period by revenue type. This line could also be known as Net Revenue/Sales, which takes into account sales returns, allowances and discounts.

Section Two: Cost of Goods Sold (COGS)
Since there are many items that comprise of COGS, many companies prepare a COGS statement internally. The COGS calculation is opening inventory plus purchases for the period, less closing inventory.

Section Three: Gross Margin (Gross Profit)
Gross margin (or gross profit) is calculated by subtracting COGS from gross/net revenue. The result is the gross profit earned on your products and services sold.

Section Four: Total or Operating Expenses
In this section, you’ll list all your operating expenses. You can divide your expenses into selling expenses (i.e., advertising costs, sales wages and commissions) and administration expenses ( i.e., rent, utilities, administration salaries and benefits). You can also use this section to include depreciation expenses. Some companies prefer to show depreciation in its own separate section.

Section Five: Operating Profit/Loss
To calculate your operating profit, subtract selling and administration and depreciation expenses from the gross margin/gross profit. Operating profit is also known as EBIT, which means earnings before interest and taxes. You can also have an operating loss, if your expenses exceed your gross profit.

Section Six: Interest Expenses
In section six, you have to add your company’s interest expense — the interest you pay on debts. In this section, you can also include other non-operating expenses — such as gain on sale of investments. In this case, you would call this section “non-operating revenue and expenses.”

Section 7: Earnings Before Taxes
This section requires you to subtract your interest expenses from your EBIT, resulting in your pre-tax income, known as EBT (earnings before taxes).

Section 8: Income Taxes
To calculate taxes in very simple terms, you multiply the appropriate tax rate by your income. However, in most cases calculation of corporate income taxes is a complicated process, as you need to take into account many factors like tax write-offs, tax credits, and provisions as well as various tax structures.

Section 9: Net Income
Subtract your income taxes to come up with net income or net loss.

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